[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
OVERVIEW OF THE TAX-EXEMPT SECTOR
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
APRIL 20, 2005
__________
Serial No. 109-6
__________
Printed for the use of the Committee on Ways and Means
_____
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
ROB PORTMAN, Ohio WILLIAM J. JEFFERSON, Louisiana
PHIL ENGLISH, Pennsylvania JOHN S. TANNER, Tennessee
J.D. HAYWORTH, Arizona XAVIER BECERRA, California
JERRY WELLER, Illinois LLOYD DOGGETT, Texas
KENNY C. HULSHOF, Missouri EARL POMEROY, North Dakota
SCOTT MCINNIS, Colorado STEPHANIE TUBBS JONES, Ohio
RON LEWIS, Kentucky MIKE THOMPSON, California
MARK FOLEY, Florida JOHN B. LARSON, Connecticut
KEVIN BRADY, Texas RAHM EMANUEL, Illinois
THOMAS M. REYNOLDS, New York
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
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unintentional errors or omissions. Such occurrences are inherent in the
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C O N T E N T S
__________
Page
Advisory of April 13, 2005 announcing the hearing................ 2
WITNESS
U.S. government Accountability Office, Hon. David M. Walker,
Comptroller General............................................ 6
Joint Committee on Taxation, George Yin, Chief of Staff.......... 39
Congressional Budget Office, Douglas Holtz-Eakin, Ph.D., Director 50
University of Illinois College of Law, Urbana-Champaign,
Illinois, John Colombo......................................... 57
University of Miami School of Law, Miami, Florida, Frances R.
Hill........................................................... 61
Morgan, Lewis and Bockius, and Commissioner, Internal Revenue
Service, 1965-1969, Hon. Sheldon S. Cohen...................... 69
Polsinelli Shalton Welte Suelthaus, P.C., Kansas City, Missouri,
Bruce Hopkins.................................................. 75
SUBMISSIONS FOR THE RECORD
America's Community Bankers, Ike Jones, statement................ 111
American Association of Debt Management Organizations, Mark
Guimond, statement............................................. 116
American Bankers Association, Floyd Stoner, statement............ 127
American Society of Association Executives, John H. Graham IV,
statement...................................................... 133
Association of Fundraising Professionals Greater Cleveland
Chapter, Cleveland, OH, Deborah S. Miller, letter.............. 136
Association of Independent Consumer Credit Counseling Agencies,
Poinciana, FL, David Charles Jones, statement.................. 137
Berns, Peter V., Standards for Excellence Institute, Baltimore,
MD, letter..................................................... 166
Castle, James R., Ohio Hospital Association, Columbus, OH, letter 161
Cates-Ortega, Tina J., Read ``Write'' Adult Literacy Program,
Moriarty, NM, joint letter..................................... 163
Central Arkansas Area Agency on Aging, Inc., North Little Rock,
AR, Ann C. Leek, letter........................................ 140
Cohen, Rick, National Committee for Responsive Philanthropy,
statement...................................................... 151
Credit Union National Association, Gary Kohn, statement.......... 141
Droegemueller, Heidi Ann, Phoenix Children's Hospital, Phoenix,
AZ, letter..................................................... 162
Fair Housing Center, Toledo, OH, Michael Peter Marsh, letter..... 145
Fortney, Mary Martha, National Association of State Credit Union
Supervisors, Arlington, VA, statement.......................... 150
Graham IV, John H., American Society of Association Executives,
statement...................................................... 133
Guimond, Mark, American Association of Debt Management
Organizations, statement....................................... 116
Hayes, David, Independent Community Bankers of America, statement 124
Hazen, Paul, National Cooperative Business Association, statement 158
Hilinski, Keith, San Diego County Veterinary Medical Association,
San Diego, CA, letter.......................................... 165
.................................................................
Independent Community Bankers of America, David Hayes, statement. 124
International Community Foundation, San Diego, CA, Richard Kiy,
letter......................................................... 146
International Health, Racquet and Sportsclub Association, Boston,
MA, John McCarthy, letter...................................... 146
Jones, David Charles, Association of Independent Consumer Credit
Counseling Agencies, Poinciana, FL, statement.................. 137
Jones, Ike, America's Community Bankers, statement............... 111
Kiy, Richard, International Community Foundation, San Diego, CA,
letter and attachment.......................................... 146
Kohn, Gary, Credit Union National Association, statement and
attachment..................................................... 141
Krehely, Jeff, National Committee for Responsive Philanthropy,
statement...................................................... 151
Leek, Ann C., Central Arkansas Area Agency on Aging, Inc., North
Little Rock, AR, letter and attachment......................... 140
Levy, Barbara R., Tucson, AZ, statement.......................... 147
Maehara, Paulette, The Association of Fundraising Professionals,
Alexandria, VA, letter......................................... 134
Marsh, Michael Peter, Fair Housing Center, Toledo, OH, letter.... 145
McCarthy, John, International Health, Racquet and Sportsclub
Association, Boston, MA, letter................................ 146
Miller, Betty, Read ``Write'' Adult Literacy Program, Moriarty,
NM, joint letter............................................... 163
Miller, Deborah S., Association of Fundraising Professionals
Greater Cleveland Chapter, Cleveland, OH, letter............... 136
National Association of Federal Credit Unions, Arlington, VA,
Brad Thaler, statement......................................... 148
National Association of State Credit Union Supervisors,
Arlington, VA, Mary Martha Fortney, letter..................... 150
National Committee for Responsive Philanthropy, Rick Cohen, Jeff
Krehely, joint statement....................................... 151
National Cooperative Business Association, Paul Hazen, statement. 158
Ohio Hospital Association, Columbus, OH, James R. Castle, letter. 161
Phoenix Children's Hospital, Phoenix, AZ, Heidi Ann
Droegemueller, letter.......................................... 162
Read ``Write'' Adult Literacy Program, Moriarty, NM, Tina J.
Cates-Ortega, Betty Miller, joint letter....................... 163
Rose, Steven M., Walpole, MA, letter............................. 164
San Diego County Veterinary Medical Association, San Diego, CA,
Keith Hilinski, letter......................................... 165
Standards for Excellence Institute, Baltimore, MD, Peter V.
Berns, letter.................................................. 166
Stoner, Floyd, American Bankers Association, statement........... 127
Thaler, Brad, National Association of Federal Credit Unions,
Arlington, VA, statement....................................... 148
OVERVIEW OF THE TAX-EXEMPT SECTOR
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WEDNESDAY, APRIL 20, 2005
U.S. House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:40 a.m., in
Room 1100, Longworth House Office Building, Hon. William M.
Thomas (Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
April 13, 2005
No. FC-7
Thomas Announces Hearing on an
Overview of the Tax-Exempt Sector
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing
titled ``An Overview of the Tax-Exempt Sector.'' The hearing will take
place on Wednesday, April 20, 2005, in the main Committee hearing room,
1100 Longworth House Office Building, beginning at 10:30 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. Invited
witnesses will include Honorable David Walker of the U.S. Government
Accountability Office, Douglas Holtz-Eakin of the Congressional Budget
Office, George Yin of the Joint Committee on Taxation, and several
legal experts. However, any individual or organization not scheduled
for an oral appearance may submit a written statement for consideration
by the Committee and for inclusion in the printed record of the
hearing.
BACKGROUND:
According to the Internal Revenue Service (IRS), there are over 1.8
million tax-exempt organizations under Sec. 501(c), not including
churches and religious organizations. Between 1998 and 2002, the assets
of tax-exempt organizations grew from $2 trillion to more than $3
trillion.
Congress first defined the exemption for charitable organizations
and allowed the first deductions for charitable contributions
approximately 100 years ago. Over time, Congress has vastly expanded
eligibility to include a wide array of entities. Since 1954, there have
been some 35 changes made to Sec. 501(c). There are now 28 tax-exempt
categories under Sec. 501(c) covering organizations ranging from public
charities and religious organizations to labor unions, trade
associations, social clubs, fraternal societies, credit unions,
cemetery companies and cooperatives.
In announcing the hearing, Chairman Thomas stated, ``This continues
the series of hearings we held last year examining the tax-exempt
sector. Congress needs a better understanding of how vast and diverse
this sector is today. Tax-exemption is an important benefit and the
Congress has a responsibility to oversee and assure the American
taxpayer that the tax-exempt sector is living up to its legal
responsibilities.''
FOCUS OF THE HEARING:
The hearing will examine the legal history of the tax-exempt
sector; its size, scope and impact on the economy; the need for
congressional oversight; IRS oversight of the sector; and what the IRS
is doing to improve compliance with the law.
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Chairman THOMAS. Good morning. This is the Committee's
second in a series of hearings on the tax-exempt sector. Last
year, the Oversight Subcommittee in a narrow, purposeful
hearing focused on the hospital pricing system and its
relationship to tax-exempt status, but that focus was primarily
on hospitals and their pricing system given profit and not-for-
profit in the hospital area. Today's hearing really is the
fundamental hearing to provide a broad overview of the tax-
exempt sector. Our government witnesses will provide
information about the laws governing tax-exempt organizations,
how they are administered, and their economic effects. We have
an exceptionally qualified panel of legal experts who will
discuss how a patchwork of laws has evolved, leading one of our
witnesses to describe it as disparate, irregular, unbalanced,
and uneven. The tax-exempt sector has grown significantly since
its creation more than 100 years ago. A growth in any area
isn't in and of itself bad, but revenue reported by tax-exempt
organizations has grown from about $3 billion in 1975 to $1.2
trillion in 2001, according to the Joint Committee on Taxation.
In 2001, this amount represented 12.2 percent of the gross
domestic product. According to the government Accountability
Office, the tax-exempt sector employs at least 9 percent of the
civilian workforce.
Despite the significant size, scope, and economic impact of
tax-exempt organizations, there has been no comprehensive
oversight by Congress in nearly two decades, and I hesitate to
call what occurred two decades ago a comprehensive oversight
because I was on the Committee and the Subcommittee. The
Committee conducted examinations in hearings on the question of
business activities of tax-exempt organizations and whether
they should be subject to an Unrelated Business Income Tax.
Many charitable organizations provide critical social services
to those in need. These organizations benefit greatly from
their legal status because they do not pay taxes and because
donors can deduct contributions they make to charitable
organizations. However, many goods and services provided by
tax-exempt organizations are similar, if not identical, to
goods and services provided by tax-paying entities. This raises
a fairly fundamental question of what makes these organizations
unique and, hence, deserving of a tax-exempt status. It is also
worth comparing Congressional interest in tax-exempt
organizations to its interest of traditional for-profit
corporations. When reports of abuse in the corporate world
emerged, there was a swift and comprehensive response. Tax-
exempt organizations should not be immune from similar
scrutiny. The Senate Finance Committee recently held a hearing
in which they reviewed abuses in the tax-exempt sector and
discussed potential reforms. Our hearing is not intended and
will not duplicate their work by examining specific proposals.
Instead, it establishes a foundation from which Members can
systematically begin to examine the tax-exempt sector and
determine what remedies, if any, are needed to provide greater
clarity, transparency, and enforcement. Now I recognize the
gentleman from New York, Mr. Rangel, for any comments he may
wish to make.
Mr. RANGEL. Thank you, Mr. Chairman. I am glad that you
shared with me the reason for this hearing. I think the subject
matter is very important, especially in view of the explosion
of the number of not-for-profits and the amounts of moneys that
are involved. I can't for the life of me see how this panel, as
distinguished as they are, can help me to deal with some of the
problems that it appears as though we are having from
organizations, from the Heritage Foundation to the audit of the
National Association for the Advancement of Colored People.
These are real problems as to whether or not lobbyists are
laundering money into these not-for-profits with trips for
Members of Congress. There are a lot of things that I would
have hoped that the Internal Revenue Service, who has oversight
jurisdiction, might help and guide the Congress, but as you
indicated, this is going to be an overview of the history of
not-for-profits and people who don't pay taxes, so I would hope
that some wealthy people would be included, because they don't
pay taxes, either, and I don't know what contribution they are
making. At a time where there are severe cutbacks in Federal
programs and more and more of the majority are saying that
people should rely on charitable organizations, I would hope
that the testimony we hear today is how we can more effectively
support these organizations that tend to provide services for
the lower-income people and the poor people that the for-
profits don't have as a priority. May I ask the Chair, do you
intend to do oversight of religious organizations, as well?
Chairman THOMAS. I will tell the gentleman that one of the
questions that I would begin with is do these people have a
constitutional right to tax-exempt status. The answer is for
most of them in the area that we are looking at, no. Pretty
obviously, religion has another location in the Constitution
which gives them a position different than most of these other
organizations. That obviously is the First amendment.
Mr. RANGEL. Would not the Internal Revenue Service
determine what is a religious organization?
Chairman THOMAS. I will tell the gentleman that is
eventually something that could be looked at, because as is
commonly known, a number of churches have activities which
border on--that don't border on, they are in competition with
tax-paying entities. This has been examined in the past. It is,
I think, worthy of an examination. The problem is, until you
understand the abject failure of Congress to provide adequate
statutory direction and oversight of IRS and other agencies is
to not understand how we reached the point that the gentleman
indicated in his opening statement was of concern to him. Once
we establish and understand that, we can then go in and examine
various areas. Without this initial understanding of how little
has been done in the past and how much needs to be done to
create a structure and definitions and transparency, we either
go into the knot with a sword and cut it or we learn how to
untie it, and the Chair believes that learning how to untie it
is the way we ought to go and that is what we are going to
begin.
Mr. RANGEL. So, they----
Chairman THOMAS. This will be ``Un-Knot-Tying 101.''
Mr. RANGEL. They will share with us how a religious
organization, what do you have to do to be entitled to be
considered a religious organization, since they are giving this
broad background, because we have a whole lot of groups out
there that call themselves religious and they are nuts, but we
will see where we go with this.
Chairman THOMAS. I tell the gentleman that is exactly the
problem, because there are people who call themselves
charitable. There are people who call themselves--so
terminology----
Mr. RANGEL. --religious organizations. I just wanted to----
Chairman THOMAS. Eventually, we will.
Mr. RANGEL. This panel is broad, so they will, too.
Chairman THOMAS. This panel could briefly touch on that. In
fact, if the gentleman has, and I know he has, looked at the
written testimony, there are offerings of definitions for what
should be allowed under this section, which certainly would
circumscribe today's activities. Frankly, regulations issued by
the IRS have caused additional groups to be qualified as
nonprofits when there is no direct relationship in the law that
allows them. That is part of the problem.
Mr. RANGEL. IRS is not here----
Chairman THOMAS. No, no.
Mr. RANGEL. This group is. I just hope they venture and
give me some guidelines as to what should be a religious
organization's exemptions, Islamic and Muslims and other groups
and communities should be given tax exemption.
Chairman THOMAS. The gentleman will have ample time to ask
the IRS why they have done what they have done in the past.
Without an understanding and structure of what has occurred in
the past, it probably would be not as worthwhile an exchange.
As we look at the theory and practice of tax-exemption and you
begin to get a structure which you believe is appropriate, we
can then examine past behavior, and the Chair believes most of
the Members of the Committee will be quite surprised at the
failure of Congress to exercise its legitimate oversight
function in this area. The problem is, without the structure,
it is difficult to oversee.
Mr. RANGEL. I thank the Chairman for his generosity, but
could I ask, is the IRS in the house? Okay. Thank you.
Chairman THOMAS. That doesn't mean they aren't in the
house.
Mr. RANGEL. Well, they can't speak up.
Chairman THOMAS. That just means they don't want to be
identified.
[Laughter.]
Mr. RANGEL. Officially, they are not here.
Chairman THOMAS. No, because we aren't going to go into
that level of detail. The Chair hopes--in fact, this hearing is
for the purpose of a broad outline of the concept, the theory,
and the practice of charity and tax exemption.
Mr. RANGEL. Let the games begin.
[Laughter.]
Chairman THOMAS. First at bat----
[Laughter.]
Chairman THOMAS. Welcome back, David Walker, the
Comptroller General of the U.S. GAO. Thank you. As I will
indicate to all the witnesses, the written testimony that you
have in front of you will be made a part of the record and you
may address this Committee as you see fit in an appropriate
period of time. The Chair wants to underscore, I have no
interest in limiting the panel members to a narrow, confined 5
minutes. I would hope that they try to sum up their position
and not repeat what others have said to try to create a broad,
immediate record in front of the Members as we begin this
investigation. Mr. Walker?
[The opening statement of Mr. Larson follows:]
STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL, U.S.
GOVERNMENT ACCOUNTABILITY OFFICE; ACCOMPANIED BY MIKE BROSTEK,
U.S. GOVERNMENT ACCOUNTABILITY OFFICE
Mr. WALKER. Thank you, Chairman Thomas, Ranking Member
Rangel, other Members of the Ways and Means Committee. It is a
pleasure to be back before you today to speak about the tax-
exempt sector and related oversight activities. As many of you
know, under section 501(c) of the Internal Revenue Code, it
covers a diverse number of entities currently estimated to be
in excess of 1.5 million entities, varying in size and purpose.
Before addressing the topics that the Committee asked, I think
it is important to note that in many ways, this sector is
indicative of the need for a fundamental review and
reassessment of the entire Federal Government that is mentioned
in the document that I mentioned before this Committee before
called ``Reexamining the Base of the Federal Government,'' the
21st century Challenges booklet, because what has happened is
over many decades, there has been a layering and layering of
new tax-exempt entities, new different types of requirements, a
significant change in the nature and composition of the tax-
exempt portion of the economy, and there is a need to step back
and engage in a fundamental review and reexamination of this
sector, just as there is in connection with many others. In
that regard, I would respectfully commend to each of the
Members some of the key questions that are noted on page two of
my testimony as an example of some of the broader type of
questions that ultimately, hopefully, the Congress will get
into at some point down the road with regard to this sector.
Specifically, the Chair has asked that I briefly address
the growth of the tax-exempt sector, certain governance
practices and transparency mechanisms, related IRS oversight
activities, and then what are some issues that the States are
involved in. You have the typical very thick GAO testimony that
has been provided. I will give you an executive summary. With
regard to the size, it is estimated that there are currently
over 1.5 million tax-exempt entities and that the reported
assets, revenues, and expenses for these entities have grown
significantly over the years. For example, between 1998 and
2002, which is the most recent year that we have data
available, the reported assets grew by 15 percent to over $2.5
trillion. Accordingly, the tax-exempt sector represents an
increasingly significant part of the Nation's economy and work
force, and as the Chairman mentioned, 11 to 12 percent of the
economy. With regard to work force, if I can show the first
slide, which is on page ten of my testimony, you will see that
the tax-exempt sector as of the year 2002 was estimated to
employ about 9 percent of the civilian work force. So, not only
with regard to the size of the economy, but also the size of
the work force.
Clearly, good governance and transparency mechanisms are
essential elements to assure that tax-exempt entities operate
with integrity and effectiveness and to prevent potential
abuse. All of us are aware of recent concerns about certain
abuses in the tax-exempt sector and, therefore, renewed
attention to good governance practices and to enhancing
transparency and improving oversight is called for. At the same
time, I think we all can recognize a vast majority of these
entities and the individuals who comprise them try to do their
jobs in accordance with laws and to the best of their ability
every day. With regard to staffing trends, you will see that
based upon this first slide, that there has been a decline in
the overall exam rate within the IRS, but that actually, while
the overall exam rate has started to increase, the increase
started earlier in the tax-exempt sector than it did overall.
Yet, the tax-exempt exam rate is still far below average, and
as one might expect, far below for-profit entities.
In addition to that, you will see that for fiscal year
2005, the number of full-time equivalents, or employees, who
are being assigned to the examination process in the tax-exempt
area is increasing for the first time in the last several
years. So, there is a marked increase in 2005. Furthermore, you
will note that the number of ``no changes'' that result in
exams as a review of the Form 990, which is the annual report
that these tax-exempt entities have to file, has declined.
Stated differently, the number of changes has increased in the
last year, as can be demonstrated by this particular graphic.
With regard to activities by the States, in addition to the
Internal Revenue Service focusing on this sector to the extent
of its ability, the information that it has and the resources
that have been allocated to it, the States also often oversee
tax-exempt entities, frequently focusing on trying to protect
the public from fraudulent activities and guarding against
misuse of charitable assets. The States and the IRS believe
that it would be in the public interest to enhance data sharing
between the Internal Revenue Service and the States in order to
be able to share more information on their respective
enforcement activities. GAO has recommended in the past that
steps be taken to increase this data sharing while protecting
certain sensitive information from public disclosure.
In summary, because I am trying to make sure that everybody
else has an opportunity to speak, tax-exempt entities provide
an incredibly diverse set of services to our equally diverse
population. They enrich our lives and improve our country. Yet,
like all organizations, they are run by human beings. As a
result, tax-exempt entities can sometimes engage in
inappropriate and unlawful practices. Ensuring that tax-exempt
entities run as effectively and efficiently as possible and in
line with the purposes of Congress, the reason that they
receive their tax-exemption, can be enhanced through
strengthening sound governance practices; number two, improving
transparency over certain of their operations; and number
three, enhanced oversight by the IRS, the States, as well as
the U.S. Congress. Regarding oversight by the States and IRS,
as I mentioned, additional data sharing would be desirable in
order to target enforcement efforts, minimize necessary
overlap, and enhance the effectiveness of both parties'
respective activities. Ultimately, the Congress is going to
have to decide what activities should benefit from a tax-
exemption and what organizations must do in exchange for this
tax advantage. As I have testified before this Committee
before, it is important to keep in mind that in many years, the
tax preferences under the Internal Revenue Code, the total
value of those tax preferences, including tax exemptions,
exceed total discretionary spending. So, this is a large and
growing part of our economy, a large and growing part of our
work force, and it is important not to let it be off the radar
screen. It is important to relook at this area and reexamine it
in light of 21st century changes and challenges. Periodic
Congressional oversight is, therefore, critical to ensuring
that the tax-exempt sector remains a vibrant contributor to the
quality of life in America, at the same point in time while
operating with integrity and making sure that entities that are
granted tax-favored status, in fact, are serving a public
purpose above and beyond entities that have not been granted
that status, and as we know, there are many sectors of the
economy where you have both not-for-profit and for-profit
entities in the same business, health care and education being
two examples. There should be some meaningful distinction
between those two in order for one to be able to be granted
tax-exempt status and another not. As always, the GAO stands
ready to help the Congress in reviewing this area, in examining
this area, and we look forward to answering any questions you
may have, Mr. Chairman. Thank you.
Chairman THOMAS. Thank you very much, Mr. Walker.
[The prepared statement of Mr. Walker follows:]
Statement of The Honorable David M. Walker, Comptroller General, U.S.
Government Accountability Office
Chairman Thomas and Members of the Committee:
I am pleased to participate in today's hearing about the tax-exempt
sector and oversight of it. The sector recognized under section 501(c)
of the Internal Revenue Code (IRC) covers a diverse group of over 1.5
million entities with varying sizes and exempt purposes (see app. I for
types of section 501(c) exempt entities). The breadth and diversity of
the tax-exempt sector allows it to address the specific needs of many
of our citizens and the general needs of society. The exempt sector,
and those that volunteer to assist, also supplements government
programs to meet various needs. For example, charities can supplement
programs by providing comfort to the aging, health care to the
uninsured, and education to the uneducated.
As the nation's tax administrator, the Internal Revenue Service
(IRS) has a key role in overseeing the tax-exempt sector. Oversight can
help sustain public faith in the sector and ensure that exempt entities
stay true to the purposes that justify their tax exemption. It also can
help protect the entire sector from potential abuses initiated by a
small minority.
Before discussing the work we did for the Committee, I want to
frame today's hearing within a broader context. GAO recently issued a
report entitled, 21st Century Challenges: Reexamining the Base of the
Federal Government.\1\ This report provides examples of a number of key
questions that need to be explored in light of our current and
projected fiscal imbalances as well as other changes and challenges. It
highlights the need for a re-examination of all major federal policies
and programs in light of 21st century realities. Although that report
did not specifically cover the tax-exempt sector, the sector is a
microcosm of the issues raised in the report. While the provisions
granting federally recognized tax-exempt status and associated policies
have been layered upon one another to respond to challenges at the
time, a comprehensive re-examination of the tax-exempt sector has not
been done in recent times. On a broad scale, a comprehensive re-
examination could help address whether exempt entities are providing
services to our citizens commensurate with their favored tax status,
whether the current number and nature of exemptions continue to make
sense, whether restrictions on the activities of tax-exempt entities
remain relevant, and whether the framework for ensuring that exempt
entities adhere to the requirements attendant to their status is
satisfactory.
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\1\ GAO-05-325SP.
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Today's hearing provides an excellent forum to launch such a re-
examination. Some of the more specific issues that may merit re-
examination for the tax-exempt sector include:
Should the criteria for granting exempt status be
reconsidered and do we need as many types of tax-exempt entities?
Do we need to modify the model used in overseeing tax-
exempt entities to ensure that the tax--exempt purpose is met and that
fraud or other misuse is deterred?
What governance standards should apply to the tax-exempt
sector, and should particular types of exempt entities have more
specific standards?
Are the operations and activities of tax-exempt
organizations sufficiently transparent to support oversight by the
public, news media, and federal, state, and local governmental
agencies?
Beyond revoking tax-exempt status and various currently
available intermediate sanctions, do we need more intermediate
sanctions to deter abuse and enhance accountability while minimizing
any damage to those served by the exempt entity?
Should certain federal audit and internal control
requirements apply to tax-exempt entities, and if so, how should the
requirements vary according to entities' size or other characteristics?
Is there sufficient transparency over the total
compensation package and its justification for executives and other
officials at tax-exempt entities?
What should be the allowable ``lobbying and political''
activities in which different types of tax-exempt entities can engage
and how should such activities be reported?
What are the differences between nonprofit and for-profit
entities that perform similar missions, such as nonprofit and for-
profit hospitals, and do the nonprofit entities provide sufficiently
different services to justify their exemption?
Based on your request, I will discuss
The growth of the tax-exempt sector, focusing on those
entities whose tax-exempt status falls under section 501(c) of the IRC.
The role of sound governance practices and transparency
in ensuring that tax-exempt entities function with integrity and
perform their missions effectively.
IRS's capacity for overseeing those exempt from taxation
under section 501(c), results of its oversight activities, and efforts
to address critical compliance problems.
The states' role in overseeing tax-exempt entities and
their relationship with IRS in conducting oversight.
To summarize the growth of the tax-exempt sector, we analyzed data
filed annually with IRS by section 501(c) entities. To summarize
governance practices and transparency in the tax-exempt sector, we
reviewed documents published by IRS and others, and official statements
made in testimony before Congress. To summarize IRS's oversight
capacity, results, and efforts to deal with critical compliance
problems, we reviewed IRS's data and interviewed IRS officials. To
summarize the role of states and their relationship with IRS, we
reviewed our previous reports \2\ and outside articles and reports. To
the extent possible, we sought data from 1998 through the most recent
year available for all descriptive statistics. We reviewed the
reliability of the data used and found them reliable for our purposes.
We did our work from December 2004 through March 2005 in accordance
with generally accepted government auditing standards.
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\2\ See Tax-Exempt Organizations: Improvements Possible in Public,
IRS, and State Oversight of Charities, GAO-02-526 (Apr. 30, 2002);
Political Organizations: Data Disclosure and IRS's Oversight of
Organizations Should Be Improved, GAO-02-444 (July 17, 2002); and
Vehicle Donations: Benefits to Charities and Donors, but Limited
Program Oversight, GAO-04-73 (Nov. 14, 2003).
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Let me begin by highlighting key points I will make.
The 501(c) tax-exempt sector has grown steadily in
reported assets, revenues, and expenses. For example, between 1998 and
2002 (the most recent year of available data), their reported assets
grew 15 percent to over $2.5 trillion. Accordingly, the tax-exempt
sector comprises a significant part of the nation's economy and
workforce. For example, spending in the tax-exempt sector appears to be
about one-tenth of our economy and the paid exempt workforce appears to
be comparable in size to some of the largest sectors of the U.S.
civilian workforce, such as food and lodging. The sector's significance
in the economy might be greater because the asset, revenue, and expense
data are likely understated to some unknown amount. For example, the
data do not include all tax-exempt entities under section 501(c)
because not all entities are required to file, such as religious
entities, and some entities do not file required Form 990.
Good governance and transparency are essential elements
to ensure that tax-exempt entities operate with integrity and
effectiveness in carrying out their missions. Governance facilitates
well-run operations that dissuade abusive behavior. Transparency sheds
light on entities' practices, which enhances incentives for ethical,
efficient, and effective operations and facilitates oversight by the
public and others. With recent concerns about abuses within the tax-
exempt sector, renewed attention is being given to improving governance
practices and expanding and increasing the transparency of the sector's
operations.
Staffing trends and insufficient data have contributed to
IRS being challenged in executing its oversight role. IRS has begun to
increase staffing during 2005, which results in 467 FTE to examine the
compliance of about a half million section 501(c) entities that file
Forms 990. However, IRS does not know the extent to which these
entities comply. Recognizing this, IRS started efforts in 2002 to
obtain compliance data for various segments of the exempt sector but
had to suspend most of these efforts to use those resources on higher
priorities such as pursuing known types of noncompliance. For example,
IRS has ongoing special compliance initiatives dealing with critical
issues such as excessive compensation and abusive tax transactions
involving exempt entities. IRS is also seeking ways to access and
better analyze existing data at IRS or elsewhere on exempt entities.
States often oversee tax-exempt entities, frequently
focusing on protecting the public from fraudulent activities and
guarding against misuse of charitable assets. States and IRS believe
that more data sharing would make their oversight more efficient and
effective. Consistent with our earlier recommendations, IRS has
improved its processes for sharing data and Congress has been
considering a legislative proposal to expanded IRS's authority to share
data with specified state officials under appropriate restrictions and
protections related to using the data.
My statement today will address each of these topics in turn.
Before that, I will provide some background on the tax-exempt sector
and IRS's oversight of it.
BACKGROUND
Internal Revenue Code (IRC) section 501(c) specifies 28 types of
entities that are eligible for tax-exempt status and over 1.5 million
entities have been recognized as exempt as of 2003.\3\ Section 501(c)
entities are involved in a variety of activities and exempt purposes.
Congress authorized the tax exemption for each type of entity to meet
specific purposes, such as health care for the uninsured.
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\3\ Other types of tax-exempt entities are authorized under other
Section 501 subsections such as for cooperative hospital service or
educational investment organizations or under other sections such as
Section 521 (farmer cooperatives) and Section 527 (political
organizations), among others.
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Almost two-thirds of these entities--over 960,000 in 2003--were
classified as 501(c)(3) charities, which have exempt purposes such as
serving the poor; advancing religious, educational and scientific
endeavors; protecting human rights; and addressing various other social
problems.\4\ About another 20 percent of exempt entities were social
welfare organizations, labor unions, and business associations--501(c)
(4 through 6), respectively. The remainder covered an array of types of
exempt entities with varying purposes and numbers. In 2003, such types
included 15 teacher retirement funds, over 10,000 cemetery companies,
over 4,000 state-chartered credit unions, an employee-funded pension
trust, 20 corporations to finance crop operations, and over 35,000
veteran organizations.
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\4\ Taxpayers may deduct from their taxable income the value of
donations to charities, unlike for almost all other types of tax-exempt
entities.
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An entity that believes it meets the requirements set by Congress
must apply to IRS to obtain tax-exempt recognition by submitting the
following: \5\
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\5\ Entities that are not required to apply include those that are
not private foundations and that have gross receipts of less than
$5,000 as well as churches and church-affiliated entities.
Form 1023 (Application for Recognition of Exemption under
Section 501(c) (3) of the Internal Revenue Code) or Form 1024
(Application for Recognition of Exemption under 501(a));
organizing documents, such as the Articles of
Incorporation, Articles of Association, Trust Indenture, Constitution,
or other enabling documents;
4 years of financial data; \6\ and
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\6\ If the entity has operated for less than a year or has not
begun operations, a proposed budget for two full accounting periods and
a current statement of assets and liabilities will be acceptable.
Otherwise, entities that have operated for less than four years should
report data for those years.
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a full description of the purposes and the activities of
the entity.
After receiving tax-exempt recognition, many entities must annually
file a Form 990 to report their financial transactions and activities
for a ``tax year'' (see app. II for a copy of Form 990) if annual gross
receipts are normally more the $25,000. Those that have less than
$100,000 in gross receipts and year-end assets of less than $250,000
may use Form 990-EZ. Generally, entities with gross receipts below
$25,000 are not required to file. Certain types of entities such as
churches and religious organizations also are not required to file.
Form 990 has information on revenues, expenses, and assets. For 2003,
the form had 105 line items on 6 pages as well as 46 pages of
instructions plus two schedules. Schedule A covers several areas such
as compensation, lobbying, and revenue sources. Schedule B covers the
source of contributions to charities and certain other exempt entities,
such as IRC Section 527 political organizations.
IRS oversight relies on two activities. First, IRS reviews
applications for tax-exempt status to determine whether a tax-exempt
purpose is envisioned. IRS can approve or deny the application. Once an
application is properly completed, the criterion for approving or
denying the exemption is whether the applicant provides sufficient
evidence that its operations will match an allowable exempt purpose.
Second, IRS annually examines some Forms 990 to determine whether
selected exempt entities meet various requirements (such as
restrictions on political activities). In general, IRS attempts to
select entities that it believes are likely to have violated
requirements. IRS can accept the Form 990 as filed or change the status
of the entity, impose excise taxes for certain types of violations, or
revoke the exempt status if the violations are serious enough. IRS can
also assess taxes if an entity has not fully paid employment taxes or
taxes on unrelated business income.
Given concerns about the tax-exempt sector, the Senate Committee on
Finance asked that a panel of experts make recommendations to Congress
to improve oversight, transparency, and governance in the sector. To do
so, the Independent Sector \7\ convened a Nonprofit Sector Panel in
October 2004, which includes 24 nonprofit and philanthropic leaders.\8\
It provided an interim report of findings and recommendations in March
2005 and plans to issue a final report in June 2005.
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\7\ The Independent Sector is a national coalition of nonprofit
organizations, private foundations, and corporate-giving programs that
is to support the tax-exempt sector.
\8\ The Panel is assisted by over 100 nonprofit executives and
other experts on five work groups.
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TAX-EXEMPT ASSETS, REVENUES, AND EXPENSES HAVE GROWN, MAKING IT A
SIGNIFICANT SECTOR IN THE NATION'S ECONOMY
The tax-exempt sector is growing. During 1998 through 2002, more
entities have been filing Forms 990 and reporting higher amounts of
assets, revenues, and expenses. These reported amounts indicate that
the tax-exempt sector is a significant part of the economy and the
civilian workforce.
The data on the growth in assets, revenues, and expenses reported
on the annual Form 990 are likely to be understated because not all
tax-exempt entities under section 501(c) are included. Entities below
certain asset or gross receipt tolerances are not required to file. Nor
are various types of religious entities. Further, an unknown number of
tax-exempt entities do not file the required Form 990. The number and
finances of those not included are unknown.
Tax-exempt Entities Have Reported Increased Assets, Revenues, and
Expenses
For tax years 1998 through 2002, the number of section 501(c)
exempt entities filing a Form 990 grew from about 450,000 to 465,000--
about 3 percent (see table 1 in app. III). These Forms 990--of which
between 63 and 65 percent are filed by charities--have been reporting
higher asset amounts. Figure 1 shows the growth in reported assets for
tax years 1998 to 2002 (the most recent year of data). The reported
assets grew 15 percent to over $2.5 trillion--about 12 percent growth
for section 501(c)(3) charities and about 22 percent growth for the
other 27 types of noncharities covered under section 501(c). (See table
2 in app. III.)
Figure 1: Assets Reported by Section 501(c) Entities in 2004 Constant
Dollars, Tax Years 1998-2002
[GRAPHIC] [TIFF OMITTED] 23916A.001
The reported revenue and expense amounts also grew from tax years
1998 through 2002 (see tables 3 and 4 in app. III). However, the amount
by which reported revenues exceeded expenses has been closing for
exempt entities filing Forms 990--from about 9 percentage points in
1998 to 2 percentage points in 2002 (see figure 2).
Figure 2: Revenue and Expenses Reported by Section 501(c) Entities in
2004 Constant Dollars, Tax Years 1998-2002
[GRAPHIC] [TIFF OMITTED] 23916A.002
Tax-exempt Sector Is a Significant Part of the Economy and Civilian
Workforce
The growth in the tax-exempt sector indicates that it has become a
major part of our economy and workforce. From 1975 to 1995, the real
assets of entities filing Forms 990 more than tripled while the economy
grew 74 percent during the same 20-year period, according to an IRS
study.\9\ More recently, based on data reported on Forms 990 during
1998 through 2002, spending by tax-exempt entities was roughly 11 to 12
percent of the United States' gross domestic product (GDP).\10\ (See
table 5 in app. III.) Because the tax-exempt sector is not measured as
a specified GDP sector, its percentage of GDP cannot be compared to
official GDP sectors such as medical care or housing, which likely
include spending by tax-exempt entities. Even so, no single sector
accounted for more than 15 percent of the GDP in 2002.
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\9\ A 20-Year Review of the Nonprofit Sector, 1975-1995, Compendium
of Studies of Tax-exempt Organizations, Volume 3, IRS Statistics of
Income.
\10\ Gross domestic product is the market value of all goods and
services produced within a country during a given time period.
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Figure 3 indicates that tax-exempt entities appear to account for a
major portion of the civilian workforce. Data from the U.S. Census
indicates that over 9.6 million employees in the tax-exempt sector
accounted for about 9 percent of the civilian workforce in 2002.
Although generally aligned with section 501(c), the Census definition
of a tax-exempt entity excluded certain types of entities (such as
universities, labor unions, religious organizations, and public
administration), which means that the number of tax-exempt employees is
understated.
Figure 3: Paid Employees by Economic Sector as Percentage of U.S.
Workforce, 2002
[GRAPHIC] [TIFF OMITTED] 23916A.003
Note: ``Other'' category includes 13 economic sectors that individually
accounted for less than 8 percent of the workforce in 2002, including
educational services such as technical, driving, and other specialized
training schools; mining; utilities; construction; and real estate.
In addition to paid workers, one study \11\ suggests that the
number of volunteers at certain tax-exempt entities (which account for
at least 60 percent of the sector)grew about 27 percent from 4.5
million in 1982 to 5.7 million volunteers in 1998.
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\11\ IRS does not transcribe data on the numbers of paid workers
and volunteers. The Independent Sector issued a nonprofit almanac with
data through 1998 on volunteers at entities classified as 501(c) (3)
charities, 501(c) (4) social welfare and civic organizations, and
religious congregations.
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STRONG SELF-GOVERNANCE AND TRANSPARENCY ARE ESSENTIAL ELEMENTS FOR A
THRIVING AND EFFECTIVE EXEMPT SECTOR
Strong self-governance and transparency are essential elements to
help provide assurance that tax-exempt entities operate with integrity
and effectiveness in meeting their missions while maintaining public
trust. A number of requirements help establish governing structures
while required public disclosure of information about exempt entities
enhances transparency. However, recent concerns about abuses in the
tax-exempt sector have prompted consideration of and support for
enhanced governance and transparency.
Good Governance Helps Provide Assurance that a Tax-exempt Entity
Effectively Manages Funding and Programs
Governance can be viewed as the collective policies and oversight
mechanisms in place to establish and maintain sustainable and
accountable organizations that achieve their missions while
demonstrating stewardship over resources. Good governance helps ensure
that tax-exempt entities are well run and that abusive behavior is
minimized. Generally, an organization's board of directors has a key
role in governance through its oversight of executive management,
corporate strategy, risk management and audit processes, and
communications with external stakeholders. This is implicitly
recognized in some of the statutory and regulatory requirements for the
tax-exempt sector.
For example, to obtain federal tax-exempt recognition, applying
entities must include charters and bylaws with their application. The
states in which they are established specify what must be included in
the charters and/or bylaws and the states' requirements help create a
basic governance structure for exempt entities. Some states, for
instance, have requirements for audited financial statements of tax-
exempt entities. For example, in one state, charities with gross
revenue in excess of $100,000 and not more than $250,000 are required
to file financial statements accompanied by a report from a licensed
certified public accountant. If gross revenues exceed $250,000, the
state requires an audited financial statement with an independent
auditor's report.
In addition, Congress and IRS have various requirements to help
ensure that tax-exempt entities do not engage in activities that are
inconsistent with their exempt purpose and to promote stewardship over
the use of the funds. For instance, to ensure that tax-exempt assets
are for public rather than private benefit, IRS has issued regulations
affecting tax-exempt entities on ``excessive compensation'' to
officers, directors, or other employees. IRS requires market
comparability studies and a review of compensation by boards of
directors. If excessive compensation is found, excise taxes under
section 4958 for charities and section 4941 for private foundations can
be levied against the overpaid individual and certain managers who
knowingly approved the payments. (See app. V for an explanation of such
excise taxes imposed against private foundations and other tax-exempt
entities.)
The federal government also has certain accountability requirements
that affect some tax-exempt entities. OMB Circular A-133, for instance,
requires those entities, including tax-exempt entities that receive
federal awards of $500,000 or more per year to perform an audit of
federal funds received and expended and ofthe programs for which the
funds were received.
Transparency complements good governance
While strong governance practices can help ensure that tax-exempt
entities operate effectively and with integrity, public availability of
key information about the entities--i.e., transparency--can both
enhance incentives for ethical and effective operations and support
public oversight of tax-exempt entities, while helping to achieve and
maintain public trust. Recognizing the importance of transparency for
tax-exempt entities, Congress provided for substantial transparency
regarding tax-exempt entities by making their Forms 990 publicly
available documents. This is in stark contrast to the strong
protections for the privacy of individuals' tax returns.
Since tax exemptions are granted to entities so that they can carry
out particular missions or activities that Congress judged to be of
special value, the public availability of the entities' Forms 990 is
one means to help ensure that the public has information to judge
whether those missions are carried out properly. Presumably, when
``sunshine'' is let in, inappropriate activities are less likely to
occur. In the particular case of charitable organizations, the
availability of their Forms 990 provides some information for
individuals to use in judging whether to make a donation. Thus,
publicly available information helps establish a ``free market'' in
which charities compete for donations, which should encourage
efficiency and effectiveness.
At various times, Congress has reinforced the commitment to
transparency over the operations of tax-exempt entities. For instance,
when some exempt entities were found to be imposing inappropriate fees
or other requirements on those seeking to obtain a copy of their Form
990, Congress modified the law to provide that copies must be provided
without charge to the individual other than a reasonable fee for any
reproduction and mailing costs.\12\
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\12\ See IRC Section 6104(d) and changes made by the Tax and Trade
Relief Extension Act of 1998, P.L. 105-277.
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Recent Concerns about Abuses Have Led to Support for Enhanced
Governance Processes and Transparency
With recent concerns about abuses in the tax-exempt sector,
attention has been renewed on improving the sector's governance and
transparency. Among the proposals being considered for improved
governance are enhancing the controls and processes for determining
executive compensation, guarding against other misuse of charitable
assets, and forestalling tax-exempt entities' participation in tax
avoidance schemes. Proposals for enhanced transparency include
requiring more information in a more timely and user-friendly fashion
on the Form 990.
In recent years, media accounts have publicized certain alleged
abuses in the tax-exempt sector that speak to failures in tax-exempt
entities' governance. For example, a series of articles in 2003
highlighted possible misuse of foundations and trusts, citing numerous
cases of excess compensation, insider loans, self-dealing, extravagant
perks, and other questionable activities.\13\ The articles cited, for
instance, alleged abuses such as:
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\13\ The Boston Globe ran a series of articles between October and
December of 2003 that uncovered questionable practices among
foundations and trusts.
A foundation in New York more than tripled its
president's compensation to over $900,000 between 1997 and 2001.
A family-based foundation in Chicago paid two family
members over $1 million during a 5-year stretch and donated only
$175,000 to charities.
Another series of articles pointed to the apparent misuse of
easements.\14\ An easement is when an owner voluntarily restricts
changes to real property, such as to preserve historic buildings and
the environment. Donation of the easement to an exempt entity provides
an income-tax break to the donor. In some cases, insiders at the
charities charged with policing the restrictions imposed by the
easements on development may have benefited the most. In other cases,
individuals may have claimed tax deductions for easement donations even
though local or other laws already required preservation of the
property.
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\14\ The Washington Post has been running periodic articles about
alleged abuses within the tax-exempt sector. The most recent series, in
December 2004, concerned the alleged donation of historic facade
easements to obtain inflated charitable contributions.
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Concerns about excessive compensation and whether some tax-exempt
entities provide sufficient services to justify their exempt status
have surfaced regarding nonprofit hospitals. An example of concerns in
these areas has been offered by the Minnesota Attorney General who
recently testified on such abuses.\15\ Among other things, his office
found that certain tax-exempt health care systems paid for trips to
vacation resorts by executives and board members without a clear
business purpose, and that some nonprofit hospitals provided inadequate
levels of ``charity'' care to patients without the resources to pay.
Across the United States, little is known about the extent to which
these potential abuses involving excess compensation and the level of
services provided by nonprofit hospitals occur. More information about
the practices employed by exempt entities to compensate executives and
others, and by nonprofit hospitals to serve their patients, would be
valuable.
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\15\ Testimony of Mike Hatch, Attorney General for State of
Minnesota, before the Senate Committee on Finance, April 5, 2005.
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Even as these abuses were surfacing, some organizations within the
tax-exempt sector were seeking to improve the governance and
transparency within the sector. For example, in recent years, the
National Association of State Charity Officials (NASCO), the
Independent Sector, and the National Committee for Responsive
Philanthropy, among others, have called for revisions to the Form 990.
Others have taken the initiative to establish self-regulatory
standards independent of those set by IRS. For example, the Better
Business Bureau has established a seal of approval program to help
donors make informed decisions and foster public confidence in
charities. Charities participating in the program are to provide
documentation that the bureau uses to determine whether its 20
standards have been met. These standards address governance and
oversight, effectiveness, finances, and public information materials.
For example, 5 standards are used to measure governance and oversight
such as through an active and independent governing board, and 7
standards are used to ensure that spending is honest, prudent, and in
accordance with fund-raising appeals.
Concerns about abuses in the tax-exempt sector also have spurred
congressional interests. This House Committee on Ways and Means'
hearing exemplifies that interest. In June 2004, the Senate Committee
on Finance released a discussion draft of proposals for tax-exempt
reforms. The draft discussed more than three-dozen proposals to
generate comments about possible legislation. The proposals addressed
conflict of interest, federal-state coordination, transparency,
governance, best practices, funding for enforcement, among many others.
Such proposals mirror similar types of recent requirements to increase
accountability and oversight of other types of large public and private
organizations, such as corporations, in which ethical, financial, and
other abuses have occurred.
The Panel on the Nonprofit Sector responded to such proposals in
its March 2005 interim report. In discussing governance and ethical
conduct, the report pointed to the need for best practices, accepted
standards, self-regulation, and education. To improve governance, the
report recommended that charities enforce a conflict-of-interest
policy, select board members with some financial literacy, and
encourage disclosure of illegal practices. The report also advocated
more transparency to enable public oversight and confidence in tax-
exempt entities. It concluded that IRS should promote transparency
while recognizing the burdens that reporting more data can place on
exempt entities that are small and lack resources. The report supported
revising the Form 990, mandating electronic filing in coordination with
the states for the Forms 990 and 1023, and increasing the sanctions for
not filing an accurate or timely Form 990. The report acknowledged that
these steps would not fully dissuade those who want to violate
standards, and concluded that some government oversight is necessary.
More specifically, among the proposals being considered to improve
governance and transparency are:
Governance Proposals:
Require that compensation for all management positions
at a charity must be approved annually and in advance, and must be
justified in a manner that can be understood by those with a basic
business background.
Require the board of directors of a charity to
establish a conflict-of-interest policy, a compliance program to
address regulatory and liability concerns, and program objectives and
performance measures, among other duties.
Prohibit board membership to those not permitted to
serve on the board of a publicly traded company.
Establish a prudent investor rule for the investment
activities of charities.
Transparency Proposals:
Require the chief executive officer of a tax-exempt
entity to sign under penalty of perjury that the Form 990 and other
forms filed comply with the Internal Revenue Code and that reasonable
assurances were given of the accuracy and completeness of the
information reported.
Require disclosure of relationships of a tax-exempt
entity with other exempt and nonexempt entities, including the
formation of taxable subsidiaries and transactions with these other
entities.
Require disclosure of annual performance goals and
measures by charities with over $250,000 in gross receipts.
Require disclosure of investments by public charities.
IRS HAS BEEN CHALLENGED TO OVERSEE TAX-EXEMPTS AND IS BEGINNING STEPS
TO ENCHANCE ITS OVERSIGHT CAPACITY
Staffing and insufficient data have constrained IRS's oversight of
the tax-exempt sector. IRS is in the midst of increasing tax-exempt
staffing in fiscal year 2005 and improving its data on tax-exempt
entities as well as enhancing its ability to analyze data to help in
targeting compliance efforts. IRS has identified compliance problems it
deems critical and is taking actions to address them.
IRS Oversight Resources Have Been Relatively Flat Until Recently
Based on a 1997 IRS memorandum and more recent data, it is apparent
that the staffing level for the functions that are now within the Tax
Exempt and Governmental Entities (TE/GE) division has been essentially
flat since 1974--2,075 in 1974 versus 2,122 in 2004. These are total
staffing levels for all of the work done within the current TE/GE,
which includes reviewing employee pension plan issues and certain other
matters. Although we did not obtain a measure of the overall change in
TE/GE workload from 1974 to 2004, the number of 501(c) tax-exempt
entities increased from around 670,000 to over 1.5 million.
From fiscal year 2000 through 2004, IRS staffing for overseeing
tax-exempt entities stayed relatively flat as measured by the number of
full-time equivalent (FTE) staff assigned to oversee tax-exempt
entities.\16\ For fiscal year 2005, IRS increased the number of FTEs
assigned for such work. The assigned FTEsdropped about 4 percent from
fiscal years 2000 through 2004 but increased about 11 percent for
fiscal year2005, resulting in a 7 percent increase in assigned FTEs
overall (see fig. 4). This 2005 increase is due to the FTEs assigned to
do examinations since the FTEs assigned to do determinations of exempt
status stayed relatively flat. As of 2005, IRS assigned 467 FTEs to
examine the hundreds of thousands of entities who generally file Forms
990 (see table 6 in app. IV).
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\16\ An FTE equals 2,087 hours in a year. IRS did not have
comparable FTE data for its exempt activities back to 1998 due to its
reorganization in 2000. FTEs assigned are what IRS budgets for this
work. We were unable to obtain reliable data on the FTEs used for tax-
exempt oversight in time for this testimony. However, because IRS may
not use the FTEs assigned to examination or determinations for those
purposes, the number of hours that staff charge to these oversight
tasks may be a better indicator of the level of effort.
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Figure 4: Assigned FTEs by Type of IRS Activity, Fiscal Years 2000-2005
[GRAPHIC] [TIFF OMITTED] 23916A.004
Note: ``Other FTE'' includes technical staff who issue rulings, the
Director's staff, and education and outreach.
Competition within IRS for resources helps explain why resources
for tax-exempt oversight have not increased much until fiscal year
2005. IRS has many other priorities in collecting the proper amount of
tax from tens of millions of individuals and businesses. IRS's budget
emphasizes areas that produce tax revenue rather than areas that are
regulatory. IRS oversight of the exempt sector is primarily regulatory
rather than revenue producing. IRS exempt officials also said that an
ongoing issue is the proper mix of resources budgeted for oversight
versus other activities such as providing guidance or education. Beyond
tax-exempt entities, TE/GE must also budget resources to deal with
pension plans, Indian tribal governments, and other types of government
entities.
Congressional tax-writing committees have attempted to provide
dedicated funding for exempt oversight. For example, in 1969, Congress
added section 4940 to the Internal Revenue Code, which imposes an
excise tax on the net investment income of private foundations (see
app. V for an explanation of this tax and tax rates). The legislative
history indicates that the tax committees intended for the amounts
collected from the excise taxes would operate as user fees to fund IRS
oversight of exempt entities. To date, congressional appropriation
committees, which have jurisdiction over annual funding, have not
earmarked these tax collections for this purpose.\17\
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\17\ The Nonprofit Sector Panel interim report concluded that
Congress should increase resources, and earmark some penalty, fee, and
excise tax amounts for IRS exempt oversight and education.
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IRS has not maintained data on how much excise tax it has assessed
or collected under Section 4940 (or any other excise tax that can be
assessed against tax-exempt entities either overall or by type of
excise tax). However, IRS did have data that showed tax-exempt entities
reported owing (i.e., self-assessed), in 2004 constant dollars, at
least $247 million in this excise tax annually (about $1.5 billion
overall) for 2000 through 2003 (see table 10 in app. V). For
comparison, the fiscal year 2003 budget for all of TE/GE (i.e., not
just tax-exempt oversight functions) was around $205 million.
IRS's Oversight Caseload Has Been Increasing in Recent Years and IRS
Has Had Difficulties Sustaining Its Oversight
For section 501(c) entities, IRS's oversight caseload has been
increasing. In its determinations' work involving applications for tax-
exempt status, in fiscal years 1998 through 2004, applications
increased about 17 percent from 78,358 to 87,080, with some annual
fluctuations (see table 7 in app. IV). IRS officials said that IRS must
review each application to make a determination of exempt status. IRS's
potential tax-exempt examination universe has grown more slowly. As
mentioned earlier, the number of exempt entities filing a Form 990 grew
from about 450,000 to 465,000 during tax years 1998 through 2002--or
about 3 percent.
IRS has had difficulty sustaining a consistent examination rate for
tax-exempt entities. As figure 5 shows, the rate at which IRS examined
filed Forms 990 fell from 1.8 percent in 1998 to 1.1 percent in 2002
before rising to 1.3 percent in 2003 (see table 8 in app. IV).
Figure 5: IRS Examination Rates for Section 501(c) Entities, Fiscal
Years 1998-2003
[GRAPHIC] [TIFF OMITTED] 23916A.005
IRS officials said that the declining examination rates primarily
resulted from a decline in FTEs for examinations and an increase in the
average hours spent per examination. The number of tax-exempt entities
that IRS examined decreased from 8,290 in fiscal year 1998 to 5,889 in
2004, or about 29 percent, after dropping as low as 5,423 examinations
in 2002. IRS officials said that they have examined more returns since
2002 because they used more of their examiners to examine Forms 990
rather than help elsewhere such as with determinations, and expedited
examinations, such as by limiting their scope and depth.
In terms of determinations' results, during fiscal years 1998
through 2004, IRS annuallydenied about 1 percent of the applications
while the approval rate was 74-80 percent (see table 7 in app. IV).\18\
Denials occur when IRS determines that an applicant has not met the
statutory requirements for exemption. In accordance with the statutory
guidance on qualifying for tax-exempt status, IRS is not likely to deny
the recognition of tax-exempt status as long as the applicant provides
all required documents, files a complete Form 1023, and provides an
appropriate statement about its intent to serve an approved exempt
purpose.
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\18\ The rest of the applications included those for which IRS had
not made a determination for reasons such as applications that were
withdrawn or incomplete.
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Regarding examination results,during fiscal years 1998 through
2003, IRS revoked exempt status in 1.2 percent of its examinations.
Revocations occur when IRS determines that the entity omitted or
misstated a material fact, operated materially different from its
stated exempt purpose, or engaged in a prohibited transaction in
conflict with its exempt purpose. IRS does not often revoke tax-exempt
status because the need for revocation often does not arise and when it
does, IRS focuses more on getting the tax-exempt entity to comply with
federal laws rather than on taking away its exempt status.
Beyond revocations, IRS examinations can produce one or more other
changes \19\ such as in the section 501(c) paragraph,\20\ foundation
status of a 501(c)(3) entity,\21\ and assessed tax.\22\ Changes in
paragraph are important because of rules governing permissible
activities. For example, a tax-exempt entity classified as a charity
under 501(c)(3) can accept donations that are tax deductible for the
donor unlike those classified as a social welfare entity under Section
501(c)(4). However, such charities are more restricted in their ability
to lobby and engage in political activity compared to social welfare
entities. Changes in foundation status are important because
foundations generally are subjected to more requirements than public
charities, such as in the requirement to annually distribute a minimum
amount of income towards its exempt purpose.
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\19\ IRS examiners can make 12 ``other'' types of changes such as
those involving related returns, delinquent returns, appeals, closing
agreements, referrals to other IRS divisions, and claims.
\20\ ``Paragraph'' refers to the types of 501(c) entities such as
(c)(3) or (c)(4). When an entity applies for exempt status, it must
tell IRS the section 501(c) paragraph under which it qualifies.
\21\ An entity that qualifies under section 501(c)(3) is a private
foundation unless it meets the criteria for a public charity, such as
having broad public support. Beyond an examination, status can be
changed when (a) an entity requests an IRS determination letter on its
status, and (b) 5 years have elapsed for an entity that has been
permitted to be a public charity for its first 5 years.
\22\ Tax-exempt entities could owe employment taxes, various types
of excise taxes, or income taxes if they operate a business activity
not related to their exempt purpose.
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Figure 6 shows that the percentage of examinations that produced no
change rose from 31 percent in fiscal year 1998 to 39 percent in 2004,
with higher rates in 2002 and 2003 (see table 9 in app. IV). In
general, IRS is not likely to find a change in every examination given
the focus on getting exempt entities into compliance and the need for
better data to select the most noncompliant entities for examination.
Higher no-change rates mean that IRS spends resources examining
compliant entities. IRS officials said that they are working to reduce
the no-change rate to or below the 1998 level.
Figure 6: No-Change Rate for Examinations of Forms 990, Fiscal Years
1998-2004
[GRAPHIC] [TIFF OMITTED] 23916A.006
IRS Has Had Insufficient Reliable Information to Guide Oversight
Efforts but Is Working to Obtain Better Information
IRS has acknowledged that it lacks sufficient data to effectively
find and address noncompliance among tax-exempt entities. At the same
time, IRS is aware that improvement to the Form 990 data made available
to the public could better support public, media, and others' oversight
of tax-exempt entities. To better enable it to collect and analyze such
data, IRS is taking a number of steps. IRS is also trying different
actions to enhance its ability to address critical and other types of
noncompliance.
To help identify noncompliance, IRS is revising the data requested
on the Form 990. IRS has determined that the Form 990 does not provide
sufficient data to identify tax-exempt entities that merit an
examination due to noncompliance. Nor can IRS easily compare Form 990
data with data reported on the Form 1023.\23\ For example, the current
Form 1023 requests data on hospitals and low-income housing that are
not captured in the Form 990. Being able to compare similar data on
both forms would better enable IRS to see whether the stated exempt
purpose is being pursued and met.
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\23\ IRS revised Form 1023 in 2004 to provide information that
helps identify potential problems early in the application process,
including potentially abusive situations involving tax-exempt entities
such as those claiming to provide credit counseling.
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To enhance the usefulness and ease of preparation of the Form 990,
IRS officials stated that the IRS is undertaking a large-scale
revision. IRS officials said that the revision process has key steps to
be taken before IRS shares the specific changes. However, IRS officials
identified some general changes being developed. To ease preparation,
IRS is attempting to write all questions in plain English and group
questions related to an issue. Further, IRS officials explained that
the revised Form 990 is to consist of one form applicable to all tax-
exempt entities and a series of organization and activity schedules.
The organization schedules would be tailored to filers such as
hospitals or veteran's organizations while the activity schedules would
be tailored to issues such as compensation packages and grant making
that may be financing terrorism.
An IRS team completed a first draft of the revised Form 990 in
December 2004. Before setting milestones for publishing the Form 990,
IRS wants to allow for review by various parties inside and outside
IRS. IRS also plans to consider recommendations on the Form 990 of the
Nonprofit Sector Panel to be presented in its final report in June
2005. Finally, IRS plans to make the revised Form 990 suitable for
electronic filing in a cost-effective manner.
IRS has also recognized that it has insufficient data on the extent
or causes of noncompliance for segments of the tax-exempt sector. IRS
has done a few studies to measure the compliance of exempt entities
filing Forms 990 and reporting items such as the unrelated business
income tax owed. IRS did these studies in the 1970s, except for a
smaller compliance study done during the 1980s.
To alleviate such data shortcomings, in 2002, IRS began over 30
studies of ``market segments,'' which are homogeneous groups of tax-
exempt entities such as charities, social clubs, and business leagues,
or of exempt issues such as business income unrelated to an exempt
purpose. These studies were to develop reliable data on the types and
extent of compliance problems. IRS planned to use the data to refine
selection criteria for identifying noncompliant returns for examination
as well as help identify other strategies to improve compliance such as
through improved guidance or instructions. However, IRS has had to
delay most of these studies due to higher priorities (such as dealing
with abusive tax transactions).
Given its concern about insufficient data, IRS also is taking steps
in fiscal year 2005 to improve its capabilities to analyze data. IRS
has been establishing a Data Analysis Unit to provide trend analysis
intended to improve the selection of tax-exempt entities for
examination and the identification of compliance issues to pursue. The
unit is to make better use of internal and external databases.\24\ A
driving force in creating the unit was the lack of research tools and
staff trained in using data. As described below, IRS has several other
efforts underway or planned to improve the use of electronic data on
the tax-exempt sector.
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\24\ The Data Analysis Unit plans to use data-mining techniques to
identify patterns and establish relationships to uncover compliance
issues. For example, by comparing state bingo databases to IRS files,
IRS could identify entities with gross receipts in excess of the
$25,000 filing threshold that failed to file a required Form 990.
IRS plans to expand electronic filing of returns, which
could help IRS to more quickly identify noncompliance and improve
public access to Form 990 data.\25\ IRS began accepting the Form 990
\26\ electronically on a voluntary basis in 2004, and plans to expand
voluntary electronic filing to Form 990-PF filed by private foundations
in 2005 and to create a single point for electronic filing of federal
and state returns in 2006. IRS plans to require electronic Form 990
filing for exempt organizations with assets in excess of $100 million
for 2006 and in excess of $10 million for 2007. Private foundations
would be required to file electronically for 2007 regardless of the
amount of their assets.\27\
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\25\ IRS has a network to image the paper Forms 990 filed by
charities. The imaged forms, minus sensitive data such as social
security numbers and donor names, are sold to groups that want such
data. Due to resource limitations, IRS transcribes little data from
Forms 990 into electronic databases. To have more electronic data from
Forms 990, IRS has a contract to have the imaged Form 990 data
keypunched.
\26\ IRS is developing electronic filing for Form 1023, which is
used to apply for tax-exempt status. IRS hopes to begin accepting the
electronic Form 1023 by 2007.
\27\ Consistent with IRC section 6011(e), only large organizations,
including exempt organizations and private foundations, that are
required to file 250 or more returns with IRS will be required to file
their Form 990 electronically. Such returns include Forms 990, annual
employee wage and tax statements (Form W-2), quarterly payroll tax
returns (Form 941), and annual information returns, such as payments to
vendors for services (Form 1099 MISC).
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IRS's Exempt Organizations Electronic Initiatives Office
\28\ is developing a ``Better Data Initiative'' intended to synthesize
IRS's electronic data for compliance purposes, such as examination
selection and compliance trend analysis. The goal is to have an
effective database management infrastructure in place by 2007. This
office also is to help find and use electronic data sources that would
be useful for trend analysis.
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\28\ The Electronic Initiatives Office manages the development and
implementation of automation efforts on exempt organizations in support
of the strategic plan.
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IRS Has Identified Priority Compliance Issues and Is Working to Address
Them
Because of increasing concerns about specific types of
noncompliance, IRS has created initiatives to address specific abuses
across the tax-exempt sector. IRS also is attempting to build a
stronger enforcement presence during 2005 through new processes to
supplement examinations of compliance among exempt entities.
IRS has identified four critical compliance problems, which it
plans to address through enforcement during fiscal year 2005, as
follows.
Anti-terrorism--examine a sample of exempt entities that
make foreign grants to ensure that the funds are used for the
charitable purpose and not for terrorist activity.
Credit counseling--examine credit counseling and consumer
credit organizations that appear to operate as businesses rather than
provide the educational or charitable services required under tax-
exempt status.
Excessive compensation--conduct compliance checks and
examinations of charities and private foundations to identify potential
excessive compensation paid to insiders.
Abusive tax avoidance transactions--focus on four types
of transactions that are intended to exploit tax-exempt status for
personal gains, including:
using non-life mutual insurance companies \29\ and
producer-owned reinsurance companies \30\ to earn tax-free profits.
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\29\ Insurance companies or associations that provide other than
life insurance are generally tax exempt under IRC section 501(c)(15) if
their gross receipts do not exceed $600,000 and more than 50 percent of
their receipts consist of premiums.
\30\ A producer-owned reinsurance company provides reinsurance for
a producer group's business; reinsurance transfers part or all of the
risk from one insurer to another.
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establishing donor-advised funds \31\ to generate
questionable deductions, benefits to donors, or management fees for
promoters.
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\31\ Donor-advised funds allow donors to advise how the charitable
contribution is to be used.
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misusing tax-exempt entities that are to support other
exempt entities by, for example, making large loans to the founder of
the supported entity or by not providing the required tax-exempt
support.
abusing Department of Housing and Urban Development
programs such as through personal use of program property.
IRS plans to address other compliance problems as well. The
problems to be addressed involve charitable gaming, disaster relief
organizations whose distributions result in private benefit or fraud,
tax-exempt political organizations that fail to annually report all
required information, and prohibited political intervention by
charities.\32\ In addition, IRS is addressing excess deductions for
conservation easements, vehicle donations and other noncash
contributions, as well as abuses involving charitable trusts, and a
``corporation sole''.\33\
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\32\ IRS plans to contact over 100 charities identified as having
potentially violated the prohibition, to educate the organizations and
prevent future violations of the law.
\33\ A corporation sole is an entity authorized under state law to
allow religious leaders to hold property and conduct business for the
benefit of a religious entity.
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To enhance enforcement overall, IRS has been developing new units
or processes. For example, IRS created the Exempt Organization
Compliance Unit in 2004 to help deal with growth in the number of tax-
exempt entities coupled with the limited examination resources. It is
to check exempt entities' compliance with record-keeping and
information-reporting requirements via correspondence rather than a
review of books and records in an examination. During fiscal year 2004,
the unit sent over 2,000 letters to check compliance and over 8,000
letters to educate the entities about how to comply. If an entity does
not respond or has questionable activity identified in the compliance
check, IRS could initiate an examination.
IRS also is developing a Financial Investigations Unit to
specialize in complex fraud and tax-avoidance schemes involving the
exempt sector. IRS recognized that it lacked staff in its tax-exempt
unit trained to trace funds through complex transactions but was being
asked to ensure that charitable assets are not diverted for illegal
purposes. IRS plans to hire specialists that can identify fraud and
track foreign grants. Furthermore, IRS has established a group to
review exempt applications for names of individuals that appear on a
Department of the Treasury Office of Foreign Assets Control listing of
suspected terrorists or that IRS knows to be tax-scheme promoters as
well as for types of entities with a history of noncompliance, such as
in credit counseling. The presence of such names or entities would
likely result in a referral to the examination group, or for a
suspected terrorist, to IRS Criminal Investigation group.
STATES PLAY AN IMPORTANT ROLE IN OVERSEEING TAX-EXEMPT ENTITIES AND MAY
BENEFIT FROM ADDITIONAL COORDINATION WITH IRS
In addition to IRS oversight, states oversee tax-exempt entities,
often focusing on potential fund-raising fraud and misuse of charitable
assets. The states believe that their oversight could be more effective
if IRS were able to share additional information with them. We have
previously recommended that IRS work with states on data-sharing
proposals that Congress could consider.
States Provide Critical Oversight
Many states oversee some aspects of the tax-exempt sector through
their attorney general and/or state charity offices. Although some
overlap in responsibility with IRS exists, state oversight differs. IRS
focuses on whether the tax-exempt entities meet tax-exempt requirements
and comply with federal laws. States have an interest in whether tax-
exempt charities' fund-raising is fraudulent and whether the entity is
meeting the purpose for which it was created.
In general, exempt entities are to incorporate in a state or the
District of Columbia. State attorneys general have broad power to
regulate the charities that are established or operate in their states.
States monitor charities for compliance with statutory and common-law
standards, and can correct noncompliance through litigation and other
means.
States can impose requirements on tax-exempt entities incorporated
or operating in their jurisdictions that specifically affect governance
or transparency. For example, some states require fund-raisers to
register and file information regarding fund-raising or monitor charity
solicitations through their consumer protection bureaus to protect
against fraud. Through its Nonprofit Integrity Act of 2004, California
established governance requirements for financial audits, audit
committees, disclosure of audited statements, and review and approval
by the board of directors of compensation paid to the chief executive
officer and chief financial officer. The act also established
requirements related to fundraising.
Coordination between IRS and the States in Sharing Data About Tax-
Exempt Entities Could Enhance Oversight and the Use of Limited
Resources
State officials believe, and IRS officials agree, that state
oversight of tax-exempt entities could benefit if IRS and states
coordinated on sharing IRS's data. IRS is working on improved data
sharing consistent with recommendations we made in 2002.\34\ First, we
recommended that IRS consult with state charity officials on how to
regularly share IRS data that federal law allowed to be shared (e.g.,
data on denials or revocations of tax-exempt status). State charity
officials told us that IRS has implemented this recommendation and has
been open to input from the states on how to better share the data on a
regular basis.
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\34\ See GAO-02-526.
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Second, we recommended that IRS work with state charity officials
and the Department of the Treasury to identify other types of IRS data
that states would find useful and provisions to protect the data from
improper disclosure or misuse, and to develop a legislative proposal
that would expand state access to such IRS data. State and IRS
officials believe that revising statutes to allow IRS to share more
data, such as about ongoing and closed examinations of charities, would
help IRS and states to better use limited resources and the states to
more quickly respond to noncompliance. Congress is now considering a
proposal to allow IRS to share more information with the states,
including their charity regulators.
CONCLUDING OBSERVATIONS
Tax-exempt entities provide an incredibly diverse set of services
to our equally diverse population. Our lives are enriched and improved
through the work of this sector. In sum, the tax-exempt sector has
become an indispensable part of American life. Yet, like all
organizations run by human beings, tax-exempt entities' operations can
at times be flawed.
Ensuring that tax-exempt entities run as effectively and
efficiently as possible, and in line with the purposes for which
Congress established their tax exemption, can best be accomplished
through a series of complementary controls. At the organization level,
a sound governance structure can establish the set of checks and
balances that help steer an entity towards result-oriented outcomes
consistent with their purposes while also guarding against abuses.
Transparency over the operations of the exempt entity provides an
incentive to help ensure the governance practices function as intended
and when they do not, transparency helps increase the chances that
inappropriate behavior will be detected and corrected. Oversight by IRS
and the states brings to bear the powers of government to investigate
errors made among tax-exempt entities, to change the rules when
necessary, and to provide consequences when rules are not followed.
Regarding oversight by states, IRS and states believe greater
sharing of federal data would help states target their enforcement
efforts and minimize unnecessary overlap with federal oversight of
exempt organizations. As we recommended, we look forward to IRS, the
Department of the Treasury, and states identifying the specific
information that should be shared and procedures for sharing it
consistent with taxpayer privacy rights, to help Congress in
deliberating changes to current restrictions on IRS sharing such data
with the states.
Ultimately, Congress determines what activities should benefit from
tax exemption and what organizations must do in exchange for that
advantage. Periodic congressional oversight is therefore critical to
ensuring that the exempt sector remains a vibrant contributor to the
quality of American lives and operates with integrity in achieving
results commensurate with the tax-favored status it has been granted.
As noted earlier, the hearing today provides an excellent forum from
which to launch a comprehensive re-examination of this vital sector as
we work to address the challenges arising in the 21st century. We stand
ready to assist Congress as it considers such a re-examination and
continues its oversight of this critical sector of our national
economy.
______
Mr. Chairman, this concludes my prepared statement. I would be
happy to respond to any questions you or other Members of the committee
may have.
For further information on this testimony, please contact Michael
Brostek at (202 512-9110) or [[email protected]]. Individuals making key
contributions to this testimony include Perry Datwyler, George Guttman,
Shirley Jones, Bob McKay, John Mingus, Jeff Schmerling, and Tom Short.
Appendix I: Types of Tax-Exempt Entities under Section 501(c)
The following lists the 28 types of tax-exempt entities under the
subsections of section 501(c) of the Internal Revenue Code.
(1) Corporations organized by Act of Congress; Central Liquidity
Facility for Federal Credit Unions; Resolution Trust Corporation;
Resolution Funding Corporation
(2) Title-holding corporations
(3) Public charities, private foundations, religious, charitable,
scientific, testing for public safety, literary, or educational,
fostering national or international amateur sports competition,
prevention of cruelty to children or animals
(4) Civic leagues, social welfare organizations, local
associations of employees dedicated to charitable, educational, or
recreational purposes
(5) Labor unions, agricultural, or horticultural organizations
(6) Trade associations, professional football leagues
(7) Social and recreational clubs
(8) Fraternal benefit societies providing payment of certain
benefits to members
(9) Voluntary employees' beneficiary associations providing
payment of certain employee benefits
(10) Domestic fraternal societies whose net earnings are devoted
to religious, charitable, scientific, literary, educational, and
fraternal purposes, which do not provide benefits to members
(11) Teachers' retirement fund associations
(12) Benevolent life insurance associations, mutual ditch or
irrigation companies, mutual or cooperative telephone, electric, or
water companies
(13) Cemetery companies
(14) Credit unions
(15) Small mutual insurance companies
(16) Corporations to finance crop operations
(17) Supplemental unemployment benefit trusts
(18) Pre-June 25, 1959 trusts to fund pension benefits
(19) Veterans' groups
(20) Group legal service organizations
(21) Black lung benefit trusts
(22) Multi-employer pension plan trusts
(23) Armed Forces insurance organizations established before 1880
(24) ERISA trusts for certain terminated plans
(25) Multi-parent holding companies
(26) State-sponsored, high-risk insurance organizations
(27) State-sponsored worker compensation reinsurance organizations
(28) National railroad retirement investment trust
Appendix II: Copy of Form 990
[GRAPHIC] [TIFF OMITTED] 23916A.007
[GRAPHIC] [TIFF OMITTED] 23916A.008
[GRAPHIC] [TIFF OMITTED] 23916A.009
[GRAPHIC] [TIFF OMITTED] 23916A.010
[GRAPHIC] [TIFF OMITTED] 23916A.011
[GRAPHIC] [TIFF OMITTED] 23916A.012
Appendix III: Form 990 Data
The following tables summarize data reported on the annual Form 990
by tax-exempt entities under section 501(c) of the Internal Revenue
Code. The tables cover reported assets, revenues, and expenses overall
and, where appropriate, broken out by charities and the rest of the
section 501(c) entities (i.e., noncharities).
Table 1: Form 990 Returns Filed by Section 501(c) Entities, Tax Years 1998-2002
----------------------------------------------------------------------------------------------------------------
Number of returns filed
Tax year -----------------------------------------------------------
Charities Noncharities All entities
----------------------------------------------------------------------------------------------------------------
1998 281,228 168,309 449,537
----------------------------------------------------------------------------------------------------------------
1999 299,204 173,239 472,443
----------------------------------------------------------------------------------------------------------------
2000 301,612 168,963 470,575
----------------------------------------------------------------------------------------------------------------
2001 301,359 171,006 472,365
----------------------------------------------------------------------------------------------------------------
2002 302,464 162,134 464,598
----------------------------------------------------------------------------------------------------------------
Source: Tabulation of data from IRS's Return Inventory Classification System, 1998-2002.
Table 2: Assets Reported by Section 501(c) Entities in 2004 Constant Dollars, Tax Years 1998-2002
----------------------------------------------------------------------------------------------------------------
All entities Charities Noncharities
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Tax year Assets (in Percent Assets (in Percent Assets (in Percent
millions) change millions) change millions) change
----------------------------------------------------------------------------------------------------------------
1998 $2,208,676 N/A $1,509,209 N/A $699,467 N/A
----------------------------------------------------------------------------------------------------------------
1999 $2,413,917 9.3% $1,664,857 10.3% $749,059 7.1%
----------------------------------------------------------------------------------------------------------------
2000 $2,474,471 2.5% $1,696,064 1.9% $778,407 3.9%
----------------------------------------------------------------------------------------------------------------
2001 $2,552,606 3.2% $1,733,734 2.2% $818,872 5.2%
----------------------------------------------------------------------------------------------------------------
2002 $2,545,189 -0.3% $1,694,435 -2.3% $850,754 3.9%
----------------------------------------------------------------------------------------------------------------
Source: Tabulation of data from IRS's Return Inventory Classification System, 1998-2002.
Table 3: Revenues Reported by Section 501(c) Entities in 2004 Constant Dollars, Tax Years 1998-2002
----------------------------------------------------------------------------------------------------------------
All entities Charities Noncharities
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Tax year Revenues (in Percent Revenues (in Percent Revenues (in Percent
millions) change millions) change millions) change
----------------------------------------------------------------------------------------------------------------
1998 $1,121,387 N/A 844,224 N/A 277,163 N/A
----------------------------------------------------------------------------------------------------------------
1999 $1,214,807 8.3% 925,849 9.7% 288,958 4.3%
----------------------------------------------------------------------------------------------------------------
2000 $1,240,216 2.1% 944,131 2.0% 296,085 2.5%
----------------------------------------------------------------------------------------------------------------
2001 $1,258,046 1.4% 953,841 1.0% 304,205 2.7%
----------------------------------------------------------------------------------------------------------------
2002 $1,250,914 -0.6% 941,197 -1.3% 309,718 1.8%
----------------------------------------------------------------------------------------------------------------
Source: Tabulation of data from IRS's Return Inventory Classification System, 1998-2002.
Table 4: Expenses Reported by Section 501(c) Entities in 2004 Constant Dollars, Tax Years 1998-2002
----------------------------------------------------------------------------------------------------------------
All entities Charities Noncharities
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Tax year Expenses (in Percent Expenses (in Percent Expenses (in Percent
millions) change millions) change millions) change
----------------------------------------------------------------------------------------------------------------
1998 $1,017,582 N/A $768,280 N/A $249,303 N/A
----------------------------------------------------------------------------------------------------------------
1999 $1,091,788 7.3% $826,572 7.6% $265,215 6.4%
----------------------------------------------------------------------------------------------------------------
2000 $1,145,280 4.9% $867,063 4.9% $278,217 4.9%
----------------------------------------------------------------------------------------------------------------
2001 $1,210,670 5.7% $912,200 5.2% $298,470 7.2%
----------------------------------------------------------------------------------------------------------------
2002 $1,221,859 0.9% $917,528 0.6% $304,330 2.0%
----------------------------------------------------------------------------------------------------------------
Source: Tabulation of data from IRS's Return Inventory Classification System, 1998-2002.
Table 5: Section 501(c) Entities' Reported Expenses as a Percentage of U.S. Gross Domestic Product, 1998-2002
----------------------------------------------------------------------------------------------------------------
Section 501(c)
U.S. GDP (in Section 501(c) Entities' Expenses
Year Millions) Entities' Expenses as a Percentage of
(in Millions) U.S GDP
----------------------------------------------------------------------------------------------------------------
1998 8,747,000 $1,017,582 11.6%
----------------------------------------------------------------------------------------------------------------
1999 9,268,000 $1,091,788 11.8%
----------------------------------------------------------------------------------------------------------------
2000 9,817,000 $1,145,280 11.7%
----------------------------------------------------------------------------------------------------------------
2001 10,128,000 $1,210,670 12.0%
----------------------------------------------------------------------------------------------------------------
2002 10,487,000 $1,221,859 11.7%
----------------------------------------------------------------------------------------------------------------
Source: Tabulation of data from IRS's Return Inventory Classification System, 1998-2002 and U.S. Department of
Commerce figures.
Appendix IV: IRS Data on Its Tax-Exempt Oversight
The following tables summarize data provided by IRS on its
oversight activities involving tax-exempt entities under section 501(c)
of the Internal Revenue Code. The tables cover resources, applications,
examinations, and examination results.
Table 6: Assigned FTEs as IRS Budgeted for Exempt Activities, Fiscal Years 2000-2005
----------------------------------------------------------------------------------------------------------------
Determination
Fiscal year Examination FTE FTE Other FTE Total FTE
----------------------------------------------------------------------------------------------------------------
2000 424 342 32 798
----------------------------------------------------------------------------------------------------------------
2001 432 347 33 812
----------------------------------------------------------------------------------------------------------------
2002 421 351 44 816
----------------------------------------------------------------------------------------------------------------
2003 394 370 38 802
----------------------------------------------------------------------------------------------------------------
2004 378 348 43 769
----------------------------------------------------------------------------------------------------------------
2005 467 347 42 856
----------------------------------------------------------------------------------------------------------------
Source: IRS Exempt Organization officials.
Note: ``Other FTE'' include technical staff who issue rulings, director's staff, and education and outreach.
FTEs assigned are what IRS budgets for this work.
Table 7: Actions Taken on Applications for Tax-Exempt Status, Fiscal Years 1998-2003
----------------------------------------------------------------------------------------------------------------
Total Percent
Fiscal year applications Approved approved Denied Other
----------------------------------------------------------------------------------------------------------------
1998 78,358 58,162 74.2% 593 19,603
----------------------------------------------------------------------------------------------------------------
1999 73,605 59,264 80.5% 585 13,756
----------------------------------------------------------------------------------------------------------------
2000 82,707 67,267 81.3% 482 14,938
----------------------------------------------------------------------------------------------------------------
2001 81,636 65,409 80.1% 646 15,581
----------------------------------------------------------------------------------------------------------------
2002 87,342 70,214 80.4% 557 16,571
----------------------------------------------------------------------------------------------------------------
2003 91,439 72,092 78.8% 1,192 18,155
----------------------------------------------------------------------------------------------------------------
2004 87,080 69,315 79.6% 1,050 16,715
----------------------------------------------------------------------------------------------------------------
Source: GAO Analysis of IRS's Exempt Determination System, 1998-2004.
Note: The ``Other'' category includes applications withdrawn; applications that did not provide the required
information; incomplete applications; IRS refusals to rule on applications because the information submitted
was insufficient to conclude whether to approve the exemption request; and applications forwarded to other
than the IRS National Office.
Table 8: Examination Rate of Section 501(c) Entities, 1998-2003
----------------------------------------------------------------------------------------------------------------
Returns filed in Returns examined in
Fiscal year previous year fiscal year Examination rate
----------------------------------------------------------------------------------------------------------------
1998 458,014 8,290 1.8%
----------------------------------------------------------------------------------------------------------------
1999 449,537 8,780 2.0%
----------------------------------------------------------------------------------------------------------------
2000 472,443 6,866 1.5%
----------------------------------------------------------------------------------------------------------------
2001 470,575 5,471 1.2%
----------------------------------------------------------------------------------------------------------------
2002 472,365 5,423 1.1%
----------------------------------------------------------------------------------------------------------------
2003 464,598 5,964 1.3%
----------------------------------------------------------------------------------------------------------------
Source: GAO Tabulation of IRS's Audit Information Management System and IRS's Return Inventory Classification
System, 1997-2002.
Table 9: Examinations Resulting in No Change to Forms 990 Filed by Section 501(c) Entities, Fiscal Years 1998--
2004
----------------------------------------------------------------------------------------------------------------
Examinations
Fiscal Year Examinations resulting in no No-change rate
change
----------------------------------------------------------------------------------------------------------------
1998 8,290 2,552 30.8%
----------------------------------------------------------------------------------------------------------------
1999 8,780 3,191 36.3%
----------------------------------------------------------------------------------------------------------------
2000 6,866 2,431 35.4%
----------------------------------------------------------------------------------------------------------------
2001 5,471 2,112 38.6%
----------------------------------------------------------------------------------------------------------------
2002 5,423 2,445 45.1%
----------------------------------------------------------------------------------------------------------------
2003 5,964 2,965 49.7%
----------------------------------------------------------------------------------------------------------------
2004 5,889 2,299 39.0%
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS's Audit Information Management System, 1998-2004.
Appendix V: Tax-Exempt Excise Taxes by Code Sections
Over the years, Congress has imposed various excise taxes that
affect tax-exempt entities, particularly private foundations under
Section 501(c)(3). Private foundations differ in several ways from
public charities. Public charities have broad public support and tend
to provide charitable services directly to beneficiaries. Private
foundations are often tightly controlled and receive a significant
portion of their funds from a small number of donors, and tend to make
grants directly to other entities rather than directly provide
charitable services. Since these differences create the potential for
self-dealing or abuse by a small group, private foundations are subject
to anti-abuse rules not applicable to public charities. In addition,
public charities and private foundations generally are prohibited from
engaging in certain types of transactions. Excise taxes are to be
levied on public charities and private foundations, as well as a few
other types of tax-exempt entities, who violate the rules. Details on
these rules and excise taxes follow.
Section 4940 Excise Tax on Private Foundation Investment Income
Section 4940 was added by the Tax Reform Act of 1969, P.L. 91-172.
The related Senate Report \35\ described the excise tax as an ``audit
fee tax'' that was believed to be necessary to cover IRS's costs for
increased supervision over private foundations under the act. Section
4940 imposes a 2 percent excise tax on the net investment income of
tax-exempt private foundations. Net investment income includes income
from interest, dividends, and net capital gains that is reduced by the
expenses incurred to earn it. This tax is 1 percent if a private
foundation meets certain distribution requirements. Private foundations
that meet the requirements to be an ``exempt operating foundation'' are
not subject to this excise tax. Among these requirements are
stipulations that the foundation be publicly supported for at least 10
years and that it have a governing body that is broadly representative
of the general public. Private foundations that are not exempt from
taxation are subject to this excise tax and unrelated business income
tax.
---------------------------------------------------------------------------
\35\ S. Rep. No. 91-552 (1969).
---------------------------------------------------------------------------
Section 4941 Excise Tax on Private Foundation Acts of Self-Dealing
Because a tax-exempt entity cannot operate to confer a benefit on
private parties,Section 4941 was enacted by the Tax Reform Act of 1969.
According to the Senate Report, generally prohibiting self-dealing
transactions would minimize the need to apply the subjective arm's-
length standard that was used for loans, payments of compensation, and
preferential availability of services under the 1950 amendments.
Section 4941 imposes a 5 percent excise tax on acts of self-dealing
between a private foundation and disqualified persons. This tax is to
be paid by the disqualified person who participated in the self-
dealing. An additional tax equal to 200 percent of the amount involved
is to be imposed if the self-dealing is not corrected during the
taxation period. A separate tax equal to 2 = percent of the amount
involved is to be imposed on the foundation's manager if that manager
knowingly participated in the act of self-dealing. If this additional
tax has been imposed on the foundation manager and that manager refuses
to agree to part or all of the correction, an additional tax equal to
50 percent of the amount is to be imposed. Acts of self-dealing include
sales, exchanges, or leases of property; lending of money or other
extensions of credit; and payment of compensation. Disqualified persons
include substantial contributors to the foundation, foundation
managers, an owner of more than 20 percent of a business enterprise
that is a substantial contributor, and certain government officials.
Section 4942 Excise Tax on Private Foundation Failure to Distribute
Income
Section 4942 was enacted by the Tax Reform Act of 1969. Prior to
it, a private foundation could lose its exemption if it failed to make
distributions towards its charitable purposes instead of just
accumulating income. According to the Senate report, the committee
believed that loss of exempt status as the only sanction was often
ineffective or harsh, and that substantial improvement could be
achieved by providing a graduation of sanctions if income is not
distributed. Section 4942 imposes a 15 percent excise tax on the
undistributed income of a private foundation for any taxable year in
which the required amount has not been distributed before the first day
of the next taxable year. If an initial tax has been imposed under
section 4942 and the income remains undistributed at the end of the
taxable period, a tax equal to 100 percent of the remaining
undistributed amount is to be imposed. This excise tax does not apply
to private operating foundations that meet distribution requirements or
to the extent that the failure to distribute is due solely to an
incorrect valuation of assets as long as other requirements are met.
Excise Tax on Private Foundation Excess Business Holdings (Section
4943)
Section 4943 was enacted by the Tax Reform Act of 1969. According
to its Senate Report, the use of foundations to maintain control of a
business appeared to be increasing, and some who wished to use a
foundation's stock holdings to control a business were relatively
unconcerned about producing income for charitable purposes. Where the
charitable ownership predominated, the business could unfairly compete
with businesses whose owners were required to pay taxes on their
business income. The committee concluded that a limit on the extent to
which a private foundation may control a business was needed. Section
4943 imposes a 5 percent excise tax on certain excess business holdings
of a private foundation. Permitted holdings generally include up to 20
percent of the voting stock of an incorporated business enterprise
(reduced by the percentage of the voting stock owned by all
disqualified persons). Similar holdings are also permitted in
partnerships and other unincorporated enterprises (except sole
proprietorships). If the excise tax has been imposed, foundations that
fail to make the required divestiture of excess holdings above the
permitted amounts are subject to an additional tax equal to 200 percent
of the excess holdings. In certain cases, foundations are allowed a 5-
year period to dispose of the excess holdings and may receive an
additional 5-year extension.
Excise Tax on Private Foundation Investments which Jeopardize
Charitable
Purpose (Section 4944)
Section 4944 was enacted by the Tax Reform Act of 1969. Under prior
law, a private foundation could lose its exemption if it invested in a
manner that jeopardized its exempt purpose. In the Senate Report, the
committee concluded that limited sanctions were preferable to the loss
of exemption. Section 4944 imposes an initial 5 percent excise tax on
the amount involved if a private foundation invests in a manner that
jeopardizes its exempt purpose (e.g., investing with the purpose of
income production or property appreciation). If such a tax is imposed
on the foundation, a separate 5 percent excise tax is to be imposed on
the foundation manager if that manager knew that making the investment
would jeopardize the foundation's exempt purpose. If an initial tax is
imposed, an additional tax equal to 25 percent of the amount of the
investment is to be imposed on the foundation if the investment is not
withdrawn within the taxable period. An additional tax equal to 5
percent of the amount of the investment is to be imposed on the
foundation manager if the investment is not withdrawn.
Excise Tax on Private Foundation Taxable Expenditures (Section 4945)
Section 4945 was enacted by the Tax Reform Act of 1969. Under prior
law, the only sanction against prohibited political activity by a
foundation was loss of exemption. The Senate committee report noted
that the standards for determining the permissible level of political
activity were so vague as to encourage subjective application of the
sanction. As a result, section 4945 was added to clarify the types of
impermissible activities and provide more limited sanctions. Section
4945 imposes an initial 10 percent excise tax on each taxable
expenditure made by the foundation. An additional 2\1/2\ percent excise
tax is to be imposed on the foundation manager if that manager
knowingly participated in the taxable expenditure. Taxable expenditures
include amounts paid to carry on propaganda or otherwise influence
legislation or the outcome of a public election, or to directly or
indirectly carry on a voter registration drive. If the expenditure is
not corrected within the taxable period, an additional tax equal to 100
percent of the amount of the expenditure is to be imposed on the
foundation and additional tax equal to 50 percent of the amount of the
expenditure is to be imposed on the foundation manager.
Excise Tax on Section 501(C) (3) Political Expenditures (Section 4955)
Section 4955 was added by the Revenue Act of 1987, P.L. 100-203.
According to the House Report \36\ for the act, the committee believed
that the excise tax applicable to private foundations for making
prohibited political expenditures (section 4945) should also apply to a
public charity. Section 4955 imposes an initial 10 percent excise tax
on each political expenditure of a section 501(c) (3) organization. An
additional 2\1/2\ percent excise tax is imposed on the organization's
manager if the manager knew that it was a political expenditure.
Political expenditures include any amounts paid or incurred by the
organization in any participation or intervention in any political
campaign on behalf of any candidate for public office. If an initial
tax has been imposed regarding a political expenditure and that
expenditure is not corrected, an additional tax equal to 100 percent of
the amount is to be imposed on the organization. An additional tax
equal to 50 percent of the amount of the expenditure is to be imposed
on the organization's manager if that manager refuses to agree to part
or all of the correction.
---------------------------------------------------------------------------
\36\ H. Rep. No. 100-391 (1987).
---------------------------------------------------------------------------
Excise Tax on Section 501(C) (3) and (4) Excess Benefit Transactions
(Section 4958)
Section 4958 was added in 1996 by the Taxpayer Bill of Rights 2,
P.L. 104-168. According to the related House Report,\37\ this excise
tax was added to ensure that the advantages of tax-exempt status
benefit the community and not private individuals. The act provided for
this intermediate sanction (i.e., something short of a loss of tax
exemption) to be imposed when nonprofit organizations engage in
transactions with certain insiders that result in private inurement.
Section 4958 imposes an initial tax of 25 percent on each excess
benefit transaction entered into between a disqualified person and tax-
exempt organizations under sections 501(c)(3) and (4). The initial tax
is to be paid by this disqualified person, including any person who at
any time during the 5-year period ending on the date of the transaction
was in a position to exercise substantial influence over the
organization, a member of such person's family, and a 35 percent
controlled entity. Such an entity exists when a disqualified person
owns more than 35 percent of the voting power of a corporation, more
than 35 percent of the profit interest of a partnership, or more than
35 percent of the beneficial interest of a trust or estate. If an
initial tax is imposed on the disqualified persons, an additional tax
of 10 percent is to be imposed on the organization's manager if that
manager participated knowing that it was an excess benefit transaction.
If the excess benefit transaction is not corrected within the taxable
period, a tax equal to 200 percent of the excess benefit transaction
will be imposed on the disqualified person. Private foundations are not
subject to this excise tax.
---------------------------------------------------------------------------
\37\ H. Rep. No. 104-506 (1996).
---------------------------------------------------------------------------
Abatement of Taxes When Corrective Action Taken (Sections 4961-4963
Sections 4961-4963 provide for abating the various excise taxes
described above. Section 4961 stipulates that additional taxes shall
not be assessed if corrective action is taken within the applicable
correction period. Similarly, it stipulates that if the additional tax
is already assessed, it will be abated if corrective action is taken.
For example, the additional tax of 200 percent for self-dealing shall
not be assessed if corrective action is taken within the applicable
period. Section 4962 provides that excise taxes shall not be assessed
if the event that gave rise to the excise tax was (1) due to reasonable
cause, (2) not due to willful neglect, and (3) corrected within the
applicable period. If already assessed under these circumstances, the
excise tax shall be abated. Section 4963 sets out the instances in
which the abatement provisions apply.
Excise Taxes Owed for IRC Violations
IRS did not maintain data on how much excise tax involving tax-
exempt entities was ultimately assessed or collected either overall or
by the various types of violations. These assessments can result from
IRS examinations but IRS's system did not maintain information on these
types of assessments. These assessments may also arise from tax-exempt
entities ``self-assessing'' excise taxes by reporting the violations to
IRS. IRS did record excise taxes owed for certain types of IRC section
violations as reported by tax-exempt entities on Form 4720, Return of
Certain Taxes on Charities and Other Persons Under Chapters 41 and 42
of the Internal Revenue Code and on Form 990-PF, Return of Private
Foundation or Section 4947(a) (1) Nonexempt Charitable Trust Treated as
a Private Foundation.
As table 10 shows, tax-exempt entities reported self-assessments of
at least $247 million in 2004 constant dollars each year or about $1.5
billion in 2004 constant dollars for tax years 2000 through 2003.
Table 10: Excise Tax Amounts That Tax-exempt Entities Self Assessed on
Forms 4720a and 990-PFb by Code Section, Tax Years 2000-2003 (2004
Constant Dollars in Thousands)
------------------------------------------------------------------------
Tax year
Code section ---------------------------------------------------
2000 2001 2002 2003 Total
------------------------------------------------------------------------
Taxes on organizations
------------------------------------------------------------------------
Section 4942-- $2,196 $4,608 $3,802 $2,421 $13,027
Undistributed
income
------------------------------------------------------------------------
Section 4943--Excess 385 178 196 35 794
business holdings;
Section 4944--
Investments that
jeopardize, other c
------------------------------------------------------------------------
Section 4945-- 1,112 702 408 316 2,538
Taxable
expenditures
------------------------------------------------------------------------
Section 4955-- 1 4 8 0 13
Political
expenditures
------------------------------------------------------------------------
Subtotal 3,694 5,492 4,414 2,772 16,372
------------------------------------------------------------------------
Taxes on individuals
------------------------------------------------------------------------
Section 4941--Self- 438 665 415 204 1,722
dealing
------------------------------------------------------------------------
Sections 4944, 4945, 70 46 35 46 197
4955, and Section
4958--Excess
benefits
------------------------------------------------------------------------
Subtotal 508 711 450 250 1,919
------------------------------------------------------------------------
Tax on net investment income
------------------------------------------------------------------------
Section 4940-- 683,767 320,811 242,187 244,627 1,491,392
Investment Income
------------------------------------------------------------------------
Total 687,969 327,014 247,051 247,649 1,509,683
------------------------------------------------------------------------
Source: GAO analysis of IRS data.
a Return of Certain Excise Taxes on Charities and Other Persons Under
Chapters 41 and 42 of the Internal Revenue Code.
b Return of Private Foundation or Section 4947(a)(1) Nonexempt
Charitable Trust Treated as a Private Foundation.
c Includes Section 4911--Excess Lobbying Expenditures and 4912--
Disqualifying Lobbying Expenditures.
(450383)
Chairman THOMAS. Mr. Yin is obviously the Chief of Staff of
the Joint Committee on Taxation, and thank you.
STATEMENT OF GEORGE K. YIN, CHIEF OF STAFF, JOINT COMMITTEE ON
TAXATION
Mr. YIN. Mr. Chairman, Mr. Rangel, Members of the
Committee, thank you very much for asking me to testify today.
In my brief comments, I am going to cover just three areas. One
is to provide some highlights about the sector. Second is to
discuss briefly some compliance issues concerning the sector.
Third, I am going to talk briefly about the rationale for tax
exemption. You should have before you a pamphlet prepared by
the staff which includes a wealth of information about the tax-
exempt sector, including a historical development as well as a
description of present law rules. If I could draw your
attention, however, to a smaller document which you should also
have before you, it is a summary table of types and tax
treatment of section 501(c) organizations. The number on the
bottom is JCX-30-05. I just want to walk you through a little
of that table to hit a few of the highlights of the sector
before going on to my other two areas.
Chairman THOMAS. If you will wait just a moment, Mr. Yin.
Members are going through trying to find it. It is the one with
the eagle on the cover and it is printed sideways----
Mr. YIN. It is just about a six- or seven-page document.
Chairman THOMAS. It is done on the long side. Thank you.
Mr. YIN. You will see, if you turn to the first page, that
we list here the 28 separate categories of exempt organizations
under section 501(c). Now, I should preface by saying that
these are not all of the exempt organizations allowed under the
Internal Revenue Code. There are a whole group of additional
organizations that are exempt. Most significantly, of course,
are the ones involving retirement and other benefit vehicles.
Here, we are focusing simply on the 501(c)s and you have 28
categories. If you look at the third column, you will see, just
glancing down, that there are a range of dates in which these
exemptions came into being. In general, there were no one or
two watershed events when Congress sat down and determined that
certain organizations should be exempt. They largely have come
into the law piecemeal. You also notice in the dates that some
of the dates are quite old. Some of the exemptions date back to
1894, which is even before the passage of the 16th amendment.
Some of them, of course, are quite recent. If you look to the
far right-hand column, you will see the number of entities
within each of these categories as listed under the IRS master
file. Now, I need to give you a little caution about the
numbers in the master file because the master file does not
necessarily exclude all organizations that have dissolved, if
the IRS hasn't received notice of that. It also does not
include all organizations. Most particularly, some churches,
are not recorded in the IRS master file. Having said that, as
Mr. Walker indicated, there are about a million-and-a-half
entities listed in the IRS master file, and if you notice on
that first page, the third line, the charitable category,
501(c)(3), makes up the bulk of that, about a million entities
in the charitable sector that are on the master file. Within
that million, about 10 percent of them comprise 80 percent of
the assets and revenue in the charitable sector.
There are other categories which have a large number of
organizations, but there are a number of categories which have
very few. In fact, nine of the categories have under 50
organizations and four of the categories have fewer than five
organizations. The remaining columns simply identify some of
the common features that are applicable to some or most exempt
organizations. If you look under the column called ``Subject to
UBIT,'' that is the Unrelated Business Income Tax, that is your
fifth column, you will see that virtually all of these
organizations are subject to a UBIT. If you look under the
column called ``Taxed on Investment Income,'' you will see
that, generally, the organizations are not taxed on their
investment income, except there are some important exceptions
to that. If you look at the next column, about contributions,
whether contributions to the organizations are deductible, you
will see that, in general, it is limited to charitable
organizations and a couple of others that allow charitable
deductions. Some of the organizations' contributions are
deductible as business expenses, but not as charitable
contributions.
Finally, if you look at the next column involving ``Subject
to Private Inurement``--this is the doctrine which prohibits
the use of organizations' assets to benefit the insiders of the
organization--you will see a somewhat mixed group. That is,
some of them are subject to those rules and some of them are
not subject to those rules. Turning now to compliance issues, I
just wanted to highlight a couple of points. In terms of the
entity, the key point is that exemption is a privilege and not
a right and it is a privilege subject to certain specific
conditions laid out by Congress. Most of the compliance
questions in this area as it relates to the entity relate to
whether one or more of the conditions are being satisfied or
not. There are, of course, various policy tools which Congress
has enacted, including taxes, which attempt to encourage or
discourage certain types of activity on the part of one or more
of these organizations, and in that regard, the effectiveness
of a tax is not necessarily measured by how much revenue it
raises, but rather on how successful it is in encouraging or
curbing the particular behavior that the tax is designed to
address. Before I leave the compliance area, I should mention
that there is another compliance issue in this area not
relating to the entities as such but on the contribution side,
and on that score, there is a balance. The balance is between
the amount of additional charitable giving that would be
induced by a policy tool that would ``not otherwise occur,''
and those last words are very important. Then to determine the
nature of the policy tool that tries to induce that type of
change in behavior and whether the policy tool is susceptible
to noncompliance or not. Last, I want to address briefly what I
suspect many of you may have in your minds, which is now that
we see there are all these different categories of exempt
organizations and they have come in in different times and they
have different labels and all of that, is there some master
scheme here? Is there some overriding purpose in which we say
that some organizations are exempt and others are not? The
short answer to that question, which is certainly a very fair
one to ask, as best we can determine, there is no master
scheme. I suppose that would be expected, given the fact that
many of these exemptions came into the law piecemeal so that
there wasn't a master plan as such that was laid down.
However, having said that, there are a few general
explanations that one can use to explain some or many of the
exemptions, and let me just mention four explanations. Some of
these explanations overlap with one another. First, it is
important to know that when an organization is exempt from
Federal taxes, that determination is an issue of the Federal
tax code and that that is different from whether an
organization is a nonprofit organization, which is largely a
determination based on State law. In general, under State law,
what nonprofit means is an organization is prohibited from
distributing its earnings to members. Not all nonprofit
organizations under State law are tax-exempt, and conversely,
some tax-exempt organizations may not necessarily be subject to
this constraint that is typically applied to nonprofit
organizations. Despite that, some have argued that the
distinctive characteristics of a nonprofit organization may
make certain classes of them appropriate choices for Federal
tax exemption. A second general explanation is that if you
review the organizations, you will quickly see that some number
of them carry out activities that one might classify as
governmental functions in nature. Just as it would generally
not be productive for the government, for example, to tax
itself, it is argued sometimes that it is not productive for
the government to tax an organization that is carrying out
largely a governmental function. Certain charities and
organizations may fit within this general explanation.
A third explanation would be that certain organizations,
because of their structure, and in particular their
relationship to their members, don't provide the kinds of
circumstances in which taxation would be appropriate. Let me
try to give you a simple example. Let us assume that all of the
Members of the Committee decided to form a social club together
in which you all agreed to assess yourselves certain membership
fees which are then used to essentially purchase certain kinds
of activities in which you all wish to engage in. Let us assume
that in a given period, the amount of fees that are collected
by the club are in excess of the costs of the club, and so in
some general sense, one could argue that the club has made a
profit. When you realize that if, in fact, under the terms of
the club that you formed, all of the excess, if you will, is
simply reinvested into the club to provide additional benefits,
future benefits for the members, I think it is easy to realize
that in some sense, this arrangement that you have made is no
different from simply each of you purchasing on your own,
spending some money to purchase current and future benefits,
perhaps in current benefits or capital expenditures, and that
there is really no income in this picture at all. Some part of
the explanation for some of the organizations' exemption may be
attributable to this type of an explanation. Finally, the
fourth explanation I will offer is that some organizations are
exempt because it is an explicit attempt by Congress to provide
an incentive, which the exemption represents. A good example of
that, of course, might be some of your retirement vehicles and
other employee benefit vehicles. Thank you very much. I would
be happy to answer any questions.
Chairman THOMAS. Thank you very much. You were obviously
trying to get the attention of the Members. As soon as you
mentioned the social club, every Member was trying to figure
out who was going to be the social Chairman.
[Laughter.]
[The prepared statement of Mr. Yin follows:]
Statement of George Yin, Chief of Staff, Joint Committee on Taxation
Mr. Chairman, Mr. Rangel, members of the Committee, I am pleased to
testify today on the tax-exempt sector. I first provide a brief
overview of the size and growth of the exempt sector, discuss some of
the reasons why organizations have been granted tax-exempt status, and
describe some common tax law features of exempt organizations. I
conclude my testimony by focusing on charitable organizations, the
largest category by far of exempt organizations. I summarize the
requirements for exempt status as a charitable organization and review
selected current issues relating to those organizations.
A. Overview of Organizations Exempt from Federal Income Tax
Size and growth of the exempt sector generally
Since the inception of the Federal income tax, the Congress has
exempted certain types of entities from income taxation. Many exempt
entities, such as charitable organizations, are familiar. Yet
charitable organizations are but one type of exempt entity. The benefit
of tax exemption is extended to groups as diverse as social welfare
organizations, title holding companies, fraternal organizations, small
insurance companies, credit unions, cooperative organizations, and
cemetery companies. The statistics reported in this document do not
include churches, which are not required to file returns with the
Internal Revenue Service (``IRS''), and are not recorded in the IRS
Master File of Exempt Organizations.
There are now 28 different types of organizations listed in the
main exemption section of the Code (section 501), and numerous other
exemptions provided elsewhere.\1\ The number and financial holdings of
these organizations are large and have grown significantly since
record-keeping began in 1975. The revenue reported to the IRS by such
organizations has increased from approximately $0.3 trillion (in 2001
dollars) in 1975 to about $1.2 trillion in 2001. The 2001 revenue
represented approximately 12.2 percent of gross domestic product in
that year. The assets reported by the organizations have similarly
increased, from approximately $0.5 trillion (in 2001 dollars) in 1975
to almost $2.9 trillion in 2001.
---------------------------------------------------------------------------
\1\ In general, my testimony does not discuss entities that are
exempt under section 401 of the Code, which are subject to a completely
different regulatory apparatus than those exempt under section 501.
---------------------------------------------------------------------------
While a large majority of exempt entities fall into familiar
categories, such as charitable organizations, there are also a fair
number of organizations that fall into more obscure categories. Eight
categories have fewer than 150 qualifying entities each, with four
categories having fewer than five entities each
Size and growth of the charitable sector
Charitable organizations described in section 501(c)(3) represent
by far the largest category of exempt organizations, comprising about
two-thirds of all exempt organizations. The 2004 IRS Master File of
Exempt Organizations shows 1,010,365 charitable organizations. In terms
of asset size and revenues, the share of charitable organizations in
the exempt sector is similar. In 2001, the total revenue of charitable
organizations (including private foundations but not including churches
and other organizations not required to file) was about 9.3 percent of
gross domestic product.
Among charitable organizations not including churches, the largest
categories of organizations are hospitals and post-secondary
educational organizations. In 2001, hospitals held 29 percent of total
assets and collected 42 percent of total revenues in the exempt sector.
Colleges and universities held 21 percent of the total assets and
collected 11 percent of total revenue.
There has been significant recent growth in the number and size of
charitable organizations. The number of such organizations has
increased from 259,523 in 1976 to 1,010,365 in 2004, an increase of 289
percent. The total asset value and revenues (in 2001 dollars) reported
to the IRS by charitable organizations similarly increased from about
$360 billion and $155 billion, respectively, in 1975, to over $2
trillion and about $942 billion, respectively, in 2001.
The growth in the number and size of charitable organizations has
been accompanied by growth in the amount of charitable deductions. In
1975, the total amount claimed as charitable deductions was about $43.7
billion whereas in 2002, the total was about $145 billion (both numbers
in constant 2000 dollars).
B. Reasons for Tax Exemption
There is no unifying theme or singular principle that explains tax
exemption for the many diverse organizations in the exempt sector,
although there are some factors that may help to explain the exemption
for certain of them.
Over the years, Congress has granted tax exemption only to certain
types of organizations. As an initial matter, not all ``nonprofit''
organizations are afforded tax exemption, and not all tax-exempt
organizations have the typical characteristics of a ``nonprofit''
organization. The term ``nonprofit'' generally refers to an
organization's form under State law, not its Federal tax status. State
law generally does not prohibit ``nonprofits'' from earning a profit,
as one might expect. Instead, State law typically prohibits the
distribution of earnings by nonprofit corporations (but not necessarily
by other forms of entities) to their members.
The Federal exemption is extended in some instances to
organizations that are not subject to a State-law constraint on
distributions, as some entities are not required for exemption purposes
to be organized in corporate form. Therefore, exemption may be obtained
by some organizations that do not fit the classic definition of
``nonprofit.'' However, the Federal tax laws applicable to certain
types of exempt organizations (though not all) contain prohibitions,
such as the ``no private inurement'' and ``no private benefit''
doctrines, that are in some respects similar to the State-law
constraint.
For some organizations, exemption from tax may be explained based
on the nature of its activities. For example, charitable activities or
activities that provide a public benefit may be viewed as governmental
in nature and therefore not appropriate subjects of taxation. This may
explain the exemption for charitable organizations, social welfare
organizations, U.S. instrumentalities, and State and local governments.
Promotion of certain activities may also be viewed as desirable policy,
and therefore tax exemption is intended to encourage the activity. This
may explain the tax exemption for arrangements to provide employee
benefits, arrangements for individuals to save for health, retirement,
and education, and the exemption for small or rural commercial
organizations that engage in certain activities, such as farming,
provision of financial services, insurance, electricity, or other
public good.
Exempt status may also be attributable to the structure of an
organization. Some organizations are funded exclusively by their
members and expend all funds exclusively for members. If such an
organization collects more in membership dues than its expenses, the
excess is reinvested in the organization for the benefit of the
members. Under general tax principles, the organization may not be
considered as having any income because there has not been a shifting
of benefit from the member to the organization--the organization merely
facilitates a joint activity of its members. Thus, in some cases, the
Code adopts a result that might occur even in the absence of statutory
law, e.g., social clubs, fraternal organizations, voluntary employees'
beneficiary associations, cemetery companies, and homeowners
associations.
Another factor that may explain some cases of tax exemption is the
nature of the legislative process. As noted, Congress did not provide
exemption for all organizations that are not organized for profit;
rather, the general rule is that an organization is subject to tax
absent a specific exemption. Such a rule means that once broad
categories of exemption are codified, there will be specific classes of
organizations that do not fit within the broad category and that seek
and receive exempt status. Social welfare organizations, business
leagues, labor, agricultural, and horticultural organizations and other
organizations may be examples.
Another factor to consider is simple expediency, in that taxing
certain small organizations was viewed at the time the exemption was
granted as too costly to administer, especially when often little or no
tax would be due. This appears partially to explain the reason for
exempting single-parent title holding companies from tax as well as
social clubs. As stated in 1916 legislative history: ``the securing of
returns from them has been a source of annoyance and expense and has
resulted in the collection of either no tax or an amount which is
practically negligible.''
C. Common Tax Law Features of Exempt Organizations
In general
Despite varying standards regarding qualification for exempt
status, different categories of exempt organizations share some common
characteristics. For example, many types of exempt organizations are
subject to a prohibition against ``private inurement,'' and most exempt
organizations are subject to the general rules regarding the taxation
of unrelated business income. Contributions to a limited number of
exempt organizations are deductible as charitable contributions, while
contributions to others may be deductible as a business expense but not
as a charitable contribution. Most exempt organizations also are
subject to rules regarding lobbying and political campaign activities
and are required to file annual information returns.
Private inurement prohibition.
The doctrine of private inurement generally prohibits an exempt
organization from using its assets for the benefit of a person or
entity with a close relationship to the organization. For example,
section 501(c)(3) provides that an organization will qualify for
charitable exempt status only if ``no part of the net earnings [of the
organization] inures to the benefit of any private shareholder or
individual.'' The regulations under section 501(a), which generally
apply to organizations subject to the inurement proscription, define
``private shareholder or individual'' as ``persons having a personal
and private interest in the activities of the organization.'' Inurement
thus applies to transactions between applicable exempt organizations
and persons sometimes deemed ``insiders'' of the organization, such as
directors, officers, and key employees. The issue of private inurement
often arises where an organization pays unreasonable compensation
(i.e., more than the value of the services) to such an insider.
However, the inurement prohibition is designed to reach any transaction
through which an insider is unduly benefited by an organization, either
directly or indirectly.
There is no ``de minimis'' exception under the inurement
prohibition, and an organization that engages in an inurement
transaction may face revocation of its exempt status. Until 1996, there
was no sanction short of revocation of exempt status in the event of an
inurement transaction. In 1996, however, Congress imposed excise taxes,
frequently referred to as ``intermediate sanctions,'' on ``excess
benefit transactions'' between certain exempt organizations and
``disqualified persons.'' The intermediate sanctions rules, which apply
only to transactions involving organizations exempt under sections
501(c)(3) and 501(c)(4), impose excise taxes on a disqualified person
who receives an excess benefit and, under certain circumstances, on
organization managers who approved the transaction. No such sanctions
are presently imposed against the organization itself.
Section 501(c)(3) organizations (but not other organizations) also
are subject to a prohibition against conferring more than incidental
``private benefit.'' The private benefit prohibition applies to non-
fair market value transactions with individuals or entities, not merely
with insiders, and thus is in some respects broader than the private
inurement prohibition.
Unrelated business income tax
In general, an exempt organization may have revenue from four
sources: contributions, gifts, and grants; trade or business income
that is related to exempt activities (e.g., program service revenue);
investment income; and trade or business income that is not related to
exempt activities. In general, the Federal income tax exemption extends
to the first three categories, and does not extend to an organization's
unrelated trade or business income. In some cases, however, the
investment income of an organization is taxed as if it were unrelated
trade or business income.
The unrelated business income tax was introduced in 1950 to address
the problem of unfair competition between for profit companies and non
profit organizations conducting an unrelated for profit activity. The
unrelated business income tax generally applies to income derived from
a trade or business regularly carried on by the organization that is
not substantially related to the performance of the organization's tax-
exempt functions. Most exempt organizations are subject to the tax.
Most exempt organizations generally may operate an unrelated trade
or business so long as it is not a primary purpose of the organization.
Therefore, engaging in a substantial amount of unrelated business
activity before jeopardizing exempt status is permitted. By contrast, a
charitable organization may not operate an unrelated trade or business
as a substantial part of its activities.
Certain types of income are specifically exempt from the unrelated
business income tax, such as dividends, interest, royalties, and
certain rents, unless derived from debt-financed property or from
certain 50-percent controlled subsidiaries.
For the tax year 2001, 35,540 organizations filed unrelated
business income tax returns, reporting a total of $7.9 billion of gross
unrelated business income. This translated into unrelated business
taxable income (after taking into account allowable deductions) of
approximately $792 million and total tax of approximately $226 million.
Contributions
Another feature of a minority of tax-exempt organizations is that
contributions to such organizations may be deductible by the donor as
charitable contributions for income, estate, and gift tax purposes.
Contributions to charitable organizations, for example, generally are
deductible for income, estate, and gift tax purposes, although the
amount of deduction may be affected by such factors as the recipient
organization's classification as a public charity or private foundation
and the type of property contributed. Other types of organizations that
are eligible recipients of charitable contributions include: certain
Federal, State, and local government entities, if the contribution is
exclusively for public purposes; certain fraternal beneficiary
societies, if the contributions are used for charitable purposes;
cemetery companies, if the contributions are used for certain purposes;
and certain organizations of war veterans.
Contributions to other types of exempt organizations generally are
not deductible as charitable contributions. Under certain
circumstances, however, contributions to a membership organization,
such as a social welfare organization or trade association, may be
deductible as a business expense under section 162. In addition,
contributions to tax-exempt employee benefit arrangements (e.g.,
qualified retirement plans) or individual savings arrangements (such as
individual retirement accounts) may be deductible.
Lobbying and political activities
Tax-exempt organizations are also subject to rules regarding the
permissible level of lobbying and political campaign activities. In
general, the lobbying and political activity rules applicable to
charitable organizations are more severe than the rules applicable to
other types of exempt organizations.
Information returns
Exempt organizations are required to file an annual information
return, stating specifically the items of gross income, receipts,
disbursements, and such other information as the Secretary may
prescribe. The requirement that an exempt organization file an annual
information return does not apply to certain exempt organizations,
including organizations (other than private foundations) the gross
receipts of which in each taxable year normally are not more than
$25,000. Also exempt from the requirement are churches, their
integrated auxiliaries, and conventions or associations of churches;
the exclusively religious activities of any religious order; certain
state institutions whose income is excluded from gross income under
section 115; an interchurch organization of local units of a church;
certain mission societies; certain church-affiliated elementary and
high schools; and certain other organizations, including some that the
IRS has relieved from the filing requirement pursuant to its statutory
discretionary authority.
D. Summary of Requirements of Exempt Status of Charitable Organizations
and Selected Issues Relating to Such Organizations
In general
In general, the requirements for exempt status of an organization
under section 501(c)(3) of the Code are that (1) the organization must
be organized and operated exclusively for certain purposes; (2) there
must not be private inurement to organization insiders; (3) there must
be no more than an incidental private benefit to private persons who
are not organization insiders; (4) no substantial part of the
organization's activities may be lobbying; and (5) the organization may
not participate or intervene in political activities. Permitted
purposes are religious, charitable, scientific, testing for public
safety, literary, educational, the fostering of national or
international amateur sports competition, or the prevention of cruelty
to children or animals. Failure to satisfy any of these requirements
should result in an organization not qualifying for exempt status under
section 501(c)(3), or should result in a loss of such status once a
violation is detected by the IRS. Most of the Federal law of charitable
organizations is designed around ensuring that each of the requirements
is satisfied by an organization initially and on an ongoing basis. Each
of the requirements is simple to state, but none are simple, as each
carries with it a significant body of statutory, common, and
administrative law.
If an organization satisfies each of the requirements, there is a
further question of what type of charitable organization it is. A
section 501(c)(3) organization is either a public charity or a private
foundation. In general, the basis for distinguishing between public
charities and private foundations is the level of public support an
organization receives over time. Organizations with widespread public
support tend to qualify as public charities; organizations funded by
just a few donors tend to be classified as private foundations. There
is a substantial body of law detailing how to determine whether an
organization is publicly supported. Certain organizations also may
qualify as public charities as a matter of law (e.g., churches,
hospitals). The classification matters because private foundations
generally are subject to more restrictions on their activities than are
public charities, are subject to tax on their net investment income,
and contributions to private foundations generally do not receive as
favorable treatment as do contributions to public charities for
purposes of the charitable contribution deduction.
Satisfaction of the requirements for exemption, classification of
an organization as a public charity or private foundation, plus the
resulting benefit that contributions to charitable organizations
generally are tax deductible provides the simplest snapshot of the law
of charitable organizations.
Exempt purposes of section 501(c)(3) organizations
The meaning of charity--present law
In general, there are two approaches to the meaning of the term
charitable--the legal sense and the ordinary and popular sense. The
legal definition is derived from the law of charitable trusts and is
broader than the ordinary sense of the term, which generally means the
relief of the poor and distressed. Since 1959, Treasury regulations
have defined the term ``charitable'' in the legal sense, to include:
Relief of the poor and distressed or of the underprivileged;
advancement of religion; advancement of education or science;
erection or maintenance of public buildings, monuments, or
works; lessening of the burdens of Government; and promotion of
social welfare by organizations designed to accomplish any of
the above purposes, or ((i) to lessen neighborhood tensions;
(ii) to eliminate prejudice and discrimination; (iii) to defend
human and civil rights secured by law; or (iv) to combat
community deterioration and juvenile delinquency.
This definition is broad, encompassing several ideas that would not
generally be considered as charitable in the ordinary sense. In
addition to meeting the regulatory definition of charitable, an
organization described in section 501(c)(3) is not organized and
operated for exempt purposes if a purpose of the organization is
against public policy or is illegal.
In addition to the public policy requirement, certain common law
principles inform the Federal tax law definition of charity. The
charitable class requirement provides that an organization be organized
to benefit a sufficiently large or indefinite class of people. The
community benefit doctrine permits exemption as a charitable
organization if the result of an activity inures to the benefit of the
community, even though a private person is the immediate beneficiary of
the activity.
The meaning of charity and the rationale for tax exemption
and charitable deductions
There is no agreed upon explanation of the rationale behind the
charitable tax exemption and tax deduction. Some of the basic
rationales that have been offered, described in greater detail in Part
II.C of this pamphlet, may be summarized as follows: (1) charitable
organizations serve the public and therefore should be supported
through provision of tax benefits; (2) charitable organizations provide
goods and services that otherwise would have to be provided by the
Government and therefore should be supported by the Government; (3) it
is difficult to measure the net income of charitable organizations, and
therefore they should be exempt from tax; (4) charitable organizations
promote pluralism; (5) charitable organizations are efficient providers
of services but have inherent limits on their ability to raise capital
compared to for-profit entities and therefore need government support
in the form of tax exemption (and charitable contributions); and (6)
exemption is afforded to those organizations that can prove their worth
through sustained donations.
Educational purposes
Tax exemption for educational organizations was provided in the
Tariff Act of 1894, and has been replicated in each subsequent income
tax act. Educational organizations have been eligible to receive tax
deductible contributions since 1917. Like the term charitable, the term
educational has no precise meaning. The Treasury regulations set forth
the basic definition as relating to the ``instruction or training of
the individual for the purpose of improving or developing his
capabilities.'' This definition is consistent with provision of
exemption for organizations that fit within the common conception of an
educational organization, such as schools, colleges, and universities.
Yet educational organizations are not limited to such traditional
forms. The ``instruction of the individual standard'' may be met by
many other types of organization. The Treasury regulations also provide
that educational means the ``instruction of the public on subjects
useful to the individual and beneficial to the community.'' The IRS and
the courts have permitted a broad array of organizations to be
considered educational under this standard.
A primary issue in determining whether some method the organization
uses to convey information, irrespective of content. In general, the
analytical exercise is to determine whether an organization's
presentation of information is objective and balanced, or whether the
organization instead is an advocate or a mouthpiece for propaganda.
Religious purposes
The Federal tax exemption for organizations operated for religious
purposes was, along with charitable and educational purposes, provided
for originally in the Tariff Act of 1894, and religious organizations
were designated as eligible for charitable contributions in 1917. There
is no definition of ``religious'' provided by regulation. The manifest
reason is the constitutional law framework that limits Federal
involvement in religion. The IRS has developed a multi-factor list of
characteristics that inform whether an organization may be considered a
church (which is a kind of religious organization), and the IRS is
careful to point out that this list is not comprehensive and that in
each case, the facts and circumstances will be considered. In many
cases in which a religious organization's claim to exempt status is
questioned, the issue of whether the organization serves religious
purposes often is not addressed because exempt status may be denied on
other grounds, for example, private benefit or private inurement,
commerciality, or violation of the political activities prohibition.
The Constitutional concerns regarding Federal involvement in
religious organizations extend to the application of regulatory
requirements. For example, certain religious organizations are exempted
from the requirement to apply for tax exempt status, from annual
information return requirements, and special audit procedures apply to
churches. As a result, although religious organizations, particularly
churches, constitute a significant part of the charitable sector,
information about such organizations is scarce.
Scientific purposes
Scientific purposes were the first addition to the original three
exempt charitable purposes and were added in 1913. Charitable
contributions to scientific organizations were made deductible in 1917.
A tax exempt scientific purpose hinges on the performance of basic or
fundamental research in the public interest. Scientific research that
is ``applied'' or ``practical'' may be subject to the unrelated
business income tax, but generally is not inconsistent with exempt
purposes. There is no precise definition of scientific research, and,
in general, courts and the IRS have determined whether an organization
is engaged in scientific research on a case-by-case basis. Scientific
research must be in the public interest. Scientific research does not
include activities of a type ordinarily carried on as incidental to
commercial or industrial operations.
Selected issues involving charitable organizations
Selected issues relating to the public charity-private foundation
distinction
In 2005, thirty-six years after Congress first drew a meaningful
legal distinction between publicly supported organizations and private
foundations, it may not be as clear, given the growth and diversity of
publicly supported organizations, why some of the private foundation
rules are not relevant for certain public charities, or whether some of
the private foundation rules are performing their intended purpose. For
example, the retention of substantial holdings in a commercial
business, the making of investments or expenditures that jeopardize or
are inconsistent with exempt purposes, or the maintenance of large
endowment funds raise some of the same concerns whether conducted by a
public charity or a private foundation.
In defining a private foundation, the 1969 Act provided that an
organization that provides support to a public charity (a ``supporting
organization'') is considered a public charity and not a private
foundation. Thus, supporting organizations receive the benefit of the
favorable charitable contribution deduction rules and avoid the excise
tax regime applicable to private foundations. Donors to supporting
organizations may take a fair market value deduction for contributions
of capital gain property such as closely held stock, which would not be
permitted for gifts to private foundations. As a public charity,
supporting organizations also are not subject to the private foundation
self-dealing rules (e.g., barring loans and other transactions with
insiders), limitations on business holdings, or subject to the private
foundation payout rules. However, unlike other public charities but
like private foundations, supporting organizations generally do not
have broadly based support, and may resemble private foundations in
other respects.
Community foundations and donor advised funds, which generally
qualify as public charities, offer limited ways for donors to exercise
post-transfer control or direction over the use of funds or other
property transferred to a charity for which the donor is entitled to a
deduction in the year of transfer. Contributors to community
foundations and donor advised funds receive the benefit of the
favorable public charity rules and some elements of the control over
distributions without being subject to the legal constraints placed on
a private foundation. Thus, a donor can fund an account in a community
foundation or donor advised fund with cash or capital gain property,
take a fair market value deduction, accumulate income in the fund, and
from time to time recommend that amounts be paid out of the fund for
charitable purposes. Community foundations and donor advised funds,
like supporting organizations, resemble private foundations in many
ways, but are considered.
Selected issues relating to the unrelated business income tax
In general, exempt organizations have greater discretion than
taxable organizations in determining whether to report income as
taxable or not, through the questions of whether income is from a
regularly conducted trade or business, and whether the conduct of such
a trade or business is ``substantially related'' to exempt purposes. In
addition, even if an exempt organization treats income as unrelated and
therefore as subject to tax, an exempt organization might allocate
expenses for an exempt activity to an unrelated activity in order to
minimize or eliminate the tax.
Issues often arise regarding whether certain types of receipts
constitute royalties, which generally are excluded in determining an
organization's unrelated business taxable income. Two issues that have
been the source of considerable debate in this area are: (1) whether
income from an affinity credit card program constitutes a royalty and
(2) whether income from a mailing list rental constitutes a royalty.
Notwithstanding several court decisions, a taxpayer that provides more
than a small amount of clerical services may risk having payments
received in exchange for a license classified as payments for services
rather than as excludable royalties.
Charitable hospitals
In general
The Code does not provide a per se charitable exemption for
hospitals. Rather, a hospital qualifies for exemption if it is
organized and operated for a charitable purpose and meets additional
requirements of section 501(c)(3). The promotion of health has long
been recognized as a charitable purpose that is beneficial to the
community as a whole. It includes not only the establishment or
maintenance of charitable hospitals, but clinics, homes for the aged,
and other providers of health care.
Medical care generally is provided by government-owned, for-profit,
and tax-exempt organizations. In the hospital sector, tax-exempt
organizations dominate, with approximately 60 percent of the nation's
hospitals operating as charitable institutions. Historically,
charitable hospitals were characterized as voluntary because they
generally were supported by philanthropy, staffed by doctors who worked
without compensation, and served, almost exclusively, the sick poor.
However, the character of the charitable hospital sector has changed
significantly over the past several decades due to the growth of such
resources as employer-provided health insurance and governmental
programs such as Medicare (for the elderly and disabled) and Medicaid
(for the poor). Today, charitable hospitals generally provide medical
and other health-related services in a manner similar to their for-
profit counterparts. They operate under the same healthcare
regulations, compete for the same patients and doctors, and derive
funding from many of the same sources as other types of hospitals.
Evolution of the legal standard
Financial Ability Standard.--Much like the nature of the health-
care industry itself, the definition of the term charitable as applied
to hospitals has not been static. In 1956, the IRS adopted the
``financial ability standard,'' requiring that a charitable hospital be
``operated to the extent of its financial ability for those not able to
pay for the services rendered and not exclusively for those who are
able and expected to pay.'' This standard effectively meant that a
charitable hospital could not refuse to accept patients in need of
hospital care who could not pay for such services. However, the IRS
acknowledged that hospitals normally charge patients who are able to
pay for services in order to meet the hospital's operating expenses and
stated that the ``fact that the hospital's charity record is relatively
low is not conclusive that a hospital is not operated for charitable
purposes to the full extent of its financial ability.'' The ruling's
requirement that charitable hospitals provide some amount of free or
reduced-rate care reflected the view that hospitals and other health
care institutions were only charitable if they both provided relief to
the poor and promoted health.
Community Benefit Standard.--The financial ability standard
governed charitable hospitals until 1969. Congress had criticized the
financial ability standard as imprecise concerning the extent to which
a hospital must accept patients who are unable to pay. In addition, the
creation of Medicare and Medicaid in 1965 had a fundamental effect on
hospitals; a substantial portion of the free care previously subsidized
by charitable hospitals now was reimbursed through these governmental
programs. In response to these developments, the IRS adopted the
``community benefit standard,'' which remains the test applied by the
IRS for determining whether a hospital is charitable. Under the
community benefit standard, the promotion of health care is ``one of
the purposes in the general law of charity that is deemed beneficial to
the community as a whole even though the class of beneficiaries
eligible to receive a direct benefit from its activities does not
include all members of the community, such as indigent members,
provided that the class is not so small that its relief is not of
benefit to the community.'' Applying this community benefit standard,
the IRS found that a hospital's operation of a generally accessible
emergency room open to all persons, regardless of ability to pay,
provided a benefit to a sufficiently broad class of persons in the
community. The requirement of the financial ability standard that
charitable hospitals provide care to patients without charge or at
rates below cost was removed. The community benefit standard applies
not only to traditional hospitals, but also other health care provider
organizations, such as clinics or health maintenance organizations
(HMOs).
Credit counseling organizations
In a 1969 ruling, the IRS concluded that a credit counseling
organization was exempt as a charitable or educational organization
described in section 501(c)(3) by virtue of aiding low-income people
who had financial problems and providing education to the public. The
organization had two functions: (1) educating the public on personal
money management, such as budgeting, buying practices, and the sound
use of consumer credit through the use of films, speakers, and
publications; and (2) providing individual counseling to low-income
individuals and families without charge. As part of its counseling
activities, the organization established debt management plans for
clients who required such services, at no charge to the clients. The
organization was supported by contributions primarily from creditors,
and its board of directors was comprised of representatives from
religious organizations, civic groups, labor unions, business groups,
and educational institutions. In 1978, a court held that the law did
not require that an organization must perform its exempt functions
solely for the benefit of low-income individuals to be considered
charitable. The court found the debt management plans of the agency at
issue were an integral part of its counseling function.
During the period from 1994 to late 2003, 1,215 credit counseling
organizations applied to the IRS for tax exempt status under section
501(c)(3), including 810 from 2000 to 2003. As of late 2003, the IRS
has recognized more than 850 credit counseling organizations as tax
exempt under section 501(c)(3). A number of new credit counseling
entities have engaged in aggressive marketing and advertising while
providing very little legitimate credit counseling or financial
training. In addition, many of today's credit counseling organizations
conduct as their primary activity, and derive most of their revenues
from, debt management planning and other activities. Because of these
changes in the industry, Congress and the IRS have expressed concern
that tax-exempt credit counseling organizations are not fulfilling
their exempt purpose. The IRS has commenced a broad examination and
compliance program with respect to the credit counseling industry. The
IRS concluded in a recent legal memorandum that many credit counseling
organizations may not qualify for exemption under section 501(c)(3)
because of operation for a substantial nonexempt purpose, substantial
private benefit, and private inurement.
Thank you for the opportunity to testify. I would be pleased to
answer any questions.
Chairman THOMAS. Mr. Holtz-Eakin, head of the Congressional
Budget Office. Welcome. Thank you.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL
BUDGET OFFICE
Mr. HOLTZ-EAKIN. Thank you, Mr. Chairman, Congressman
Rangel, and Members of the Committee. The CBO is pleased to
have the opportunity to be here today. We have submitted our
written statement and I will briefly make four points. Point
number one, which has been touched on already, is that there
are economically significant, measured by sales or employees or
purchases, economically significant entities who compete with
traditional for-profit firms and who are exempt from Federal
income taxation. The key characteristic of these entities is
that their ownership structure differs from a traditional
structure in which there are conventional shareholders, and
that as a result of this traditional--the absence of this
traditional owner claimant, the managers of these entities have
greater incentives to lower prices, increase costs, or bolster
their retained earnings instead of returning any profit to
their owners. For this reason, the responses to any attempted
taxation of these entities might lead to a much lower tax
liability and a lower receipt than any initial appearance might
suggest, and I thought I would briefly expand on those. These
entities, which have been touched on by both Mr. Walker and Mr.
Yin, are significant. They generate substantial revenues by
selling goods and services. They incur substantial costs. In
particular, they hire a great many workers in the economy and
they purchase many inputs from other firms. These entities,
which we call business entities and which collectively we refer
to as the untaxed business sector, form an economically
significant component of the U.S. economy.
Three types of entities appear to stand out in this regard.
The first are nonprofits, for example, nonprofit hospitals,
engaged in business-like activities, at least in part, or
universities with spin-off businesses such as R&D partnerships
or private firms. The second are cooperatives, such as credit
unions and others, in which the clients are often the owners of
the activity itself. Finally, business enterprises of State and
local governments, such as municipal utilities that are
operated on a fee-for-service basis. They are large. It is
difficult to get a handle on the absolute magnitude both
because size can be measured in output, size can be measured in
employment, it can be measured in investment and assets. We
provide some estimates, as well. I think it is fair to say that
this is an important aspect of the U.S. economy. Let me talk a
bit about the two issues that might present a policy maker.
First, the issue of economic policy. What is the impact of
having side-by-side traditional for-profit firms and these
business entities competing in retail markets? There, the
question really depends on how any apparent surplus, any excess
of price per unit over cost per unit, and that would include
tax costs, how that surplus affects managerial behavior. One
possibility is that that surplus simply gets translated into
higher input costs--pay the workers more, live in bigger
offices with nicer furnishings, and if so, the fact that you
can have the same price with a higher cost interferes with
traditional market discipline that rewards economic efficiency
and allows these entities to maintain their competitive status.
An alternative possibility is that this surplus is translated
into lower prices and allows these entities to expand and,
indeed, could allow the sector as a whole to expand, drawing
more workers, drawing more capital into that sector at the
expense of other parts of the economy. So there is a policy
level efficiency issue that arises in examining them. The
second is what would happen to budgetary impacts if there were
any attempt to bring them into the Federal income tax system,
and there, you essentially run the same logic in reverse. How
would an attempt to tax the apparent surplus lead managers to
respond? It could be that they, again, lower prices, and if so,
and if sales were to other businesses, you could raise profits
elsewhere and capture that indirectly, although you wouldn't
get it directly from these entities. Alternatively, if there
are sales, final sales to consumers, it is unlikely you would
get them. It could be that in the process of doing that, you
would expand them at the expense of their competitors by giving
them an incentive to lower prices even more. It could be that
they do this in the form of higher compensation, in which case
it could be picked up under the individual income tax if this
was wages or salaries, for example. In either event, that
attempt would have the impact, to the extent that the managers
followed these incentives, to lower any retained surplus and
thus affect their ability to grow in the future if those
retained earnings are the source of expansion in the untaxed
business sector. So, we thank you for the chance to be here
today and I will look forward to your questions.
Chairman THOMAS. Thank you very much.
[The prepared statement of Mr Holtz-Eakin follows:]
Statement of Douglas Holtz-Eakin, Ph.D., Director, Congressional Budget
Office
Mr. Chairman and Members of the Committee, I am grateful for the
opportunity to appear before you.
My testimony addresses several tax policy, budgetary, and economic
issues that arise from the presence of economic entities whose revenue
comes primarily from selling goods and services in direct competition
with traditional for-profit firms and whose income is exempt from both
the federal corporate and individual income taxes. In my discussion of
the Congressional Budget Office's (CBO's) analysis of those issues, I
will refer to such organizations individually as ``business entities''
and collectively as ``the untaxed business sector.'' Three types of
business entities have the characteristics noted above:
Certain nonprofit institutions--for example, nonprofit hospitals
that are wholly engaged in businesslike activity or universities that
have undertaken ``spinoff'' business activities (such as research
development partnerships with private firms);
Cooperatives, including credit unions, which differ from other
businesses primarily because their clients are their owners; and
Business enterprises of state and local governments, such as
municipally owned utilities, that are operated on a fee-for-service
basis.
CBO's analysis--which was restricted to the exemption from federal
income taxation and does not consider any other tax treatment received
by these entities--leads to several conclusions:
The ownership structure of untaxed business entities differs
significantly from that of conventional for-profit firms in that there
are no separate claimants, such as shareholders, for the entities'
residual profits. The lack of owners in the usual sense is what
primarily determines how any attempt to tax such entities is likely to
affect federal revenues and the economy.
Because of the absence of owner-claimants, managers of these
entities have different incentives from those of managers of privately
owned businesses. Instead of seeking to return profits to owners, the
entities' managers have incentives to lower prices, increase costs, or
bolster retained earnings.
Accordingly, taxation of these entities might not generate as
much revenue as initially anticipated. Taxation would bolster managers'
incentives to reduce or eliminate entities' tax liabilities by using
more of any surplus to cut prices, boost costs, or both. As a
consequence of being taxed, however, those entities would retain fewer
funds for expansion.
What Is an ``Untaxed Business``?
Business activity can be thought of as the provision of goods and
services for a price. Only those consumers who pay the price receive
the goods or services, and the entities that provide them finance their
production with the receipts from those private transactions. In the
United States, most business activity is undertaken by privately owned
for-profit firms. The government often provides and finances through
taxation services that are not amenable to being provided by
businesses, such as those whose benefits reach beyond the buyer or
seller and benefit others as well.
There is no bright line, of course, between the kinds of goods and
services that conventional businesses produce and those that have broad
public benefits. Nonprofit entities, which are deemed to serve a public
purpose and for that reason are not taxed, provide a number of them.
Some nonprofit entities, such as nursing homes and mental institutions,
may be less likely than their for-profit counterparts to take advantage
of consumers who have limited information. In the case of cooperatives
and state and local government businesses, the tax benefit that they
receive has been justified in the past as an offset to the monopoly
power of for-profit firms, power that might cause prices to be too
high. Tax exemption may also encourage the provision of services when
there are too few customers in an area to motivate a for-profit entity
to engage in business activity. Over time, however, economic growth,
technological advances, and increases in population may have altered
the circumstances that justified the formation of many of those
entities in the past.
Many untaxed business entities sell goods and services that compete
directly with those provided by traditional for-profit firms. The
surplus generated by untaxed entities escapes the income tax system if
it is passed on to retail customers in the form of lower prices or if
it is retained for reinvestment. But the income tax system does capture
surplus that is passed on to workers or managers as higher pay or to
commercial customers as lower prices that then allow them to increase
their profits.
The Internal Revenue Code subjects the surplus generated by most
business activity to the income tax. Profits generated by firms that
are organized under the tax code as C corporations are taxed once at
the corporate level and a second time at the individual level, when
they are received as dividends or capital gains. Firms organized as
proprietorships, partnerships, limited liability companies, S
corporations, and other so-called pass-through entities are not subject
to the corporate tax. However, the surplus they generate is taxed at
the individual level.
Which Businesses Make Up the Untaxed Sector?
Three types of entities have the characteristics of businesses but
are not subject to income taxation either at the ``firm'' level or
through the pass-through mechanism. The three are nonprofit
institutions, cooperatives, and state and local government enterprises.
Nonprofit Institutions
Many nonprofit institutions produce output that is sold to
customers in much the same way that private businesses sell goods and
services. The most prominent example is nonprofit hospitals that
finance virtually all of their health care services with revenue from
sales. On average, nonprofit health care institutions receive
relatively few donations, garnering 92 percent of their income from
program revenue (revenue from the sale of services). Those health care
institutions alone represent about half of the total revenue of all
nonprofit entities that must file financial information returns. (All
nonprofit entities whose gross receipts exceed $25,000 must file
financial information with the Internal Revenue Service.)
Many nonprofit institutions whose primary activity fulfills a
public purpose also engage in substantial business activity. The tax
code contains provisions to tax income from business activity that is
unrelated to a nonprofit's public purpose. In practice, however, much
of that unrelated business income (such as income from royalties,
payments from corporations for the right to associate their name with a
nonprofit organization's activities, and income from the sale of
membership lists) has been classified under tax law as related to the
entity's public purpose and thus is not subject to taxation.
Universities, for example, receive royalties from research development
partnerships with private business and receive income from athletic
events that compete with professional sports leagues.
CBO estimates that businesslike nonprofit institutions add roughly
$314 billion of value to the economy, or 3.4 percent of net domestic
product (see Table 1). That estimate is based on the share of each
entity's revenue that comes from payments made by customers. Of the
revenue for all nonprofit institutions, 65 percent accrues to entities
whose program revenue exceeds 75 percent of their total revenue. CBO
assumed in its calculation that their share of net domestic product
(the net value added to the economy) was proportional to their share of
total revenue.
Cooperatives
A second type of untaxed entity is cooperatives--businesses whose
owners are also its clients. Virtually all of the activity of
cooperatives is conducted in a businesslike fashion--that is, their
goods and services are sold to (or for) their client-owners. They
operate under several different sections of the tax code but, with only
a few exceptions, are exempt from taxes on their income.
Table 1. Estimated Size of the Untaxed Business Sector and Its Share of
Net Domestic Product
------------------------------------------------------------------------
Percentage
Billions of of Total
Type of Entity Dollars NetDomestic
Product a
------------------------------------------------------------------------
Nonprofit Institutions that Serve Households 314.0 3.4
------------------------------------------------------------------------
Cooperatives (Four industries) b 32.1 0.5
------------------------------------------------------------------------
State and Local Business Enterprises 127.4 1.4
------------------------------------------------------------------------
Source: Congressional Budget Office based on data for 2000 through 2003
from a variety of sources including the national income and product
accounts, Census of Governments, and the National Center for
Charitable Statistics.
a. U.S. net domestic product in 2002 totaled $9,192 billion.
b. The four industries are credit unions and three types of utilities
providing electric, telephone, and water services.
Many cooperatives are small and generate only a modest volume of
sales, but some cooperatives are quite substantial enterprises. The
larger credit unions compete effectively with segments of the
commercial banking industry. Moreover, cooperatives include such large
and well-known firms as Land O'Lakes, Southern States, and Welch's.
Information on the size of the cooperative sector is not available, but
in 2001 and 2002, four industries together--credit unions and three
types of utilities providing electric, telephone, and water services--
earned $77 billion in total revenue.
CBO estimates that cooperatives in those four industries added
roughly $32 billion in value to the economy in 2002, or about 0.3
percent of net domestic product. Again, CBO's estimate incorporated the
assumption that those cooperatives' share of businesses' contribution
to net domestic product was proportional to their share of businesses'
total output.
State and Local Government Businesses
The third category of untaxed entities comprises firms owned by
state and local governments that are operated on a fee-for-service
basis but that are typically exempt from federal taxation under the
doctrine of intergovernmental tax immunity. The most common of those
entities are utilities--primarily electric, water, and gas--which have
many private-sector analogues. Others, such as water and sewer services
and solid waste collection, have fewer for-profit counterparts. States
and localities also operate a number of transportation and recreation
businesses. (Transportation enterprises include parking garages, ferry
boats, wharves, and airports. Businesses related to recreation include
swimming pools, golf courses, hotels, and motels.) Miscellaneous
commercial activities undertaken by states include a commercial bank
and a flour mill in North Dakota and the manufacture of vaccines by a
public entity in Massachusetts. In addition, states and localities
operate such businesses as liquor stores and lotteries to generate
additional revenue.
CBO estimates that the value added to the economy by state and
local entities that might be performing tasks similar to those carried
out in the for-profit sector is roughly $127 billion, or 1.4 percent of
net domestic product. (Again, CBO assumed that the state and local
government sector's share of net domestic product was proportional to
its share of total revenue.) The state and local sector received a
total of $93 billion in revenue from operating water, electric, and gas
utilities in fiscal year 2002. Another $194 billion of charges and
miscellaneous revenue is attributable to the sale of private goods,
such as motel room rentals.
Issues Surrounding the Tax Treatment of Untaxed Businesses
Several objections have been raised to the differential tax
treatment granted to these business entities. Competitors of tax-exempt
businesses have objected that it is unfair, and analysts have been
concerned about its effects on economic efficiency. Evaluating fairness
is problematic. To begin with, such an exercise reflects the values of
the observer. In addition, fairness is best evaluated with respect to
the owners of firms; the institutions are merely legal constructs that
exist to organize and facilitate production. But owners change over
time, making it impossible to trace how former owners of competing or
potentially competing firms were affected. Eliminating the differential
tax benefit would not redress any past inequities and could introduce
new ones.
Differential tax treatment could lead to inefficiency in several
ways. Untaxed firms have the opportunity to use their surplus (which
includes their tax savings) to offset any higher production costs they
might incur and still compete with taxed firms on the basis of price.
Consequently, the tax benefit may interfere with the market's
discipline, which rewards efficient firms and penalizes inefficient
ones. Alternatively, using the tax savings to reduce the price of the
firm's output could shift the economy's mix of production toward less-
valued goods and services.
The favored treatment of untaxed businesses, however, stems from
their public--purpose nature, and the continuation of that treatment
will depend on the judgments of policymakers.
The Tax Exemption and Forgone Receipts
The three categories of untaxed businesses have a significant
attribute in common: the absence of conventional owners, which relieves
them of the need to report and distribute profits in the usual sense.
The incentives of managers of untaxed businesses thus differ from those
of managers of commercial businesses. Not seeking to maximize profits
or surplus, they have greater latitude with regard to their costs of
production and prices. Indeed, the purpose of some untaxed entities in
part is to sell output at prices lower than its costs. As a result,
taxing the untaxed business sector may yield much less revenue than
might be expected, given the scale of its activities.
The scope of tax-avoidance options available to for-profit firms is
limited by the necessity to deliver a return to the firms' owners. The
tax-avoidance strategies that nonprofit businesses, cooperatives, and
state and local government enterprises can command are more numerous
because of those entities' ownership structure. That statement is true
regardless of whether the entity attempts to reduce the price and
increase the availability of the good it sells or whether it takes less
care to adopt lowest-cost methods of production and as a result pays
its operators and employees higher wages than they would otherwise
receive. Hence, if a tax was imposed, a nonprofit business entity could
more easily distribute any surplus to its managers or customers than a
for-profit firm could; a cooperative would have more latitude to
deliver its surplus to its owner-clients as lower prices than to parcel
it out; and state and local government businesses could distribute
their surplus in several different ways without necessarily handing it
over as explicit profits to the state or locality. (They could
distribute it as lower prices to their customers, higher wages to
employees and managers, or some combination of lower taxes and more
public services to the voters who ultimately control those businesses.)
A surplus that is passed on in the form of lower prices or higher
pay reduces profits. Without conventional owners and the necessity to
distribute profits as dividends or retain them as earnings, untaxed
business entities could avoid a tax by passing on the surplus and
minimizing taxable profits (see Box 1).
If a tax was imposed, previously untaxed business entities would
probably choose among tax-avoidance strategies on the basis of their
circumstances. For an electric utility owned by a state and local
government, for example, the shares of the surplus received by
individuals in the jurisdiction differ depending on whether the surplus
is distributed as a lower price, higher pay, or reduced tax burden.
Similarly, the shares of any surplus received by an individual owner-
client of a cooperative will differ if the surplus is distributed as a
reduction in prices instead of as profits. Regardless of the particular
strategy an untaxed business entity chooses, the difference between its
ownership structure and that of a private firm provides it with
substantially more flexibility in undertaking measures to avoid taxes
and still meet its objectives.
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Box 1.
----------------------------------------------------------------------------------------------------------------
Taxing the Surplus from a Hypothetical Municipal Golf Course
As an illustration, imagine a municipal golf course that is run as efficiently as a private
competitor and priced the same--say, $40 per round. The municipal course incurs $36 in
costs per round and generates a surplus of $4. The corporate tax rate is assumed to be 30
percent and the individual rate, 20 percent.
Presented as an equation, price ($40) = cost per round ($36) + before-tax profit per round
($4). In the absence of any taxes, the entire surplus of $4 per round can be paid to the
untaxed municipal treasury to offset other costs of local government. In contrast, the
private competitor must record the equivalent $4 per round as a profit and pay a 30
percent tax ($1.20).
Should a corporate tax be imposed on the municipal firm, rather than paying it, the firm
might distribute the surplus to its customers as a price cut and charge only $36 per
round. Costs would equal revenue, and the surplus would still escape the tax. The golf
course's books would show the following: $36 = $36 + 0.
Alternatively, the golf course might pay its employees higher wages. The price per round
would still be $40, but costs would be increased to $40, leaving no surplus to tax. In
that case, however, the surplus would be subject to individual income taxes. If the
individual rate was 20 percent, only 80 cents would be collected rather than the $1.20
that would be collected from a for-profit firm. The golf course's books would show the
activity this way: $40 = $40 + 0.
Another option for the municipal firm would be to convert the $4 surplus to the local
government's general fund by shifting $4 of its general fund costs to the golf course. No
tax is collected on revenue that goes into the general funds of state and local
governments. The golf course's books would, again, show the following: $40 = $40 + 0.
----------------------------------------------------------------------------------------------------------------
The opportunities for tax avoidance are even greater for secondary
business activity carried on by untaxed entities whose primary activity
is pursuing socially beneficial objectives. Profits from any business
activity in which such an entity engages--whether related or unrelated
to its main activity--are difficult to segregate from profits earned in
the pursuit of its primary purpose. As a result, the taxation of any
non-primary-activity profits becomes extremely difficult in the face of
skillful management and accounting. In tax year 2000, a total of $4.8
billion of gross unrelated business income was reported by more than
11,000 organizations classified as 501(c)(3) under the tax code. The
organizations reported total deductions for business expenses of about
the same amount--for a net loss of $49,000. Fewer than half reported
unrelated business income that was subject to taxation, and the
revenues raised totaled only $4.1 million.
Because of those opportunities and incentives, any shift toward
taxing the currently untaxed business sector can be expected to yield
considerably less revenue than the size of the sector might otherwise
suggest. The Joint Committee on Taxation has estimated that taxing some
of the institutions in the sector in a manner analogous to the taxation
of C corporations would yield about $2 billion in revenue a year. If
the estimates covered more of the sector's businesses, the revenue gain
would probably be larger. But it appears that the amounts involved are
small relative to the size of the entire economy--and might in fact be
even more modest if the estimates did not take into account the scope
such firms have for tax avoidance.
The Economic Effect of Taxing the Untaxed Business Sector
Taxation of currently untaxed business entities would be unlikely
to generate much revenue for the government, but it would have the
economic consequence of constraining their growth. Taxation of their
surplus would amplify the incentives they already have to lower their
prices and incur higher costs, which could significantly reduce the
amount of internal capital that those institutions accumulated. That
constraining effect of taxation on growth would tend to be much
stronger than it is for privately owned for-profit firms, which must
pay tax on their profits but face strong incentives to retain the
after-tax surplus or distribute it to owners.
Chairman THOMAS. Dr. Colombo, and I will just go from left
to right across the panel with our guest witnesses. Dr. Colombo
is a professor of law at the University of Illinois College of
Law. Obviously, based upon his written testimony, he has spent
a long time looking at this area. Dr. Colombo?
STATEMENT OF JOHN D. COLOMBO, PROFESSOR, UNIVERSITY OF ILLINOIS
COLLEGE OF LAW, URBANA-CHAMPAIGN, ILLINOIS
Mr. COLOMBO. Thank you, Mr. Chairman, and I want to thank
the Committee for inviting me today. I am a professor of law at
the University of Illinois at Urbana-Champaign and I have
taught and written about tax-exempt organizations for the past
18 years. I would like to make three points about tax exemption
that I think are useful in organizing this area. First, when
you think about tax exemption, it really is helpful to divide
the world into charities exempt under 501(c)(3) and everything
else. When people hear the phrase ``tax-exempt organization,''
they tend to equate it with the charitable contributions
deduction under section 170, but that is not the way things
work. section 501(c) lists 28 different kinds of organizations
that are tax-exempt, but with a couple of exceptions, only
charitable organizations are eligible to receive deductible
contributions. In addition, the underlying rationales for
exemptions vary between charitable organizations and everything
else. Most of us think that charitable organizations are exempt
because they are improving general public welfare in some way.
For non-charitable entities, however, the rationale tends to be
much more entity-specific, for example, the social club pooling
of resources rationale that you heard from Mr. Yin. Finally,
charitable organizations, as Mr. Yin pointed out, are by far
the largest subset of exempt organizations, both numerically
and financially.
Second, it is useful to remember that within this special
group of charitable organizations, we also have two categories,
public charities and private foundations. Again, people
sometimes get confused about this, but a private foundation is
an exempt charity under section 501(c)(3) just as much as a
church or a private school. We do more highly regulate private
foundations, and the reasons for that heightened regulation
relate to the public accountability concept. Public charities
get their money from a broad cross-section of the general
public and hence are accountable to the general public. Private
foundations generally get their money from a single donor or
family and hence are accountable to their primary donor. If you
have public accountability, then you have some reason to
believe that the managers of a charity will be careful about
what they do because the public is watching them. Think back to
the outcry that happened when the Red Cross announced that it
was going to divert some money donated to it for 9/11 victims
to other needs. People got mad, this Committee got involved,
and the Red Cross changed its mind. When you do not have this
public accountability, then there is enormous room for abuse,
which is why Congress adopted the much tighter regulatory
scheme for private foundations in 1969, including the
prohibitions on self-dealing, the stricter limits on the kinds
of investments private foundations can hold, and stricter
limits on deductions for donations to private foundations. The
accountability principle tells us that there are two
particularly important issues here. One is transparency, is the
public getting information it needs to hold charities
accountable, and the other is whether taxpayers have found
structures that avoid the private foundation regulations but
yet are not truly accountable to the public.
My final point concerns the overall system for identifying
exempt organizations, and here, I want to talk specifically
about that subgroup of exempt charities. Charitable tax
exemption just sort of happened. We never really agreed on a
core rationale for exempting charities. The operation of
charities has changed dramatically over the years. Private
nonprofit hospitals, for example, were largely shelters for the
poor until World War II. Now, they are mostly very large fee-
for-service businesses. So, why are they still exempt? Some
people think it is because they provide free care to the poor,
but free care is not currently required by the tax laws for
hospitals to be exempt. So, here is an example, and there are
others, where we have ended up with a disconnect between our
traditional views of charities and how they operate in the real
world today. Over a decade ago, my colleague, Mark Hall, and I
suggested a system in which charitable tax-exemption under
501(c)(3) would be limited to entities that were substantially
dependent on donations for their operating revenues each year.
We still think that system would make a lot of sense. People
donate to organizations because they see the needs these
organizations serve and see a lack of resources to meet those
needs. If an organization doesn't get significant donations,
then either it isn't doing anything the public thinks is
worthwhile or the public sees that they have ample resources
without donations. In either case, such organizations don't
need tax-exemption. Using donative status, therefore, seems to
be a pretty good way to distinguish organizations that do
things that ought to warrant tax-exemption from those
organizations that don't. Whether you agree with our donative
idea or not, I would urge the Committee to give some thought to
the overall rationale for charitable exemption as it debates on
these issues. If you don't like my theory, that is fine. There
are lots of them out there. Find one that you do like and
conform the law to that theory and you will have made an
enormous improvement in the law relating to tax-exempt
organizations. Thank you very much.
Chairman THOMAS. Thank you very much.
[The prepared statement of Mr. Colombo follows:]
Statement of John Colombo, Professor, University of Illinois College of
Law, Urbana-Champaign, Illinois
Mr. Chairman, Members of the Committee:
My name is John Colombo. I am a professor of law at the University
of Illinois College of Law in Urbana-Champaign, and I have taught about
and written on issues of tax-exempt organizations for the past 18
years. I think my job today is to give you some background and context
regarding tax exemption rules, particularly as they apply to private
foundations and trade associations.
Charitable Exemption vs. Other Exemption
Let me start with two very basic and very useful distinctions to
keep in mind when assessing policies regarding nonprofits and tax
exemption. The first distinction is that when it comes to tax
exemption, there are charities exempt under Code Section 501(c)(3) and
then there is everything else. Section 501(c) grants exemption to 28
different kinds of organizations, but the ``charities vs. everything
else'' distinction is a very useful way to think about this for several
reasons. First, in general only charities exempt under 501(c)(3) are
eligible to receive additional major tax benefits like tax-deductible
contributions. Other exempt entities, like trade associations (which
are exempt under Sec. 501(c)(6), rather than Sec. 501(c)(3)), get
exemption from having to pay the corporate income tax on their
earnings, but are not permitted to receive deductible contributions.
Second, the underlying rationales for exemption vary between
charitable organizations and everything else. Although we academics
carry on a lively debate about the rationale for charitable tax
exemption, all of us would agree, I think, that at some level exemption
for charities is tied to a concept that they are improving general
public welfare in some way. For non-charitable entities, however, the
rationale tends to be much more entity-specific.
For example, trade associations are exempt if they carry on
activities designed to promote a common business interest of its
members; such organizations must not ``engage in a regular business of
a kind ordinarily carried on for profit.'' \1\ These organizations are
exempt because they represent simply a pooling of resources by people
with a common interest to conduct activities that, if conducted by the
members themselves, would not be profit-making businesses. Hence we
believe that creating an ``association'' for members to pool their
resources in this manner should not result in taxation of those pooled
resources. But if a trade association does conduct regular business
activities or provides specific services for members, then the
organization should not be exempt because it no longer represents this
nontaxable collective pooling of resources, but rather is now engaging
in a for-profit business.
---------------------------------------------------------------------------
\1\ Treas. Regs. 1.501(c)(6)-1.
---------------------------------------------------------------------------
Third, charities constitute the bulk of exempt organizations under
501(c). Data complied in 2002 indicated that there were in excess of
900,000 exempt charitable organizations in the IRS's master file,
constituting well over half the total number of all exempt
organizations.\2\ Trade associations under 501(c)(6) were the next most
numerous category, with approximately 84,000 organizations, but still
less than a tenth of the number of charitable organizations.
---------------------------------------------------------------------------
\2\ Marion Fremont-Smith, Governing Nonprofit Organizations 6-7
(Belknap Press 2003). This number is likely significantly higher than
what is reported, because churches do not have to file with the IRS for
recognition of exemption under Section 501(c)(3) and therefore are not
included in the IRS Master File.
---------------------------------------------------------------------------
Public Charities vs. Private Foundations
The second major distinction in tax-exemption law occurs within the
charitable sector itself. This distinction is between public charities
and private foundations. People often get confused about the tax-exempt
status of private foundations; so the first thing to remember is that
private foundations are charitable organizations eligible for exemption
under Section 501(c)(3) just as much as a church or a private school.
The IRS has long recognized that making monetary grants to other
charities is itself a charitable activity, and that's largely what
private foundations do--make grants to other charitable organizations.
Historically, in fact, private foundations preceded the income tax. The
wealthy industrialists of the 19th century, such as Andrew Carnegie,
for example, created trusts to benefit charitable organizations long
before we had a functioning income tax. As a result, prior to 1969,
private foundations and public charities were treated pretty much the
same for tax purposes.
In the 1969 Tax Reform Act, however, Congress decided to subject
private foundations to more specific regulation designed to prevent
abuses of the private foundation form. The best way to understand why
we have this heightened regulation of private foundations is to focus
on two main differences between private foundations and public
charities: accountability and continuing control.
Public charities are organizations that are accountable to the
general public because they get their money in one way or another from
a broad cross-section of the public. Private foundations, however,
generally receive their funding from a single individual or family, and
therefore are accountable to and controlled by that primary donor.
These two distinctions are the basis for our different regulation
of public charities and private foundations. When you have true public
accountability and ``public control'' over assets, then you have some
reason to believe that the managers of the charity will be careful
about their mission and the execution of that mission, because a
publicized misstep will have significant adverse effects on the public
funding of that organization. Think back to the adverse publicity for
the United Way a couple of years ago when its CEO's salary and perks
were disclosed in the national media, or the outcry that happened when
the Red Cross decided to divert some money donated for 9/11 victims to
other needs--I believe, in fact, that this Committee held hearings
about the Red Cross's decision and was instrumental in bringing the
weight of public accountability to bear on that.
When you do not have this public accountability, however, and you
have significant continuing control by one person or family over
donated wealth, then there is enormous room for abuse, which is why we
have the much tighter regulatory scheme for private foundations. This
tighter regulatory scheme generally is set forth in Sections 4940-4946
of the Code, and includes a requirement that a foundation pay out a
certain amount of its assets each year to other charities, a
prohibition on self-dealing transactions of any kind, limits on the
kinds and size of certain business holdings of a foundation, limits on
certain kinds of investments that a foundation can make, more stringent
limits on lobbying, and so forth. In addition, in 1969 Congress also
tightened the rules with respect to charitable donations to private
foundations, again to avoid abuse situations in which individuals could
eliminate tax liability by making gifts of certain kinds of property,
like stock of a privately-held corporation, that could still be
controlled for by the donor after the gift. So while individuals can
make deductible donations of up to 50% of their adjusted gross income
to public charities, and in many cases can take a deduction for the
full fair market value of donated property to public charities,
deductions to private foundations are limited to 30% of AGI and
deductions for property gifts generally are limited to the taxpayer's
tax basis in the property, not its market value.
Defining ``Charitable'' Organizations for Tax Exemption
While I think this short summary gives a useful overview of the two
main distinctions in our tax exemption laws (charities vs. everything
else, and within the ``charity'' category, public charities vs. private
foundations), I would like to close with an additional thought about
tax exemption, particularly as it applies to charitable organizations.
One of the core problems with tax exemption for charities over the
years has been that exemption more or less ``just happened'' without a
great deal of thought regarding why we hand out tax exemption. Many
organizations, such as churches and private schools, for example, were
already exempt from state property taxes when Congress passed the first
corporate income tax law in 1894; these organizations were not
businesses in any sense of the word, and hence exemptions were
incorporated into the ``new'' income tax law without much debate.
As a result, while we have this vague notion that we grant
exemption to charities because they ``do good things'' for society,
there has never been a specifically-articulated rationale that allows
us to tie down exactly what good behavior should be rewarded with
exemption. Currently, the IRS relies on the 400-years of legal
precedent in the law of charitable trusts to define charitable
organizations. As the operation of nonprofit organizations has changed
over time, however, difficult questions have come up regarding tax
exemption for certain nonprofits. For example, in the 1800's private
nonprofit hospitals were essentially shelters for the poor. Today, most
of them are very large fee-for-service businesses. So why are modern
private nonprofit hospitals still exempt? Is it because they ``do good
things'' for society? There is no question that nonprofit hospitals in
fact do good things for their communities, but one could argue that
many for-profit businesses do good things for their communities, as
well. Is it because they provide free care for the uninsured poor in
some cases? Maybe so, but that is not currently required by law and the
empirical evidence on whether nonprofit hospitals provide significant
charity care is mixed.\3\ So in some cases we have ended up with a sort
of disconnect between our traditional views of charities and the way
they operate in the real world today.
---------------------------------------------------------------------------
\3\ Under the ``community benefit'' test of exemption promulgated
by the IRS in 1969, free care for the uninsured is not a requirement
for a hospital to receive exemption under Section 501(c)(3). See Rev.
Rul. 69-545, 1969-2 C.B. 117; John D. Colombo, The Role of Access in
Charitable Tax Exemption, 82 Wash. U.L.Q. 343, 347 (2004). For a review
of the empirical evidence, see John D. Colombo, The Failure of
Community Benefit, 15 Health Matrix 29 (forthcoming 2005).
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Over a decade ago, my colleague Mark Hall and I suggested a system
in which tax exemption under Section 501(c)(3) would be limited to
entities that were substantially dependent on donations for their
operating revenues each year.\4\ There is a reason why limiting
exemption to donative organizations makes sense--in brief, donations
are the signal that people believe an organization is doing something
worthwhile, and is not otherwise being sufficiently funded by the
private market or by the government. People donate to organizations
because they see the needs these organizations serve and see a lack of
resources to meet those needs. In contrast, organizations that do not
get significant donations either aren't doing anything the public
thinks is worthwhile, or the public sees that they have ample resources
without donations. In either case, such organizations do not need tax
exemption. Using donative status, therefore, seems to be a pretty good
way to distinguish organizations that do the things that ought to
warrant tax exemption from those organizations that do not. In fact, if
I asked all of you to name your paradigm charities, I suspect that most
of you would name donative entities--your church, the Salvation Army,
the Red Cross, the United Way, maybe certain arts organizations.
---------------------------------------------------------------------------
\4\ John D. Colombo and Mark A. Hall, The Charitable Tax Exemption
(Westview Press, 1995); Mark A. Hall and John D. Colombo, The Donative
Theory of the Charitable Tax Exemption, 52 Ohio St. L.J. 1379 (1991).
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I think that any discussion of reforming the rules for tax
exemption ought to include some thought about the overall system for
granting tax exemption, particularly for charitable entities under
501(c)(3), and whether you agree with my suggestion about using
donations as this core rationale or not, I would urge the Committee to
give some thought to this general point as it deliberates on these
issues.
Thank you.
Chairman THOMAS. Dr. Hill is a professor of law. Thank you
for being with us, and we look forward to your testimony.
STATEMENT OF FRANCES R. HILL, PROFESSOR, UNIVERSITY OF MIAMI
SCHOOL OF LAW, CORAL GABLES, FLORIDA
Ms. HILL. Thank you, Mr. Chairman, Mr. Rangel, and Members
of the Committee for the opportunity to present testimony this
morning. I am here to suggest that although there are many
rationales that have been suggested over the years for exempt
status, we have, in fact, not settled on one, but there is one
that is, in fact, fundamental to the law, even as currently
implied, and what we need to do is recognize it, make it
operational, make it practical, and build the law around it.
That is the fundamental message. The rationale is based on
providing a public benefit to a defined category of
beneficiaries. The exempt sector is large, growing, and
diverse. It must be accountable, but it should not be
improperly constrained. Evidence of malfeasance by certain
organization managers or the inattentiveness or even
dereliction by certain directors should not be generalized to
the entire sector, just as these tacky, unacceptable, and
thoroughly regrettable forms of behavior should not be excused
by reference to the benefits provided by exempt organizations.
government oversight, both with regard to lapses and with
regard to structure, continues to be vitally important.
Of all the multiple types of exempt organizations that we
have had outlined to us today, they certainly differ in their
requirements for exemption, the activities that support exempt
status, but they share the common feature that in every case,
exemption depends upon providing a public benefit to a defined
class of beneficiaries. This public benefit rationale is an
analytical framework for understanding current law and deciding
whether current law and the way it is being administered are
consistent with the proper use of the tax subsidy. Preventing
misuse of exempt organizations' resources is a matter of
central responsibility. In fact, we have probably focused
exclusively on simply bad behavior, on what some have called a
non-distribution constraint, what some have called a private
benefit prohibition. This is what academic analyses have
focused on. This is what Congress has focused on for a very
long time, things like section 4958, the inurement concept and
the private benefit concept. The idea of preventing
impermissible private benefits is important, but preventing
these impermissible private benefits will not in itself assure
that exempt entities operate for a public benefit, and that is
what I am urging the Committee to focus on as its work goes
forward. A rationale, a framework for understanding exemption
is vitally important. It should not just be a justification for
either the status quo or for one's preferred reform ideas. A
framework ensures that the law in this area does not simply
become a cluster of isolated requirements that are easily
manipulated to support activities largely unrelated to the
provision of a public benefit. When the law is easily
manipulated, a classic moral hazard results. Aggressive actors
pursuing problematic programs win at least passive acceptance,
while entities that are attempting to comply are given little
useful guidance and find few positive rewards for their
efforts.
I am going to try to move the concept of a public benefit
beyond some warm and fuzzy invocation of the good that exempt
organizations do on to a usable, practical concept. This
concept certainly requires that we reconceptualize exempt
organizations, which I believe, despite all the good work that
has been done by government agencies, private scholars over the
years, remains incompletely described and incoherently
conceptualized. Exemption should be efficient, and it is
efficient only if it is dedicated to providing a public benefit
to designated beneficiaries. Right now, it is impossible to
answer the question of whether the increase in number and
revenue of exempt entities means that there has been a
commensurate increase in the provision of public benefits to a
charitable or other exempt class. Part of this is because we
have focused so long on simply preventing private benefits, and
the other reason is that we have not conceptualized what
constitutes a public benefit and we have not asked a number of
fundamental questions about this sector. My testimony on page
five in the written form outlines a number of questions that
remain amazingly unaddressed after all of these years, and it
is perhaps now time to address the longstanding question and
move forward also to address the new challenges. We don't know
what is meant by a public benefit. It is not simply a matter of
saying zoos should not run gift shops because those things are
commercial, or museums shouldn't have little coffee shops in
them. I like a cappuccino when looking at the art. Personally,
I don't think it does any harm. The question is how to tax it.
There are obviously more substantial examples, but I use a
somewhat trivial one to suggest that not everything that is
commercial is in our capitalist republic tainted. It is a
question of the terms of engagement.
It is the work of Congress, ultimately, I think, to think
about public benefits and to exercise oversight and to work
with the IRS and Treasury to help define it. Part of the
concept of a public benefit is who is being benefited. What is
the charitable class? As Professor Colombo referred to,
certainly, there was dynamic testimony before this Committee in
the past relating to what constitutes a charitable class when
it was unfortunately suggested the 9/11 victims' surviving
family members were not a charitable class because although
they may well have certainly been quite distressed, they were
not poor. The IRS, of course, clarified what it meant by this
testimony immediately. I bring this up only to suggest that
what constitutes a charitable class or an exempt class requires
careful thought and is not an easy question, but one we need to
know. Number three, much of the diversion of resources from
exempt functions to non-exempt functions occurs within exempt
organizations not by just simply doing private benefits outside
them and we need a mechanism to find out what is going on
inside exempt organizations. At the moment, I would submit, we
do not know. This is not to suggest malfeasance or a plot. It
is not to suggest that people who work with data are ignorant
or inattentive. We don't have the conceptual framework, and I
have in my written testimony suggested how we might go about
asking some of these questions. I would like to point out to
the Committee that questions of operating through complex
structures of multiple types of exempt entities, or exempt
entities and taxable entities, should not be regarded as
inherently wrong or problematic. The question remains, how do
they operate, and then my fifth question, how are resources to
be transferred?
There is no guidance on what kind of resource transfers can
be engaged in consistent with various types of exempt status.
Some of these are efficient and productive and necessary.
Others are beyond problematic and should be interdicted fairly
quickly. UBIT, what is it there for these days? It was enacted
to make sure that taxable entities were not put at disadvantage
when they were making spaghetti. Long ago, a Member of this
Committee expressed the fear that all noodles in America would
be made by universities, referring to the famous Mueller
Macaroni New York University Law School example. Well, that
didn't happen, but there was a justifiable concern about the
tax advantage. The issue with UBIT, the Unrelated Business
Income Tax issues now, is are resources being diverted inside
the entity to business activities? Why are we capitalizing
business activities with deductible charitable contributions? I
submit we need to know to the extent this is happening and
think about whether that is appropriate. Finally, a new issue.
Tax shelter promoters are enticing exempt organizations to
serve as accommodation parties in the niftily designed
transactions that are undermining the very integrity of the
Internal Revenue Code. I would urge this Committee to become
engaged in making sure that whatever else is done with tax
shelters, tax-exempt organizations are not made enablers of
these unworthy schemes, and that I think the IRS has done a
good job in this area of at least identifying the issue.
I would like to make one point about IRS staffing and
funding. I am not an expert on IRS staffing, but I believe they
need more people with a more finely developed expertise and
they need to be able to retain them longer to develop
experience in administering the tax law, and frankly, if you
will pardon a professor for being a capitalist, that requires
paying people. I believe that Congress could usefully exercise
oversight to make sure that the IRS is hiring and keeping
people with an appropriate level of expertise, because without
expertise, the moral hazard of misusing exempt organizations
will, in fact, become worse. There has been little precedential
guidance in recent years, and I hope I have given you enough of
a list to suggest to you that very fundamental issues remain
unaddressed, but should not do so any longer. Thank you, and I
look forward to questions.
Chairman THOMAS. Thank you very much, Professor Hill.
[The prepared statement of Ms. Hill follows:]
Statement of Frances R. Hill, Professor, University of Miami School of
Law, Miami, Florida
Thank you for the opportunity to present this testimony. The
comments presented are my personal views and do not represent the
views, if any, of the University of Miami or the University of Miami
School of Law.
Exempt entities provide important benefits to the public. Without a
vibrant, diverse, dynamic and growing exempt sector, many important
social, cultural, and economic needs of the American people could not
and would not be served. All of us are beneficiaries of this sector no
matter how fortunate or unfortunate our circumstances.
Maintaining the vibrancy and dynamism of the exempt sector that
provides such important benefits to the public is enhanced by
continuing oversight from Congress and responsible administration of
the law by the Internal Revenue Service (the ``Service'). Such efforts
must protect the public interest in ensuring that exemption serves
public purposes. At the same time, efforts to constrain the creativity
of the exempt sector by unduly circumscribing the independence of
exempt entities would be counterproductive. The exempt sector must be
accountable but should not be constrained. Evidence of malfeasance by
certain organization managers or the inattentiveness or even
dereliction by certain directors should not be generalized to the
entire sector, just as these unacceptable behaviors should not be
excused by reference to the benefits provided by exempt organizations.
Government administration and oversight should be seen as part of a
larger process of ensuring accountability through participatory
monitoring by organization members and beneficiaries.
The twenty-eight types of exempt entities enumerated in section
501(c) of the Internal Revenue Code of 1986, as amended (the ``Code'')
differ in their requirements for exemption and the activities that
support exempt status. But, they share the common feature that, in
every case, exemption depends upon providing a public benefit to a
defined class of beneficiaries.\1\ This common feature provides a
rationale for exemption and an analytical framework for understanding
whether current law and the way it is being administered are consistent
with the foundational reason for exemption.
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\1\ For analyses of these various types of exempt entities, see
Frances R. Hill and Douglas M. Mancino, Taxation of Exempt
Organizations Warren, Gorham & Lamont, 2002, with semiannual
supplements) (``Hill and Mancino'').
---------------------------------------------------------------------------
While current law indeed provides that provision of benefits to the
designated class of beneficiaries is the foundational requirement for
exemption, this requirement has not been developed as an affirmative
requirement. Instead, administrative efforts, policy discussions, and
academic analyses focus largely on preventing impermissible private
benefit. Preventing misuse of exempt organizations' resources is a
matter of central importance. But, it does not provide either a
rationale for exemption or an analytical framework for understanding
exemption. As exempt entities engage in an ever-broadening range of
activities and as the exempt sector grows larger, more dynamic and more
diverse, this is an appropriate time to consider the reasons for the
exemption and the relationships between these fundamental rationales
and current law.
A rationale or framework addressing the reasons for exemption is an
analytical and policy tool, not a justification offered to defend every
element of current law. Without such a framework, a rationale rather
than a mere rationalization, rules become isolated requirements that
are easily manipulated to support activities largely unrelated to the
statutory purposes exempt entities are created to serve. When the law
is easily manipulated, resources are diverted from activities that
serve exempt purposes to activities that serve other ends and
confidence in the exempt sector erodes. The result is a classic moral
hazard in which aggressive entities pursing problematic strategies win
at least tacit acceptance, while entities that are attempting to comply
are given little useful guidance and find few positive rewards for
their efforts.
This is not to suggest applicable law and acceptable practices will
not or should not change. The world in which exempt entities operate is
changing and the needs addressed by exempt entities are changing.
Change in activities undertaken, structures created, and relationships
with other sectors developed should be seen as practical adaptations to
changing circumstances. At the same time, certain things need not and
should not change. Exempt entities should always operate to provide a
public benefit to the beneficiaries they have been organized to serve.
Exempt entities should never be treated as the private domain of
managers or board members or substantial contributors who treat either
the tangible or intangible resources of the exempt organization as
something to be used for personal benefit. The challenge is to
reconcile useful change with these foundational principles. This is the
work of every person who cares about the exempt sector. In a democracy,
views on how to do this can be expected to differ.
My comments today will focus on a public benefit framework for
exemption. I shall address the following topics: (1) the elements of a
public benefit framework; (2) oversight priorities arising from a
public benefit framework; (3) oversight priorities for data collection
and research; (4) oversight priorities relating to guidance and
compliance; and (5) oversight and ensuring that exempt entities operate
for a public benefit.
I. Elements of a Public Benefit Framework
Exemption is a subsidy granted for defined public policy
purposes.\2\ The Code, the applicable regulations, and the legislative
history all support the nexus between exemption and provision of a
public benefit. No one would disagree that provision of the statutorily
mandated public benefit is the essential activity of any exempt entity.
---------------------------------------------------------------------------
\2\ Regan v. Taxation with Representation, 461 U.S. 540 (1983).
---------------------------------------------------------------------------
Yet, the concept of a public benefit has not figured centrally in
either policy discussions or academic analyses of exempt entities.
Instead, both policy makers and commentators have equated the absence
of private benefit with the presence of a public benefit. The dominant
academic framework in the last quarter century was based on the private
benefit avoidance framework presented by Professor Henry Hansmann in
terms of a ``nondistribution constraint.'' \3\ Much of policy focus
during this same period was on developing an administrable private
benefit provision, which was enacted in the excess benefit transaction
provision of section 4958.
---------------------------------------------------------------------------
\3\ Henry Hansmann, The Role of Nonprofit Enterprises, 89 Yale L.J.
835 (1980); Reforming Nonprofit Corporation Law, 129 U. Pa. L. Rev.497
(1981).
---------------------------------------------------------------------------
Concern with private benefit is a fundamentally important element
in the law relating to exemption. But, the mere absence of a private
benefit does not provide a rationale for exemption that can provide
guidance for administration and oversight of the exempt sector. A
rationale for exemption and a framework for analysis, policy,
administration, and oversight depends on developing the concept of a
public benefit, which provides an affirmative rationale for exemption
consistent with the exempt purposes set forth in current law. A public
benefit rationale for exemption points toward additional issues that
are critical in determining whether entities are serving their intended
exempt purposes.
Making public benefit a focal point of inquiry leads to the
question of whether current law and the manner in which it is being
administered are consistent with the efficiency of exemption. To the
extent that exemption means that a public benefit is being provided to
an appropriate class of beneficiaries, it is operating efficiently. To
the extent that exemption serves simply as a mechanism for avoiding
taxes on income that would be taxed if performed by another type of
entity, then exemption is inefficient. A focus on efficiency in this
sense permits one to raise the question of whether increases in the
number and revenue of exempt entities mean that provision of public
benefits has increased to a commensurate extent. The only response in
light of current data is that no one can say with any certainty. As
this testimony suggests below, development of a public benefit
framework for exemption permits the kind of analysis that can lead to
collection of the information required to answer this fundamental
question.
A public benefit framework directs attention to a fact that has
been curiously overlooked. Analyses of exempt organizations have
overlooked the significance of the noun and focused instead on the
adjective. Ignoring the fact that exempt activities are conducted
through organizations is a central analytical error. This error is
compounded by the unarticulated ``organizational presumption'' of
current law and its administration.\4\ Activities conducted by exempt
organizations are generally presumed to be consistent with the
organization's exempt status. In practice, the definition of an exempt
activity is an activity conducted by an exempt organization. But, no
one knows what exempt entities are in fact doing. Current law
anticipates that exempt entities will engage not only in exempt
activities but also in permissible activities that do not in themselves
support exemption and which are not intended to be the organization's
primary activity. But, to the extent that these permissible activities
become characterized as exempt activities by invoking the
organizational presumption as the core element of characterization,
exemption becomes inefficient.
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\4\ Frances R. Hill, Targeting Exemption for Charitable Efficiency:
Designing a Nondiversion Constraint, 56 Sn. Meth. L. Rev. 675
(2003)(``Targeting Exemption'').
---------------------------------------------------------------------------
A second problem obscured by the lack of attention to the concept
of an organization is the difficulty of determining the primary purpose
of an organization. Section 501 and the regulations there under provide
that exempt organizations of all types are exempt only if they are
organized and operated primarily for an exempt purpose. There is no
guidance on what constitutes ``primary'' for this purpose. Is a
peppercorn of exempt activity sufficient? No one can say, and there is
no guidance on how to determine which activities in fact support
exemption. This is not simply a problem of data but more fundamentally
a problem of conceptualizing exempt organizations. This issue is
particularly important in light of the dynamism of the exempt sector.
Balancing this necessary dynamism with an administrable concept of what
is a primary purpose is not an easy task but it is a necessary one
which should no longer be deferred.
The dynamism of the exempt sector has led some to suggest that the
kind of activities in which exempt entities are permitted to engage
should be closely constrained. This not likely to be a useful or
workable approach. The idea that certain activities should be performed
solely by exempt entities or solely by taxable entities is no longer
either plausible or desirable. Efforts to prohibit taxable schools or
to ban gift shops at zoos or restaurants at museums would seem to serve
no useful purpose. The question posed here is not what activities are
permissible but what activities are consistent with the efficient
provision of a public benefit to an appropriate class of beneficiaries.
To the extent that exempt entities use resources for activities that do
not provide a public benefit, exemption operates inefficiently. This
kind of inefficiency cannot be addressed by a ``nondistribution
constraint'' implemented through the private benefit provisions. The
absence of private benefit does not establish the presence of a public
benefit. Addressing exemption inefficiency requires specification of a
public benefit framework implemented through a ``nondiversion
constraint'' that imposes disincentives on the diversion of resources
from exempt activities to other activities.\5\
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\5\ For a discussion of a nondiversion constraint, see Targeting
Exemption, supra note 4.
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II. Oversight Priorities: Reconciling a Public Benefit Framework with
Unaddressed Issues and Contemporary Developments
The following discussion of six contemporary developments in the
exempt sector should not be read as identification of problematic or
abusive behavior. As noted above, the dynamism of American social,
cultural and economic life are strengths of our country. This is true
with respect to the exempt sector as well as to the taxable sector. At
the same time, exemption must continue to serve its public purposes by
providing public benefits to appropriately defined beneficiaries. The
six oversight priorities arising from a public benefit framework for
understanding exemption are: (1) what constitutes a public benefit; (2)
identifying beneficiaries; (3) overcoming internal diversions of
resources; (4) operation of complex structures; (5) transfers of
resources among various types of exempt and taxable entities; (6) the
role of the unrelated business income tax (``UBIT'') provisions from a
public benefit perspective; and (7) interdicting the abuse of exemption
represented by serving as accommodation parties in tax shelter
transactions. Each of these will be discussed in turn.
1. Specifying What Is Meant By a Public Benefit
Some subsections of 501(c) specify permissible exempt benefits in
some detail. The primary exception is section 501(c)(3). The broad
range of exempt purposes under section 501(c)(3) is consistent with
providing public benefits that range from such tangible benefits as
food, clothing, and shelter to intangible benefits like education.
Efforts to address perceived abuses by restricting the nature of
benefits, with only certain kinds of benefits treated as qualifying
public benefits, would introduce a counterproductive inefficiency that
robs the exempt sector of its dynamism and its ability to fulfill its
purposes. The issue is not to restrict activities, but to determine
what kinds of activities should be funded with exempt funds.
2. Identifying Appropriate Beneficiaries Entitled to Receive Public
Benefits
Many types of exempt entities have clearly defined criteria for
beneficiaries, who are also members of the organization. This is the
case with respect to section 501(c)(5) labor organizations, section
501(c)(6) business leagues, section 501(c)(7) social clubs, section
501(c)(8) fraternal benefit organizations, section 501(c)(10) fraternal
societies, section 501(c)(19) veterans organizations, and section
501(c)(21) black lung trusts.
Section 501(c)(3) does not specify categories of persons who may
receive the benefits providing the foundation for exemption.
Beneficiaries of section 501(c)(3) are in some cases readily identified
but in other cases are not. Generally recipients of more tangible
public benefits are more readily identifiable, while recipients of less
tangible but still vitally important benefits are not readily
identifiable as a distinct ``charitable class.'' This distinction
causes significant confusion with respect to organizations providing
intangible benefits to a charitable class that is not readily
identifiable. In these cases, it is easy but wrong to take the position
that the organization is providing no public benefit to appropriate
beneficiaries. Greater attention to issues of the concept of a
charitable class would help eliminate such confusion and would protect
the diversity and dynamism of the exempt sector.
3. Overcoming Internal Diversion of Resources by Addressing the
Organizational Presumptions
As discussed above, exempt purposes are pursued through exempt
organizations. Current law requires that exempt purposes constitute an
organization's primary purpose. However, current practice is based on
an ``organizational presumption'' that treats activities as exempt
activities if they are conducted by an exempt entity. The resulting
circularity facilitates an internal diversion of resources to
activities that are only tangentially, at best, related to exempt
purposes.
There are two possible approaches to addressing this kind of
internal diversion. One is to provide guidance on what constitutes an
organization's primary purpose. While this would seem to be fundamental
to administering current law, in fact there is no practical, useful
guidance at all on this matter.
A second approach would be to direct tax benefits only to
expenditures for exempt activity while not constraining other
activities. This approach treats an exempt organization as an aggregate
of activities, only some of which are treated as exempt, and makes the
benefits of exemption available only with respect to funds used for
exempt activities. This approach is based on targeting the benefits of
exemption to those activities that in fact provide a public benefit to
an appropriate class of beneficiaries.
4. Complex Structures
Exempt entities are increasingly operating in complex structures of
related exempt entities of different types with different exempt
purposes serving differently defined beneficiaries. How these various
purposes and beneficiaries are to be appropriately served is a question
of what public benefits are being provided. In the worst case,
activities that are consistent with the exempt status of one type of
exempt entity can jeopardize the exempt status of other types of exempt
entities. The issue is to avoid inappropriate diversion of resources
while at the same time appropriately protecting the exempt statuses of
the various entities. Complex structures may also involve both taxable
and tax exempt entities. These structures can create synergy that
enables exempt entities to provide a public benefit more efficiently.
At the same time, issues of diversion and potential conflicts of
interest require more timely guidance and continuing oversight.
5. Transferring Resources
Exempt entities may choose to fund projects or programs operated by
other exempt entities. There is virtually no guidance on such
transfers. Unaddressed issues include questions of what kinds of
transfers between what types of entities are permissible, what kind of
oversight and recordkeeping are required, and under what circumstances
transfers might jeopardize the exempt status of either the transferor
or the recipient. These kinds of questions arise with respect to
transfers between exempt entities of the same type, between exempt
entities of different types, and between exempt and taxable entities.
6. UBIT and Public Benefit
The UBIT provisions exist to tax the income derived from unrelated
trade or business activities. The original purpose of the UBIT
provisions was to prevent unfair competition with taxable business
engaged in the same activities. The issue now is more a matter of
diversion of resources to capitalizing the unrelated trade or business
than a matter of unfair competition with taxable entities. UBIT is not
designed to address this kind of diversion and in fact does not do so.
The issue is whether UBIT should be reconsidered or whether some other
form of no diversion constraint should be considered. In addition, the
extent of unrelated trade or business activity that is consistent with
exempt status remains unaddressed. It should also be noted that those
activities subject to the unrelated business income tax represent only
a portion of the commercial activities exempt entities engage in
because the exceptions to UBIT have come to be so expansively applied.
7. Exempt Entities as Accommodation Parties in Tax Shelters
Serving as an accommodation party in a tax shelter can never be
treated as an activity that provides a public benefit.\6\ More
attention is needed to efforts of shelter promoters to entice exempt
entities to play this role.
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\6\ See new Chapter 37, Exempt Entities and Tax Shelters, in the
most recent supplement to Hill and Mancino, suprara note 1.
---------------------------------------------------------------------------
The appropriate response is likely to involve some mixture of tax
on the fee on the theory it is a taxable fee for providing a service,
as well as penalties imposed on organizations, organization managers,
and professional advisers and the possibility of revocation of
exemption. Revocation by itself is unlikely to have much effect on
special purpose exempt entities created for the purpose of serving as
an accommodation party. In addition, the Service has historically been
reluctant to revoke exempt status even in cases of quite egregious
private benefit.
III. Oversight Priorities for Data Collection and Research
A public benefit framework directs attention to the question of
whether the growth in the number of exempt entities and the increase in
their revenue is matched by an increase in provision of benefits to
appropriate beneficiaries. This question can be answered only by
developing a more precise idea of what exempt entities are in fact
doing.
There are two important components to this inquiry. The first
relates to the sources of funds and the second relates to the uses of
funds and what empirical patterns, if any, can be identified between
sources and uses. Looking at the relationship between sources and uses
of funds inside organizations creates an empirical basis for assessing
claims that all funds, however derived, are used for exempt activities.
This is a rationalization for ignoring the primary purpose issue and
for defining virtually anything an exempt organization does as an
exempt activity.
Current data provide little basis for addressing this issue. Most
research is based on Form 990, which is publicly available. But, the
data on Form 990 are collected for compliance, not for research. In
addition, there is no external check on the reliability of this self-
reported data.\7\ The data needed will necessarily be based on the
books and records of organizations, which poses a significant barrier
to research. Such research should not be linked to enforcement efforts
by the Service.
---------------------------------------------------------------------------
\7\ See, General Accounting Office, Tax-Exempt Organizations:
Improvements Possible in Public, IRS, and State Oversight of Charities
(2002)(GAO-02-526).
---------------------------------------------------------------------------
IV. Oversight Priorities Relating to Guidance and Compliance
Guidance and compliance are inextricably interrelated. Compliance
initiatives are one means of identifying areas requiring issuance of
additional guidance. Guidance permits organizations and their
professional advisers to comply more effectively. Guidance is also a
necessary predicate for compliance initiatives and public acceptance of
such initiatives. Concerns about compliance burdens on exempt entities
are important, and issuance of timely guidance will ease the compliance
burden.
The Service has issued little precedential guidance in recent
years. The lack of a program for issuing precedential guidance with
respect to the most significant foundational issues exacerbates the
moral hazard of giving greater scope for aggressive actions while
failing to assist those seeking to comply. Any such comprehensive
program for issuing guidance requires personnel with a high level of
expertise and experience in the substantive area. The issues to be
addressed call for a sophisticated understanding of the technical
rules, an appreciation of the policy purposes being served, and a well-
honed sense of what kinds of approaches the Service can administer.
Any priorities identified through the oversight process must
necessarily lead to administrable tax policies. There are substantial
questions about what the Service can administer at its current funding
and staffing levels. The lack of guidance and the slow pace of
compliance efforts suggest to this outside observer that the Service
requires additional resources and additional personnel. The Service
seems particularly short of persons with the required expertise in
developing guidance. It is also important to provide funds for
attracting, training, and retaining young lawyers who now may not be
inclined to consider careers with the Service.
These comments should not be construed as lack of confidence in the
skill and commitment of the many dedicated tax professionals who work
on exempt organization matters. There are simply too few persons with
the requisite expertise to provide the guidance needed by the exempt
sector. I urge Congress to consider substantially increasing the
funding for the exempt organization function at the Service.
V. Oversight and Public Benefit
Oversight efforts can help ensure that the provision of public
benefits is the criterion for retaining exempt status. This is
consistent with the mission of exempt entities and the commitments of
the dedicated people who work in the exempt sector.
Oversight can help develop greater understanding of how the
provision of public benefits is funded and what are the main reason
that organizations divert particular types of funds to other uses. Such
empirical research and consideration of the policy responses to such
research are not likely to be developed rapidly or in response to one
or another example of indefensible behavior. Incremental efforts based
on greater understanding of what exempt entities in fact do and how
they do it seems the most productive approach to ensuring that this
vital sector can continue to make its unique contributions. Continued
consideration of an appropriate framework for exemption will keep
attention focused on what should never change in exempt organization
law and what changes are appropriate accommodations to changing
circumstances.
Chairman THOMAS. Mr. Cohen, I didn't out you when the
Ranking Member wanted to know if there were any IRS folk in the
room----
[Laughter.]
Chairman THOMAS. --but obviously Mr. Cohen is a former
Commissioner of the Internal Revenue Service and has at least a
historically intimate understanding of the structure. I want to
thank you. I want to thank you for your testimony, and the time
is yours.
STATEMENT OF SHELDON S. COHEN, PARTNER, MORGAN, LEWIS AND
BOCKIUS, AND COMMISSIONER, INTERNAL REVENUE SERVICE, 1965-1969
Mr. COHEN. Thank you, Mr. Chairman, Mr. Rangel, and Members
of the Committee. I am pleased to appear before you, and I
should preface my remarks by saying I appear on my own behalf,
not on behalf of my clients or my firm. I did have ten
wonderful years at the Revenue Service at various times and I
have produced two daughters who both served for ten to 12 years
at the Revenue Service, so----
Chairman THOMAS. That must be a genetic flaw.
Mr. COHEN. We have done our duty.
[Laughter.]
Mr. COHEN. If you will forgive me, I am going to skip
around on my testimony because much of it has been covered and
I know you don't want to hear that again. A piece of history
would help you. George Boutwell was the first Commissioner of
Internal Revenue. He was later Governor of Massachusetts and a
U.S. Senator. Boutwell, in his manual on running the Revenue
Service in 1862, spelled out that he was going to exempt--he
had no statutory authority--he exempted most charities and what
we would now call exempt organizations. He did it on the basis
that it was impracticable and that it was useful. They served a
useful purpose. Lest you think it is a late arrival in the
income tax, it arrived in the 1862 version that Abraham Lincoln
signed. Also, I would like to suggest that one of the problems
of administration that occurs is if you give the Commissioner
$5 million, $50 million more to help administer the tax laws,
or $500 million, as has been asked in the President's budget,
and you were Commissioner of Internal Revenue, how many of
those dollars would go into exempt organizations? Do you
remember Willie Sutton? Why did he rob banks? That is where the
money is. You folks and your compatriots on the Appropriations
Committees hold him responsible and the organization
responsible for bringing in money, particularly at a time like
this when they are running huge deficits. So, I doubt that much
of that would be allocated. Now, if you express an interest,
more of it will be.
One other aside. In the early seventies, there was a
conference at Dichley, which is a conference center in Britain.
Jack Nolan, who was then the immediate past Assistant Secretary
of Treasury for Tax Policy under the Nixon Administration and I
were representatives of the United States. Those Dichley
conferences are about ten or 12 Americans and ten or 12 Brits
and they talk about a topic of current interest for three,
four, five days. They get into the depth of it. One of the
things we discovered, Jack and I, was that the British use a
different system of encouraging charities than we. They have a
Charities Commission. That commission is composed, I think, of
three commissioners--it was then--and their object is to
encourage charity. They write the rules. They write the rules
of what is charity, what qualifies for tax-exemption. Those
rules are enforced by England Revenue. So, you don't have the
Commissioner of Internal Revenue with the two hats, one to
encourage and move charity forward and the other one to
restrict it and audit it. We planted that idea in the Ways and
Means Committee in the mid-seventies. Unfortunately, it went
the way every--and I understand completely the charities. My
own clients would react the same way. It is the devil I know
for the devil I don't know every time, even though it might be
better, it might be worse, and therefore I will take it as it
stands. I have covered the same area as many others in my
testimony in regard to the multiplicity of organizations. They
arise with no rhyme or reason. Why is there a section 501(c)(2)
and (c)(25), both of which cover title-holding organizations,
both of which were enacted at various times, and because there
was some restriction on (2), instead of amending (2) and
allowing multiple entities to own the title-holding entity,
(25) is enacted, and there are several areas like that. There
are many veterans' organizations covered with different
categories and different qualifications. There are, likewise
many pension plans where they have just thrown in one--there
are several categories where there either is one organization
or no organization, as Mr. Yin has indicated, which would
indicate that little thought had been given to the
organizational structure.
Once we get past (c)(3), you and your staffs and the rest
of the world really don't pay any attention, and yet there are
at least a half-a-million other organizations. Of course, one
of the things we said, we don't know about many of these
organizations. These organizations are not required to file a
1023. So, they don't even have to tell the Service they exist.
Now, normally, the Service will ask them to file a 1023 when
they get the 990. They are required to file 9nineties. The
small organizations that don't file 9nineties, those that make
less than 25, in my day, they had to file a postcard that
somebody had to sign certifying that they were in existence and
that they were under--it was less. It was $5,000 or $10,000
then, but it is now $25,000. Again, you don't know about them.
You don't know about the churches because we don't have a list
of churches. They don't have to apply. I have asked a variety
of questions that are very much like the questions that others
have raised on the--but I feel it is important that every
organization should be registered. They should have to tell the
Revenue Service, here we are. I don't have any problem with the
exchange of information to the States, because most of those
exchange agreements were signed while I was in office. States
now have the same kinds of restrictions that the Federal
government has on the passing on of that. That is, it is a
Federal crime for a State official to violate the confidence of
the information. The States' Attorney Generals, we have many of
the State Attorney Generals are active and effective. Most are
not. That is, the State Attorney General is generally the
parent of the State entity which is the charity of whatever
category and they pay no attention, and it is very difficult. I
have been in situations where a client has felt the charity was
abused. That is, he gave money to the charity, it didn't do
what it was supposed to do, and tried to activate the State
Attorney General. Many will, as I say, effectively try to make
sure that the right thing is done. Many will ignore it. Thank
you, Mr. Chairman.
Chairman THOMAS. Thank you very much, Mr. Cohen.
[The prepared statement of Mr. Cohen follows:]
Statement of The Honorable Sheldon S. Cohen, Partner, Morgan, Lewis and
Bockius, and Commissioner, Internal Revenue Service, 1965-1969
Chairman Thomas and distinguished members of the Committee, I am
Sheldon Cohen, senior counsel in the Washington D.C. office of the law
firm of Morgan, Lewis & Bockius and a former Chief Counsel and
Commissioner of the Internal Revenue Service. I am pleased to appear
before you today at your request to testify on issues relating to the
historical background of certain organizations that are tax-exempt
under Section 501(c). My testimony today is in my personal capacity and
represents my own views and not those of my firm or any of its clients.
By way of background, I served in the Internal Revenue Service on
several different occasions. During the period 1952-1956, I served as a
legislative draftsperson during the drafting of the 1954 Code and
Regulations. In the period from January 1964 through January 1969, I
served as Chief Counsel for one year and then as Commissioner of the
Internal Revenue Service for four years. I have also served as an
officer and Trustee of the National Academy of Public Administration
and have served as a panel member of several studies dealing with the
administrative aspects of the Internal Revenue Service. I also served
as Co-Chair of a study of the collection and privacy portions of the
Internal Revenue Code for the Administrative Conference of the U.S.
(The changes recommended by that group, co-chaired by Justice Scalia in
one of his prior positions as chair of the Administrative Conference of
the United States, were adopted by the Congress in 1976.)
Given our limited time today, I will first discuss some background
information about a number of the numerous organizations that are tax-
exempt under Section 501(c) and some of the changes Congress and the
IRS have made over the years as various problems have arisen with
respect to different exempt organizations. Then, I will briefly address
some of the critical questions that arise with respect to evaluating
these organizations' qualification for exemption from Federal income
tax. I have attached an appendix to my written testimony listing all of
the categories of organizations exempt under Section 501(c).
Questions about the tax-exempt sector are increasingly important
given that the sector is growing in both size and assets and has been
playing an ever more important role in our society. The number of
organizations exempt from tax in the United States has increased
tremendously in the past 30 years. According to the Statistics of
Income Division, there were only about 220,000 organizations (excluding
private foundations) exempt under Section 501(c) filing Form 990 annual
information returns with the IRS in 1975. (Please note that this figure
does not include churches and religious organizations and a few other
organizations not required to file Form 990.) By 1995, the number of
organizations filing an annual information return with the IRS had
skyrocketed to approximately 1.2 million exempt organizations. The
sector has even grown tremendously in the past 10 years alone--today,
there are over 1.8 million organizations exempt from tax under Section
501(c) filing Form 990 with the IRS each year.
There are 28 categories of tax-exempt organizations under Section
501(c), and approximately 1 million of the organizations exempt under
Section 501(c) are categorized under Section 501(c)(3). Section
501(c)(3) organizations stand apart from other exempt organizations,
and have, over the years, received a good deal of the attention focused
on the non-profit sector. In fact, they have received almost all of the
attention.
Section 501(c)(3) organizations are distinguished by being
considered charitable in nature and include organizations such as
universities and schools, hospitals, scientific research organizations,
social service organizations, community development groups, performing
arts groups, and environmental support organizations. Also exempt under
Section 501(c)(3) are private foundations, which operate programs,
provide services and/or make grants in order to fulfill their
charitable purposes.
Organizations exempt from Federal income tax under one of the other
Section 501(c) subsections of the Internal Revenue Code provide an
array of not-for-profit services, and are frequently formed as
membership organizations to primarily benefit their members. These
other tax-exempt organizations are distinguished from Section 501(c)(3)
organizations because they are not considered to be charitable in
nature or to primarily benefit the public. Unlike Section 501(c)(3)
organizations, most of these other exempt organizations are not
eligible to receive tax-deductible charitable contributions. The
primary advantage they receive for qualifying under Section 501 is,
therefore, exemption from Federal income tax. As you requested, I will
not be addressing Section 501(c)(3) organizations or organizations that
are exempt under Section 501(c)(5), which are labor, agricultural and
horticultural organizations, or Section 501(c)(6) organizations, which
are business leagues.
One of the hot topics in the exempt organizations field today
concerns the exemption of credit unions. Credit unions can potentially
be exempt under two sections--501(c)(1) and 501(c)(14). Section
501(c)(1) exempts federal instrumentalities from tax. Organizations
exempt under this section include the FDIC, Federal Land Banks, Federal
Reserve Banks and similar organizations. Also included are Federal
credit unions organized and operated in accordance with the Federal
Credit Union Act, which are considered instrumentalities of the United
States. Section 501(c)(1) organizations are not required to file Form
990 annual informational returns, they are not subject to the unrelated
business income tax and they are entitled to receive tax-deductible
contributions. In the 1970s, the IRS conducted a review of the 1,000 or
so organizations exempt under this Section. This review revealed that
many of these organizations did not qualify as Federal
instrumentalities and were classified under Section 501(c)(1)
inadvertently. As a result, there are only about 150 Section 501(c)(1)
organizations today.
Credit unions that are state chartered and other mutual financial
organizations may obtain exemption under Section 501(c)(14) rather than
Section 501(c)(1). Exemption under Section 501(c)(1) is preferable for
credit unions because the IRS has assumed an audit position that
501(c)(14) credit unions are subject to the unrelated business income
tax whereas 501(c)(1) organizations are not, given that the Internal
Revenue Code does not address this point.
Organizations that are exempt under Section 501(c)(2) and Section
501(c)(25) are title holding companies for tax-exempt organizations.
Section 501(c)(2) provides exemption for single parent organizations,
and was added to the Code in 1916. Section 501(c)(25) was added to the
Code in 1986 in response to the IRS' position that title-holding
entities which otherwise qualified under Section 501(c)(2) could not be
exempt if two or more of its parent organizations were unrelated.
Section 501(c)(4) was incorporated in the Code in 1913 and includes
organizations to promote the common good and general welfare of the
community, such as civic leagues, social welfare organizations,
homeowners' associations, etc. They are similar to Section 501(c)(3)'s
but they are permitted to engage in some legislative and political
activities, so long as this does not constitute their primary activity.
Section 501(c)(4) does not include social clubs or other clubs
organized for pleasure or recreation. Such organizations are instead
exempt under Section 501(c)(7) and have been exempt since 1916. A few
years ago, the IRS made an enforcement drive to ensure that social
clubs were properly paying the unrelated business income tax on their
investment income.
Many veterans organizations used to be exempt under Section
501(c)(4) and (c)(7). In 1969, 501(c)(4) organizations were made
subject to the unrelated business income tax. Given that veterans
organizations often provide insurance, many were concerned that their
insurance activities would be taxable. As a result, Section 501(c)(19)
was passed in 1972 to specifically provide exemption for veterans
organizations offering insurance to their members.
Section 501(c)(8) exempts fraternal organizations which were
historically created to provide insurance to their members. I believe
there are about 30,000 Section 501(c)(8) organizations. Section
501(c)(10) was added in the Tax Reform Act of 1969 to exempt certain of
these organizations that stopped providing insurance to their members,
like the Masons.
Section 501(c)(9) is for VEBAs--Voluntary Employees' Beneficiary
Associations, which provide for life, sickness, accident and other
benefits to their members who must all have a common employment-related
bond. In the early 1980s, VEBAs were used in an abusive scheme in which
employers were seeking to take advance deductions for contributions to
welfare plans that provided benefits in the nature of deferred
compensation. Congress solved this problem by passing Section 419 in
the Deficit Reduction Act of 1984, which places objective limits on the
amount an employer can deduct for contributions to welfare plans for
employees.
Section 501(c)(12) originated in 1916 and is designed for mutual
and cooperative associations. Section 501(c)(13) has been around since
1913 and provides exemption for non-profit cemeteries.
There are several subsections of 501(c) that exempt very few
organizations in practice. I understand that there are only 2
organizations currently exempt under Section 501(c)(23). Section
501(c)(23) was passed in 1982 to exempt associations organized before
1880 more than 75 percent of the members of which are present or past
members of the Armed Forces and a principal purpose of which is to
provide insurance and other benefits to veterans or their dependents.
It is my understanding that there is also only a single remaining
organization that is exempt under Section 501(c)(18) (Employee Funded
Pension Trusts, which must have been created before June 25, 1959) and
Section 501(c)(24) (Trust Described in Section 4049 of ERISA). I do not
believe there are any organizations exempt as Section 501(c)(22) Trusts
for Multiemployer Plans Under ERISA. Section 501(c)(20) (Group Legal
Services Plan) expired in 1992, although there are still a handful of
organizations exempt under this Section. Furthermore, I understand that
there are only about 50 or significantly fewer organizations exempt
under Section 501(c)(11) (Teachers' Retirement Fund Associations of a
Purely Local Character), Section 501(c)(16) (crop financing
organizations), Section 501(c)(21) (Black Lung Benefit Trusts), Section
501(c)(26) (State-Sponsored High-Risk Health Coverage Organizations)
and Section 501(c)(27) (State-sponsored Workmen's Compensation
Reinsurance Corporations).
These are just some examples of the numerous organizations that are
exempt under Section 501(c), and some of the various considerations
that have arisen over time. As Congress reviews exempt organizations,
there are several questions to consider with respect to those
organizations that are exempt under subsets of Section 501(c) other
than Section 501(c)(3).
First, given that exempt organizations have been added to the Code
piecemeal over time to address particular contemporary factors, the
most basic issues in assessing these organizations are to determine
whether they still serve their intended purpose and whether the Code
should be amended to reflect current realities. As you can see from
this review of Section 501(c), specific exemptions were made to address
particular concerns at various points in time. In many instances,
Congress and the IRS have reacted to the realities--the concerns, needs
and abuses--of the tax-exempt sector. Nonetheless, although many, if
not most, of these organizations are still serving the purpose for
which they were granted exemption, others merit revisiting.
The second question is whether all organizations exempt under
Section 501 should be required to apply to the IRS for recognition of
their exempt status. Of all the Section 501(c) organizations, only
those exempt under Section 501(c)(3) are required to apply to the IRS
for recognition of their exempt status. Other organizations are
nonetheless required to file an annual information return, Form 990,
but only if they have gross receipts over $25,000 a year. In practice,
the IRS tends to request that any organization filing a Form 990 submit
an application for recognition of tax exemption. But because
organizations that have gross receipts of less than $25,000 a year are
not required to file Form 990, small organizations may escape the IRS'
notice completely or for a long time.
Third, Congress may want to consider whether the Code should be
amended to institute penalties against insiders who deal unfairly with
all Section 501(c) exempt organizations. Although nine categories of
organizations exempt under Section 501(c) are prohibited from having
any benefits ``inure'' to insiders at an organization, only Section
501(c)(3) and (c)(4) organizations are subject to rules which sanction
the actual individuals who deal improperly with an exempt organization.
Attention has been focused on exempt organizations recently in part
because of high profile cases in which private individuals received
inappropriate benefits from charities with which they were affiliated.
Private foundations are subject to the ``self-dealing'' rules of
Section 4941 (passed by Congress in the Tax Reform Act of 1969) and
public charities are regulated by the ``intermediate sanctions''
provisions of Section 4958 (passed in 1996). Section 501(c)(4)
organizations were also specifically made subject to the intermediate
sanctions rules. These rules are an important part of IRS oversight of
exempt organizations, in large part because they provide a way to halt
and redress abuse of tax-exempt resources without revoking the exempt
status of an organization that may be making valuable contributions to
our society.
Finally, although these categories of organizations exempt under
Section 501(c) merit review, IRS resources are scarce. The question of
whether the IRS is devoting appropriate audit attention to these
organizations may depend to a large extent on budgetary constraints and
the need for enforcement efforts in other areas.
In closing I would like to thank the Committee and its staff for
allowing me to give you my views on this topic.
APPENDIX
Types of Exempt Organizations under Internal Revenue Code Section
501(c)
------------------------------------------------------------------------
Internal Revenue Code
Section Description of activities
------------------------------------------------------------------------
501(c)(1) Corporations organized under Act of Congress
Instrumentalities of the United States
------------------------------------------------------------------------
501(c)(2) Title holding corporation for an exempt
organization
------------------------------------------------------------------------
501(c)(3) Charitable, religious, educational, scientific,
and literary organizations, international
amateur sports competitions, organizations
that prevent cruelty to children and animals,
and organizations that test for public safety
------------------------------------------------------------------------
501(c)(4) Civic leagues, social welfare organizations and
local employees' associations
------------------------------------------------------------------------
501(c)(5) Labor, agricultural, and horticultural
organizations
------------------------------------------------------------------------
501(c)(6) Business leagues, chambers of commerce, and
real estate boards
------------------------------------------------------------------------
501(c)(7) Social and recreational clubs
------------------------------------------------------------------------
501(c)(8) Fraternal beneficiary societies that provide
life, sickness, or accident benefits to
members
------------------------------------------------------------------------
501(c)(9) Voluntary employees' beneficiary associations,
which provide for payment of life, sickness,
accident, or other benefits
------------------------------------------------------------------------
501(c)(10) Domestic fraternal societies that do not
provide life, sickness, or accident benefits
to members
------------------------------------------------------------------------
501(c)(11) Teachers' retirement fund associations
------------------------------------------------------------------------
501(c)(12) Local benevolent life insurance associations,
mutual ditch or irrigation companies, mutual
or cooperative telephone companies, and like
organizations
------------------------------------------------------------------------
501(c)(13) Cemetery companies
------------------------------------------------------------------------
501(c)(14) State-chartered credit unions and mutual
financial organizations
------------------------------------------------------------------------
501(c)(15) Certain mutual insurance companies or
associations that provide insurance to members
substantially at cost
------------------------------------------------------------------------
501(c)(16) Farmers cooperatives organized to finance crop
operations
------------------------------------------------------------------------
501(c)(17) Supplemental unemployment benefit trusts
------------------------------------------------------------------------
501(c)(18) Employee-funded pension trusts
------------------------------------------------------------------------
501(c)(19) War veterans organizations (e.g., American
Legion Posts)
------------------------------------------------------------------------
501(c)(20) Group Legal Services Plan Organizations
------------------------------------------------------------------------
501(c)(21) Black Lung Benefit Trusts
------------------------------------------------------------------------
501(c)(22) Trusts for Multiemployer Plans Under ERISA
------------------------------------------------------------------------
501(c)(23) Association organized before 1880 more than 75%
of the members of which are present or past
members of the Armed Forces and a principal
purpose of which is to provide insurance and
other benefits to veterans or their dependents
------------------------------------------------------------------------
501(c)(24) Trust Described in Section 4049 of ERISA
------------------------------------------------------------------------
501(c)(25) Title-Holding Corporations or Trusts for
Multiple Parents
------------------------------------------------------------------------
501(c)(26) State-sponsored high-risk health coverage
organizations
------------------------------------------------------------------------
501(c)(27) State-sponsored Workers' Compensation
Reinsurance Organizations
------------------------------------------------------------------------
501(c)(28) The National Railroad Retirement Investment
Trust established under Section 15(j) of the
Railroad Retirement Act of 1974
------------------------------------------------------------------------
Chairman THOMAS. Mr. Hopkins, you are last not because you
are least but because, based upon your testimony, I thought it
would be appropriate that you would bat cleanup in terms of
your background, the structure that you presented, and the,
what I consider to be a kind of a withering analysis of what
has been done recently and what could be done. The time is
yours.
STATEMENT OF BRUCE R. HOPKINS, ATTORNEY, POLSINELLI SHALTON
WELTE SUELTHAUS, P.C., KANSAS CITY, MISSOURI
Mr. HOPKINS. Thank you, Mr. Chairman, Mr. Rangel, and other
Members of the Committee. Thank you very much for the
opportunity to appear before you today. I do have a prepared
statement and I will summarize it briefly here. Basically, my
testimony consists of three segments. One is a summary of the
history, the evolution of the Federal tax law pertaining to the
tax-exempt sector in the United States. We have heard a bit of
history, examples, and from the standpoint of a constitutional
law, tax-exemption for these organizations is traceable to the
Revenue Act 1913, but as we have heard, tax-exemption can be
found in earlier laws. So, these rules are rapidly approaching,
at least the constitutional ones, 100 years of existence.
Second, I will provide the Committee with my view of the
present day state of the statutory law of tax-exempt
organizations. Then, third, if there is time, I have been asked
to provide a summary of the law concerning tax-exempt labor
organizations. My testimony essentially centers on four points.
The first one is that the statutory law concerning tax-exempt
organizations has evolved over the decades in a disorderly and
unplanned fashion. My second point is that Congress made major
revisions in this law in 1917, 1950, and 1969, but overall,
Congress has frequently modified and expanded the law
concerning the sector. Nearly 30 tax acts over the decades have
brought some revisions or addition to this area of the law. My
third point is that the Federal tax law today concerning exempt
organizations is unbalanced and uneven. The fourth point is
that many aspects of today's law of exempt organizations are
unclear. As the sector has grown, this sector has fostered or
facilitated misunderstandings and abuses by certain tax-exempt
organizations and tax law professionals. Federal tax law that
addresses the gaps in the present day structure would provide a
full legal regime that could address this problem. This, in
turn, would facilitate the ability of the IRS to provide
meaningful guidance within that framework.
In my prepared statement, I have provided the Committee
with the history and evolution of the statutory law,
summarizing each of the 28 Acts. This history illustrates the
point I made a minute ago, that the statutory law in the exempt
organizations area has, indeed, evolved in a disorderly
fashion. Another factor shaping the evolution of the Federal
statutory law of exempt organizations is Congressional reaction
to positions taken by the Internal Revenue Service. In the
attached statement, I have provided 18 instances where
statutory exempt organizations law was created in response to a
policy position of the agency. Today, the tax-exempt sector of
the United States is confronted with a dazzling array of
Federal tax law reform proposals, and many of these proposals
are reflective of the inadequate state of the Federal statutory
tax law of exempt organizations. In short, there are many more
gaps in this body of law than there should be. I have been
practicing in the field for 35 years and it never ceases to
amaze me how redundant, disparate, irregular, unbalanced, and
uneven the Federal tax statutory law can be. In my view, this
aspect of the tax law consists of 20 elements, and I have
listed these elements in my statement. What I think is striking
is that of these elements, only six of them are generally
adequately reflected in existing law. In my prepared statement,
I have identified 12 areas where statutory exempt organizations
law is necessary, and I will just take a minute to identify six
of these at the present time. One, you have already heard
testimony on, create laws spelling out the criteria for tax-
exempt status, and this is just not confined to charitable,
educational, scientific entities, but 501(c)(4) social welfare
entities, (c)(5) labor organizations, and (c)(6) entities,
business leagues, could use a great deal of clarification.
Number two, spell out the elements of the private inurement
doctrine and the private benefit doctrine. Number three,
amplify the political activities rules, both for charitable
entities and other forms of tax-exempt organizations. Number
four, codify a version of the commerciality doctrine. Number
five, develop statutory law concerning tax-exempt
organizations' use of the Internet. Six, consider whether there
is a need for more reporting and disclosure. There are a number
of proposals being discussed, including a five-year review
filing with the IRS, an annual notice requirement for small
organizations, and certification as to compliance with the
unrelated business rules. This type of statutory law is
required to eliminate the imbalances in the present law and to
provide the IRS with a complete regulatory framework within
which to provide guidance in the form of regulations, revenue
rulings, private determinations, and more. My sense here is
that there are a number of questions the Committee may have,
and I think, unless directed otherwise, I will simply submit my
discussion of the law concerning labor organizations to you in
the form of the prepared statement and I will stop at this
point and, like the other members of the panel, be happy to
take any questions that you might have.
Chairman THOMAS. Thank you.
[The prepared statement of Mr. Hopkins follows:]
Statement of Bruce Hopkins, Attorney, Polsinelli Shalton Welte
Suelthaus, P.C., Kansas City, Missouri
I have been asked to provide the Committee with a summary of the
history and evolution of the federal tax law pertaining to the
charitable sector of the United States. The term ``charitable''
includes charitable, educational, scientific, and religious
organizations within the meaning of Internal Revenue Code section
(``IRC Sec. '') 501(c)(3)). This sector thus embraces both public
charities and private foundations.
Tax exemption for these organizations is traceable to the Revenue
Act of 1913 and can be found in earlier laws. Therefore, we are rapidly
approaching the centennial of these rules.
I have also been asked to provide the Committee with my view of the
present-day state of the statutory law of tax-exempt organizations.
Further, I have been asked to provide a summary of the law
concerning tax-exempt labor organizations.
Summary of Testimony
My testimony essentially centers on four points:
1. The statutory law concerning tax-exempt organizations has
evolved over the decades in a disorderly, unplanned fashion. Congress
has not been sufficiently explicit about the rules governing tax-exempt
organizations.
2. Congress made major revisions in this law in 1917, 1950, and
1969. Overall, Congress has frequently modified and expanded the law
concerning the exempt sector. Nearly 30 tax acts have brought some
revision and/or addition to this area of the law.
3. The state of the federal tax law today is that it is unbalanced
and uneven.
4. Many aspects of today's statutory law of tax-exempt
organizations are unclear. As the sector has grown, this situation has
fostered or facilitated misunderstandings and abuses by certain tax-
exempt organizations and tax law planners. Federal tax statutory law
that addresses the gaps in the present-day overall statutory regime
would provide a full legal structure that would address this problem.
This, in turn would facilitate the ability of the IRS to provide
meaningful guidance within that framework.
As background, I have been in the private practice of law for 35
years, representing charitable and other tax-exempt organizations. I
have taught in two law schools, and continue to present at conferences
and seminars around the country. I have written several books,
including The Law of Tax-Exempt Organizations (8th ed., annually
supplemented). I write a monthly newsletter on exempt organizations law
subject, Bruce R. Hopkins' Nonprofit Counsel.
Summary of Statutory Law Evolution
Tax exemption for charitable organizations began in 1913, when
Congress enacted the first constitutional federal income tax. There
have, of course, been many major pieces of tax legislation since then.
The following acts are of major consequence: establishment of the
concept of federal income tax exemption in 1913; enactment of the
charitable contribution deductions in 1917, 1921, and 1932; enactment
of the unrelated business rules in 1950; and enactment of the public
charity and private foundation definitions and rules in 1969.
Thus, the statutory law of tax-exempt organizations was initiated
in 1913, and given major boosts in 1950 and 1969. Indeed, today's
statutory structure (along with the charitable giving rules) was shaped
substantially by the 1969 legislation.
In somewhat of a second-tier categorization of important exempt
charitable organizations legislation, the limitations on legislative
activities were enacted in 1934, the prohibition on political campaign
activities was adopted in 1954, public charity lobbying rules were
enacted in 1976, excise taxes on legislative and political expenditures
were enacted in 1987, and the excess benefit transactions (intermediate
sanctions) rules were enacted in 1996.
Nearly every tax act of any consequence since then (particularly in
1974, 1976, 1982, 1984, 1986, 1987, 1993, 1996, 1997, 2000, 2002, 2003,
and 2004) has added to this body of law. (Additional legislation that
would have augmented this collection of law, passed in 1992, 1995, and
1998, was vetoed.)
Below, I have provided the Committee with the history and evolution
of this statutory law, summarizing each of the 28 acts. Also, I traced
the history of these acts by year and Internal Revenue Code sections.
This history illustrates the fact that the statutory law of tax-exempt
organizations has indeed evolved in a disorderly fashion.
Another factor shaping the evolution of the federal statutory law
of tax-exempt organizations is Congressional reaction to positions
taken by the IRS. In the attached statement, I have provided 18
instances where statutory exempt organizations law was created in
response to a policy position of the agency.
State of the Statutory Law
Today, the tax-exempt sector of the United States is confronted
with a dazzling array of federal tax law reform proposals. These are
found in a recent report from the staff of the Joint Committee on
Taxation, a paper prepared last year by the staff of the Senate
Committee on Finance, the Administration's fiscal year 2006 proposed
budget, and the interim report recently published by Independent
Sector's Panel on the Nonprofit Sector.
Some of these proposals are referenced below. Before addressing
them, however, I note that many of these proposals are reflective of
the inadequate state of the federal statutory tax law of tax-exempt
organizations. There are many more gaps in this body of law than there
should be. The Department of the Treasury, the Internal Revenue
Service, and the courts, from time to time, attempt to fill these voids
but the absence of a full and balanced statutory regime contributes to
the need for many of the reforms being advocated at this time.
The state of the federal statutory law of tax-exempt organizations
can best be described in words that may be somewhat redundant:
disparate, irregular, unbalanced, and uneven. This aspect of the tax
law (other than the charitable giving rules) consists of the following
20 elements:
1. Criteria for exemption
2. Organizational test
3. Operational test
4. Public charities and private foundations
5. Private inurement
6. Private benefit
7. Intermediate sanctions
8. Legislative activities
9. Political activities
10. Commerciality
11. Unrelated business
12. Tax-exempt subsidiaries
13. For-profit subsidiaries
14. Exempt organizations in partnerships
15. Exempt organizations in other joint ventures
16. Internet use
17. Reporting requirements
18. Disclosure requirements
19. Corporate governance principles
20. Fundraising
Of these 20 elements, only six of them are generally adequate
reflected in existing statutory law: the subjects of public charities
and private foundations, the intermediate sanctions rules, the law as
to attempts to influence legislation, the unrelated business rules,
tax-exempt subsidiaries (often supporting organizations), and the
reporting requirements.
By contrast, the statutory law concerning the income, gift, and
estate tax charitable giving rules is far more complete and balanced,
enabling the IRS to issue timely and meaningful guidance.
These gaps in the exempt organizations statutory law cannot be
properly filled by tax regulations and rulings. Treasury and the IRS
try this from time to time and often trigger litigation over whether
the department and agency have the authority to promulgate the rules.
Some examples of these attempts are the regulations concerning the
facts-and-circumstances test for qualifying as a publicly supported
charitable organization, and the advertising and travel tour
regulations in the unrelated business context.
In fact, two law changes made by the IRS years ago reverberate in
controversy today. Back in 1959, the IRS promulgated what was then
radically new regulations defining what is charitable, educational, and
the scientific. Before these rules, the definition of charitable and
the like was quite narrow. Also, in 1969, the IRS ruled that promotion
of health is a stand-alone definition of what is charitable, setting in
motion today's ongoing debate over the scope of that term.
The IRS lacks the capability to promulgate sufficient regulations
in this area and, to a large degree, should not be placed in that
position. Indeed, these holes in the statutory structure create an
environment where the IRS issues private letter rulings containing
questionable, incorrect, and even ludicrous statements. Here are some
examples of IRS private letter rulings that fit these criteria:
1. Ruling purporting to state the ``traditional attributes of a
charity'' (none of which are correct) (Exemption Denial and Revocation
Letter 20044044E).
2. Ruling that an exempt organization's website is evidence of
unwarranted commerciality (Ex. Den. and Rev. Ltr. 20044045E),
3. Ruling stating that ``avoidance of regulation'' is nonexempt
activity (Priv. Ltr. Rul. 200452036).
4. Ruling applying private benefit standard to social welfare
organizations (Ex. Den. and Rev. Ltr. 20044008E).
5. Ruling applying commerciality doctrine to social welfare
organizations (Priv. Ltr. Rul. 200501020).
6. Technical advice memorandum declaring that charities must
devote assets of for-profit subsidiary to charitable ends (Tech. Adv.
Mem. 200437040).
Ideally, then, the full statutory design would be established by
Congress and then the IRS could provide meaningful guidance within that
framework.
As noted, these voids are mirrored in the reform proposals being
advocated in various quarters. For example, proposals to add law
concerning tax exemption for hospitals, credit counseling agencies,
fraternal beneficiary societies, donor-advised funds, and to some
extent supporting organizations reflect the paucity of law concerning
the criteria for tax-exempt status.
Here are some proposals for the Committee's consideration:
1. Create law spelling out the criteria for tax-exempt status.
For example, legislation could address what is charitable, educational,
and scientific. Other categories of exemption, however, could also
benefit from this type of clarification, such as social welfare
organizations (IRC Sec. 501(c)(4) entities), labor organizations (IRC
Sec. 501(c)(5) entities, and business leagues (IRC Sec. 501(c)(6)
entities). It is in this setting that law could be created stating
criteria for exemption for hospitals, donor-advised funds, fraternal
beneficiary societies, and the like.
It may be noted that, as an example of this imbalance, the
statutory law spelling out the criteria for exemption for
multi-parent title-holding companies (IRC Sec. 501(c)(25)), of
which there are few, is three times the size of the statutory
law concerning the bulk of the tax-exempt sector: entities
referenced in IRC Sec. 501(c)(3)-(7).
2. Develop law outlining an organizational test for at least the
principal categories of tax-exempt organizations.
3. Spell out the elements of the private inurement doctrine,
including the criteria for determining the reasonableness of
compensation, lending arrangements, rental arrangements, and sales
transactions.
4. Codify a version of the private benefit doctrine, in the
process clarifying whether the doctrine applies to tax-exempt
organizations other than charitable entities.
5. Amplify the political activities rules, both for charitable
entities and other forms of tax-exempt organizations, particularly
social welfare organizations (IRC Sec. 501(c)(4) entities), labor
organizations (IRC Sec. 501(c)(5) entities), and associations (business
leagues) (IRC Sec. 501(c)(6) entities).
6. Codify a version of the commerciality doctrine, in the process
clarifying whether the doctrine applies to tax-exempt organizations
other than charitable entities.
7. Enact rules concerning the use of for-profit subsidiaries by
tax-exempt organizations.
8. Enact rules concerning the involvement of tax-exempt
organizations in partnerships and other joint ventures.
9. Develop statutory law concerning exempt organizations' use of
the Internet, such as for advocacy, unrelated business, and fundraising
purposes.
10. In the context of reporting and disclosure, consider whether
the proposals for a five-year review filing with the IRS, an annual
notice requirement for small organizations, and certification as to
compliance with the unrelated business rules for large exempt
organizations.
11. Enactment of federal law corporate governance principles.
12. Federal law concerning charitable fundraising.
This type of statutory law is required to eliminate the imbalances
in the present law and to provide the IRS with a complete regulatory
framework within which to provide guidance in the form of regulations,
revenue rulings, private determinations, and more.
History and Evolution of Statutory Law
The original statutory tax exemption for nonprofit organizations in
U.S. law for charitable organizations was part of the Tariff Act of
1894.\1\ The provision stated that ``nothing herein contained shall
apply to . . . corporations, companies, or associations organized and
conducted solely for charitable, religious, or educational purposes.''
\2\
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\1\ 28 Stat. 556 (Act ch. 349).
\2\ The income tax law enacted in 1894 was declared
unconstitutional by the U.S. Supreme Court in Pollock v. Farmer's Loan
& Trust Co., 158 U.S. 601 (1895), overruled on other grounds in State
of S.C. v. Baker, 485 U.S. 505 (1988). Congress first created the
office of the Commissioner of Internal Revenue and enacted an income
tax in 1862, to finance Civil War expenses; that tax was repealed in
1872.
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After ratification of the Sixteenth Amendment by the states in
1913, which provided Congress with the authority to enact an income
tax, Congress enacted the Revenue Act of 1913, exempting from federal
income tax ``any corporation or association organized and operated
exclusively for religious, charitable, scientific, or educational
purposes, no part of the net income of which inures to the benefit of
any private shareholder or individual.'' \3\
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\3\ 38 Stat. 114, 166.
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The federal income charitable contribution deduction was enacted
when Congress passed the Revenue Act of 1917.\4\ The Revenue Act of
1921 brought the estate tax charitable contribution deduction, which
was made retroactive to 1917.\5\ The gift tax charitable contribution
deduction can into being as part of the Revenue Act of 1932.\6\
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\4\ 40 Stat. 300.
\5\ 42 Stat. 227.
\6\ 47 Stat. 169.
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In the Revenue Act of 1918, the enumeration of tax-exempt
charitable organizations was expanded to include those organized ``for
the prevention of cruelty to children or animals.'' \7\ The Revenue Act
of 1921 further expanded the statute to exempt ``any community chest,
fund or foundation'' and added ``literary'' groups to the list of
exempt entities.\8\ The Revenue Acts of 1924,\9\ 1926,\10\ 1928,\11\
and 1932 \12\ did not provide for any changes in the law of exempt
organizations.
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\7\ 40 Stat. 1076.
\8\ 42 Stat. 227.
\9\ 43 Stat. 282.
\10\ 44 Stat. 40.
\11\ 45 Stat. 813.
\12\ 47 Stat. 193.
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The Revenue Act of 1934 carried forward the tax exemption
requirements as stated in the prior revenue measures and added the rule
that ``no substantial part'' of the activities of an exempt charitable
organization can involve the carrying on of ``propaganda'' or
``attempting to influence legislation.'' \13\ The Revenue Acts of 1936
\14\ and 1938 \15\ brought forward these rules, as did the Internal
Revenue Code of 1939.\16\
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\13\ 48 Stat. 700.
\14\ 49 Stat. 1674.
\15\ 52 Stat. 481.
\16\ 53 Stat. 1.
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Tax-exempt organizations were required to file annual information
returns, beginning in 1944. This requirement came into the federal tax
law as part of the Tax Revenue Act of 1943.\17\
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\17\ 58 Stat. 21.
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The unrelated business rules were enacted as part of the Revenue
Act of 1950.\18\ These rules tax the net income of charitable and other
tax-exempt organizations when they regularly carry on businesses that
are not substantially related to the achievement of exempt purposes.
This was a radical addition to the law, in part because it introduced
the concept that some or all otherwise tax-exempt organizations could
be taxed. This would lead to many more federal taxes on or in
connection with ``tax-exempt'' organizations.
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\18\ 64 Stat. 906.
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The rules for charitable and like organizations, as stated in the
tax exemption law provision that remains in use today,\19\ came into
being as a consequence of enactment of the Internal Revenue Code of
1954.\20\ The previous rules were retained and two additions to the
statute were made: The listing of exempt organizations was amplified to
include entities that are organized and operated for the purpose of
``testing for public safety,'' and organizations otherwise described in
the provision became forbidden to ``participate in, or intervene in
(including the publishing or distributing of statements), any political
campaign on behalf of any candidate for public office.''
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\19\ IRC Sec. 501(c)(3).
\20\ 68A Stat. 163.
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Enactment of the Revenue and Expenditure Control Act of 1968
brought rules concerning cooperative hospital service
organizations.\21\ These rules were amended by provisions of the Tax
Reform Act of 1976, the Revenue Act of 1988, and the Taxpayer Relief
Act of 1997. The rules pertaining to cooperative service organizations
of operating educational organizations were enacted in 1974 \22\ (as
was statutory law concerning political organizations).\23\
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\21\ 82 Stat. 269.
\22\ 88 Stat. 235.
\23\ 88 Stat. 2108.
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The Tax Reform Act of 1969 \24\--the most significant of the modern
tax acts from the standpoint of the law of tax-exempt organizations--
introduced a stupendous array of exempt organizations laws, including
the exemption recognition application rules, rules differentiating
public charities from private foundations, imposing taxes on various
aspects of the operations of private foundations, and revising the
unrelated debt-financed property rules.\25\
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\24\ 83 Stat. 487.
\25\ While, as discussed, there was law pertaining to, and law
practices concerning, tax-exempt organizations before 1969, enactment
of the Tax Reform Act of 1969 ushered in the contemporary bases of this
area of the law (other than the unrelated business law structure) and
the modern exempt organizations law practice).
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The Tax Reform Act of 1976 brought law concerning declaratory
judgment rules for charitable organizations, lobbying by public
charities (the expenditure test), and amateur sports organizations.\26\
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\26\ 90 Stat. 1520.
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The Tax Equity and Fiscal Responsibility Act of 1982 amended the
law concerning amateur sports organizations.\27\ The Tax Reform Act of
1984 brought the church audit rules, changes in the U.S.
instrumentalities rules, and the child care organizations rules.\28\
The Deficit Reduction Act of 1984 brought the tax-exempt entity
leasing rules.\29\
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\27\ 96 Stat. 324.
\28\ 98 Stat. 494.
\29\ Id.
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The Tax Reform Act of 1986 changed the Internal Revenue Code formal
reference to the Code of 1986 (which, as amended, is its status
today).\30\ This act also introduced the law concerning provision of
commercial-type insurance, liquidations of for-profit entities into
tax-exempt organizations, and multiparent title-holding corporations;
also, it revised the exempt entity leasing rules.
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\30\ 100 Stat. 1951.
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The Revenue Act of 1987 brought taxes on public charities for
engaging in excessive lobbying and political campaign activities, as
well as fundraising disclosure requirements for noncharitable
organizations.\31\ Enactment of the Omnibus Budget Reconciliation Act
of 1993 introduced rules concerning the nondeductibility of expenses
for lobbying and political campaign activities, and disclosure rules as
to these activities for associations.\32\ The 1993 legislation also
introduced law in the charitable giving arena, concerning
substantiation requirements and quid pro quo contributions.
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\31\ 101 Stat. 1330.
\32\ 107 Stat. 312.
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Legislation known as the Taxpayer Bill of Rights 2, enacted in
1996, added the intermediate sanctions rules, expanded the penalties
for failure to timely file complete annual information returns,
expanded the contents of these returns, revised disclosure rules, and
added the private inurement language to the law pertaining to tax-
exempt social welfare organizations.\33\ The Small Business Job
Protection Act of 1996 added revisions to the unrelated business rules,
exemption opportunities for charitable risk pools and state tuition
programs, and the ability of exempt charitable organizations to own
stock in small business corporations.\34\
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\33\ 110 Stat. 1452.
\34\ 110 Stat. 1755.
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The enactment of the Taxpayer Relief Act of 1997 caused several
changes and additions to the law of exempt organizations, including
various modifications of the unrelated business income rules.\35\
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\35\ 111 Stat. 788.
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The Victims of Terrorism Tax Relief Act of 2001 brought rules
concerning the provision of assistance by charitable organizations to
individuals who are victims of terrorism and clarified the law
concerning exempt organization-funded disaster relief programs.\36\
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\36\ 115 Stat. 2427.
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The Jobs and Growth Tax Relief Reconciliation Act of 2003 changed
the tax rates for dividends and capital gains, which has had an impact
on charitable giving and rules pertaining to the administration of
charitable remainder trusts.\37\
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\37\ 117 Stat. 752.
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The Military Family Tax Relief Act of 2003 introduced rules by
which the tax-exempt status of charitable organizations could be
suspended if designated as supporting or engaging in terrorist
activity.\38\ The Working Families Tax Relief Act of 2004 extended the
rules concerning charitable contributions of computer technology and
equipment used for educational purposes.\39\
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\38\ 117 Stat. 1335.
\39\ 118 Stat. 1166.
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The American Jobs Creation Act of 2004 introduced rules concerning
the treatment of charitable contributions of patents and other forms of
intellectual property, rules concerning the treatment of charitable
contributions of motor and other vehicles, increasing reporting for
noncash contributions, an exclusion from unrelated business income for
gain or loss on the sale or exchange of certain brownfield properties,
and extended the IRS user fee program.\40\
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\40\ 118 Stat. 1418.
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References by Present-Law Internal Revenue Code Sections
The following provisions of the Internal Revenue Code, concerning
tax-exempt charitable organizations, are correlated by the year of
enactment:
1913
Tax exemption for charitable organizations created, with inclusion
of private inurement doctrine (predecessor to IRC Sec. 501(c)(3)).
1917
Income tax charitable contribution deduction enacted (predecessor
to IRC Sec. 170).
1918
Tax exemption for charitable organizations expanded (predecessor to
IRC Sec. 501(c)(3)).
1921
Estate tax charitable contribution deduction enacted (predecessor
to IRC Sec. 2055). Tax exemption for charitable organizations expanded
again (predecessor to IRC Sec. 501(c)(3)).
1932
Gift tax charitable contribution deduction enacted (predecessor to
IRC Sec. 2522).
1934
Addition to law of prohibition on substantial legislative
activities by exempt charitable organizations (predecessor to IRC
Sec. 501(c)(3)).
1944
Tax-exempt organizations become required to file annual information
returns (predecessor to IRC Sec. 6033).
1950
Unrelated business income rules enacted (predecessor to IRC
Sec. Sec. 511-514).
1954
Tax exemption for charitable organizations expanded again (IRC
Sec. 501(c)(3)). Addition to law of prohibition on political campaign
activities by exempt charitable organizations (id.).
1968, 1974, 1976, 1988, 1997
Enactment of rules concerning tax-exempt charitable cooperative
entities (IRC Sec. 501(e), (f)).
1969
Enactment of exemption notice rules (IRC Sec. 508), definitions of
public charities and private foundations (IRC Sec. 509), the private
foundation rules (IRC Sec. Sec. 507, 4940-4948), expansion of the debt-
financed income rules (IRC Sec. 514), and introduction of the planned
giving rules (such as for charitable remainder trusts (IRC Sec. 664)).
1976
Enactment of declaratory judgment rules for charitable
organizations (IRC Sec. 7428), public charity lobbying rules (IRC
Sec. Sec. 501(h), 4911), and rules concerning amateur sports
organizations (IRC Sec. 501(c)(3)).
1982
Addition of rules concerning amateur sports organizations (IRC
Sec. 501(j)).
1984
Enactment of church audit rules (IRC Sec. 7611), the child care
organizations rules (IRC Sec. 501(k)), and the tax-exempt entity
leasing rules (IRC Sec. 168(h)).
1986
Enactment of the commercial-type insurance rules (IRC Sec. 501(m)),
liquidations of charitable and other exempt organizations (IRC
Sec. 337), and revision of exempt entity leasing rules.
1987
Enactment of excise taxes on public charities for excessive
lobbying (IRC Sec. 4912) and for political campaign activity (IRC
Sec. 4955).
1993
Enactment of general charitable gift substantiation rules (IRC
Sec. 170(f)(8)) and quid pro quo contributions rules (IRC Sec. 6115).
1996
Enactment of the intermediate sanctions rules (IRC Sec. 4958) and
extension of the doctrine of private inurement to exempt social welfare
organizations (IRC Sec. 501(c)(4) entities). The unrelated business
rules (IRC Sec. Sec. 512, 513) were revised, rules concerning
charitable risk pools (IRC Sec. 501(n)) and prepaid tuition plans (IRC
Sec. 529) were enacted, and charitable organizations were accorded the
ability to own stock in small business corporations (IRC Sec. 512(e)).
1997
The unrelated business income rules were modified again and the
corporate sponsorship rules (IRC Sec. 513(i)) were enacted
2001
Congress clarified rules for providing assistance by charitable
organizations to victims of terrorism and natural disasters.
2003
Tax rates for dividends and capital gains lowered (affecting the
charitable remainder trust distribution ordering rules). The tax
exemption suspension rules (IRC Sec. 501(p)) were enacted.
2004
Enactment of rules concerning the treatment of charitable
contributions of patents and other forms of intellectual property (IRC
Sec. 170(m)), rules concerning the treatment of charitable
contributions of motor and other vehicles (IRC Sec. 170(f)(12)),
increasing reporting for noncash contributions (IRC Sec. 170(f)(11)),
an exclusion from unrelated business income for gain or loss on the
sale or exchange of certain brownfield properties (IRC
Sec. 512(b)(19)), and extension of the IRS user fee program (IRC
Sec. 7528).
Other Law
The foregoing statutory framework has been augmented and expanded
over the decades by court opinions, Department of the Treasury
Regulations, and Internal Revenue Service public and private
determinations. Indeed, in some instances, the statutory law was
enacted in response to the position of a court, the Treasury
Department, or the IRS.
In the tax-exempt organizations context, for example, Congress has
added 18 provisions to the Internal Revenue Code to overturn an IRS
position. They are:
1. Enactment of law in 1950 (IRC Sec. 513(a)(3)) to exempt from
unrelated business income tax sales of items acquired by gift, to
overrule IRS position that nonprofit thrift shops were not tax-exempt.
2. Enactment of cooperative hospital service organization rules
in 1968 (IRC Sec. 501(e)), to overrule IRS position that cooperatives
could not qualify for tax exemption by reason of IRC Sec. 501(c)(3).
3. Enactment of cooperative service organization of educational
organizations rule in 1974 (IRC Sec. 501(f)), to overrule IRS position
that this type of entity could not qualify for tax exemption by reason
of IRC Sec. 501(c)(3).
4. Enactment of definition of term agricultural in 1976 (IRC
Sec. 501(g)), to overrule IRS position that the term, for purposes of
IRC Sec. 501(c)(5), does not encompass the harvesting of aquatic
resources.
5. Enactment of public entertainment rules in 1976 (IRC
Sec. 513(d)((2)), to overrule IRS (and courts') position that horse
racing at exempt agricultural organizations' fairs was nonexempt
activity.
6. Enactment of trade show rules in 1976 (IRC Sec. 513(d)(3)), to
overrule IRS position that order-taking and selling at these shows was
nonexempt activity.
7. Enactment of law in 1976 (IRC Sec. 513(e)) to allow exempt
hospitals to provide certain services to other exempt hospitals, to
overrule IRS position that these services were nonexempt functions.
8. Enactment of law in 1978 concerning securities lending
transactions (IRC Sec. 513(b)(1)), to overrule IRS position that
securities lending by exempt organizations was unrelated business.
9. Enactment of law in 1978 (IRC Sec. 513(f)) to exempt bingo
games from unrelated business rules, to overrule IRS position to the
contrary.
10. Enactment of special rules for amateur sports organizations in
1982 (IRC Sec. 501(j)), to overrule IRS position that these
organizations could not qualify for tax exemption by reason of IRC
Sec. 501(c)(3).
11. Enactment of child-care center rules in 1984 (IRC
Sec. 501(k)), to overrule IRS position that day care and like
organizations could not be exempt educational entities because of too
much private benefit.
12. Enactment of rules in 1986 (IRC Sec. 513(h)) to allow
charitable organizations to distribute low-cost articles in fundraising
context, to overrule IRS position that charities were selling these
articles.
13. Enactment of charitable deduction rule for certain payments to
institutions of higher education in 1988 (IRC Sec. 170(l)), to overrule
IRS position that no portion of these payments was deductible as
charitable gifts.
14. Enactment of a rule in 1993 that tax-exempt title-holding
companies (IRC Sec. 501(c)(2) and (25) entities can generate a certain
amount of unrelated business taxable income, to overrule IRS position
that these entities could not have any active unrelated business
income.
15. Enactment of rules in 1996 (IRC Sec. 512(d)) to exempt certain
associate member dues from unrelated business income taxation, to
overrule IRS attempt to tax many forms of these dues.
16. Enactment of rules in 1996 (IRC Sec. 512(b)(17)) concerning
foreign source income taxable as unrelated business income, to overrule
IRS position that certain forms of this income were nontaxable
dividends.
17. Enactment of rules in 1997 concerning revenue received by tax-
exempt organizations from controlled subsidiaries (IRC
Sec. Sec. 512(b)(13), 318), to overrule IRS position that these rules
did not extend to revenue from second-tier subsidiaries.
18. Enactment of corporate sponsorship rules in 1997 (IRC
Sec. 513(i)) to overrule IRS position that payments by corporate
sponsors were forms of unrelated business income.
Some amendments to the Internal Revenue Code in this context were
added at the request of the IRS. Examples of this are the intermediate
sanctions rules (IRC Sec. 4958) and the commercial-type insurance rules
(IRC Sec. 501(m)).
There is relatively little law on the federal tax exemption for
labor organizations. This category of exemption, in present-day IRC
Sec. 501(c)(5), was first added to the statutory law in 1909
(Corporation Excise Tax Act of 1909, 36 Stat. 11). The statute provides
merely that tax exemption is available for ``labor'' organizations. No
criteria for exemption are provided--an instance of the need for
statutory criteria for exemption if the federal statutory law in this
context is to be brought into balance.
The tax regulations amplify this aspect of exempt organizations
law. There it is provided that an exempt labor organization is an
entity that has as its objects the betterment of the working conditions
of its members and development among its members of a higher degree of
efficiency in their occupations, and does not cause its net earnings to
inure to the benefit of a member (Reg. Sec. 1.501(c)(5)-1(a)). This
category of exemption is not available for organizations that have as
their principal activity the investing and management of funds
associated with savings or investment plans, including retirement
savings programs (Reg. Sec. 1.501(c)(5)-1(b)). The regulations make it
clear that exempt labor organizations are nonetheless subject to the
unrelated business rules (Reg. Sec. 1.501(c)(5)-1(c)).
There are a few court opinions and IRS revenue rulings on the
subject. This law amplifies somewhat the concept of the exempt labor
organization. One court held that a labor organization is an entity
that is organized to ``protect and promote the interests of labor''
(Portland Cooperative Labor Temple Association v. Commissioner, 39
B.T.A. 450 (1939)).
Labor organizations have traditionally engaged in collective action
directed toward the workers' common objective of improving working
conditions. They include labor unions that negotiate with employers on
behalf of workers for improved wages, fringe benefits, hours and
similar working conditions, and certain union-controlled organizations,
such as strike funds, that provide benefits to workers that enhance the
union's ability to effectively bargain (Rev. Rul. 67-7, 1967-1 C.B.
137), and publishers of labor newspapers. Exempt labor organizations do
not include strike funds that provide income to union members but are
not controlled by unions (Rev. Rul. 76-420, 1976-2 C.B. 153).
Labor organizations may also meet the requirements for exemption by
providing benefits that directly improve working conditions or
compensate for unpredictable hazards that interrupt work. Examples of
these benefits include operating a dispatch hall to match union members
with work assignments and providing industry stewards who represent
employees with grievances against management (Rev. Rul. 75-473, 1975-2
C.B. 213; Rev. Rul. 77-5, 1977-1 C.B. 148). Conversely, managing saving
and investment plans for workers, including retirement plans, does not
bear directly on working conditions (Rev. Rul. 77-46, 1977-1 C.B. 147).
Accordingly, the IRS does not accord exemption to organizations that
manage retirement savings as their principal activity (cf. Morganbesser
v. United States, 984 F.2d 560 (2d Cir. 1993), which led to
promulgation of the above-referenced Reg. Sec. 1.501(c)(5)-1(b)).
Chairman THOMAS. Given the sheet that Members have in front
of them from Mr. Yin in terms of the catch-as-catch-can
historical picture of how this developed, it appears to me,
based upon the testimony that you made, notwithstanding
understood rationales or not understood rationales as to why
various provisions are in the law, yet all of you think it is
possible to create a coherent definition, theory, and
structure. Mr. Cohen?
Mr. COHEN. I was privileged to be the youngest person who
drafted the 1954 Code. Before the 1954 Code, the Internal
Revenue Code had not been really amended much since 1939. It
was first enacted in 1939 as a Code, and then, of course, the
war came and there was just emergency legislation. Nobody did
it coherently. So, we had to do it coherently. Two of us were
assigned. One was assigned to do only substantive provisions,
to rearrange them in some kind of a substantive order. I was
assigned to do all the administrative provisions. You can
imagine what a job that was. There were separate administrative
provisions for every single tax. That is, there was no unified
set of rules. That took a year. It took us a whole year to do
that. Before we started the job, we had small groups--now, this
is the kind of job where you would need a group like that, that
would sit down for a sustained period of time--they may be
insiders or outsiders or a combination of it--and try to
rationalize and give you alternatives. That is, they will come
back with policy decisions that only you folks can make. You
can't assign this to your inside staff and give them 6 months
and say, do it, while they are doing everything else because it
will never get done that way. It has to be a special project in
which there is a devoted set of staff that work on it and work
to make it coherent. So, for example, we have insider penalties
that apply to (c)(3)s, that apply to certain (c)(3)s. They
don't apply to (c)(4)s. They did apply to (4)s, but they didn't
apply to many of the other organizations. All those kinds of
things and the things that Bruce and the others have raised
need to be considered, but that takes time and staff.
Chairman THOMAS. I will tell you that in today's world,
where we have a Presidential panel to look at fundamental tax
reform and they have 6 months to report back, you just outlined
a time line which the VH1 generation can't focus on in terms of
length. If we were to pursue this, is it worthwhile at all to
create a kind of an onion approach, or going down in a
hierarchial way, to look at what is most important at the
Federal level, which we obviously ought to be focusing on--the
panel indicated that tax-exempt tends to be a State
classification, and should we then look at what charity is and
create a definition for charity first, or do you just have to
jump into this and begin to sort out a structure with what is
there, because I think you will find that this Committee and
even any structure that we put together probably won't be able
to agree on all of those particular levels and produce a
product in any reasonable timeframe. Mr. Hopkins?
Mr. HOPKINS. I would like to respond to that. I think, as
you have heard, the charitable sector does predominate and it
performs--along this way we are made, I think the Committee
would find that a lot of what it did in the 501(c)(3) context
could be used in other areas, particularly (c)(4)s, (c)(5)s,
and (c)(6)s. So, as a practical matter, it might make sense to
start writing a better law as to what charitable, scientific,
educational is, and work with the private inurement doctrine,
private benefit doctrine, intermediate sanctions, and if that
could be accomplished, then I think you would have a template
that could be used in many respects with resect to other
categories of exempt organizations.
Chairman THOMAS. Okay. Let us start with charity. Normally,
if you talk about the charity area, lists were made, or at
least referred to as to which ones were the most numerous. So,
if I asked the panel if you were to select out the area in
which there was the most dollar involvement in the charity
area, and I don't know that the volume relates to dollar
amount--you understand it better than I do--where would the--is
there an area in which half of the charity concept is involved,
or 25 percent, or do they all have 3 percent and you just have
to look at the entire universe?
Mr. Colombo?
Mr. COLOMBO. Yes. The IRS can probably give you, or the GAO
can probably give you more statistics. Financially, it is
pretty clear that hospitals and health care providers are the
1,000-pound gorilla of the charitable organization area, that
they command a large portion of the revenue in the charitable
area. In terms of the conceptual problems, I really don't think
you can lay them out that way. There is this charitable sector,
and I think you can divide charities from everything else and
work in the charitable sector. I think it would be very hard to
focus on a little piece of the charitable sector itself without
focusing on the area as a whole.
Chairman THOMAS. Well, does anybody have the percentage
that hospitals are of the charitable areas so that you know
what we are biting off? We have to start somewhere. Anybody.
You guys fight it out.
Mr. YIN. In our document, in the pamphlet on page 21, we
actually have a table showing the breakdown of the charitable
organizations and Professor Colombo is exactly right. The
largest, at least by assets and revenue, is in the health area,
and of that, the largest component would be hospitals. The next
largest looks like it would be education. Of course, in that
would be the colleges and universities. Then there are a couple
of other areas that are somewhat large, as well.
Chairman THOMAS. Okay. I accept your structure and
category. Now I turn to the definitions that are offered. Mr.
Colombo, we are going to deal with charity. You want to define
charities as those who live off of contributions or donations
because it appears as though their services are recognized on a
voluntary basis to be supported by people freely providing
their money. If that is going to be the definition of charity,
do nonprofit hospitals fit your definition?
Mr. COLOMBO. No, not most of them. I think there would be a
few. Children's hospitals, the Shriners' hospitals probably get
significant donations. As a sector, the last number I saw was
that about two percent of their revenues come from donations,
and I suspect most of that goes to like the children's
hospitals.
Chairman THOMAS. Well, this goes to the point that the
Ranking Member made early on in terms of IRS and is a real
reason why IRS is going to have to appear before us, because in
1969 when they were defining charity, they decided that relief
of the poor and distressed is not an essential criteria for
charity, and so I would turn, Professor Hill, to your offering
of a definition of public benefit to a defined population. If,
in fact, nonprofit hospitals don't have to provide services to
the poor or distressed to be classified as a charity, and it
isn't based upon donation, then I appreciate the offers of
definitions, but we are either going to have a wholesale
revision of what is and what is not defined as a charity or
both of your definitions are going to have to be boozed up
quite a bit.
Ms. HILL. Definitions always have to be boozed up quite a
bit, and those of us who come to hearings do so because we
think maybe the process of having them boozed will be useful in
the end. To be responsive to the question of how can a public
benefit concept help and does it apply to hospitals, I would
like to get on the table a consideration also of the human
services sector. If you look at the table on page 21, we notice
that that is also quite significant here in terms of revenue
and the number of entities, and I think we can all think of the
social services sector as the direct delivery of goods and
services to people who probably would come closest to a
charitable class in our view--the hungry, the homeless, those
needing clothes, food, shelter, assistance with various
problems. I bring them into it because in my testimony, I
raised the question, what is public benefit? What is a
charitable class? The difficulty here in answering the question
is to say, does a charitable class have to be the same for all
kinds of charities? Does it only have to be poor people or
distressed people? Well, that would leave out the arts
organizations. If it is only the poor people, then, of course,
social services are good, but churches become problematic
because rich people also love God and wish to go to church. I
think with hospitals, if we think only of charity care as the
public benefit, and I do think there should be more charity
care in this country across the board, of all kinds of health
care providers, including outpatient clinics, but I think part
of that problem isn't rooted in the exempt sector. Part of that
problem, as this Committee knows much better than I, is rooted
in the larger problem of health care policy and whether a
health care insurance net linked to employment is the best way
to go. These are huge questions which kind of transcend it. I
would say that if we begin by saying what is the public
benefit--let us take a university. Is it the students who
presumably are going to get out and get nice jobs, are they the
beneficiaries of education, or is it society more generally who
has then this educated pool of young people who would be good
citizens? I think one can ask the same question about
hospitals. What are all the public benefits they represent? How
do we count the public benefit? I think that charity care is
one part. Education of doctors and other health care providers
is another. Frankly, there is a benefit to all the rest of us
who may not be ill at the moment, but we do not have to watch
people die before our very eyes and have some hope.
Chairman THOMAS. Professor Hill, everything you said about
that aspect, in my mind, corresponds to hospitals generically,
some of which are for profit, some of which are not-for-profit.
So, what is the criteria for placing some in not-for-profit and
those others in for-profit except the self-definition that they
have chosen, which if we are looking at for a rationale for all
the money we are dealing with, the definitions that were
provided early on in an abstract way, I think we start bumping
up against reality immediately. All I am trying to do is get
you to share the problems we are going to have as a Committee
if you simply said, go in, begin defining, and structure the
areas.
Ms. HILL. May I just follow up?
Chairman THOMAS. Sure.
Ms. HILL. One more perspective on this whole question of
comparing activities conducted in the taxable sector,
activities conducted in the exempt sector. I think we have to
be careful when we talk about the comparison and the benefits
with the exemption that we are sure that the taxable entities
are making a profit, not generating losses and thereby not
having a tax burden. I think it would be very useful to have
side-by-side comparisons of universities, of hospitals, of
schools that are taxable and tax-exempted social service
providers. Then I think the discussion of the benefit of the
exemption in the two and whether there is really a difficulty
in having the activities across two sectors, an inappropriate
taxation becomes more real, and I do not have those data.
Others may.
Chairman THOMAS. My problem when you introduce that is that
one is a conceptual problem of defining somebody as a charity
and not. The other one is an examination of the Tax Code to see
if the deductions are appropriate for a for-profit to wind up
not paying taxes, and those are two entirely different
pursuits, both of which are probably worthwhile, but with
setting aside the examination of the Tax Code and the
deductible aspects of it for for-profits to examine the
definition you have provided me with that I am now trying to
apply to this area. Mr. Holtz-Eakin?
Mr. HOLTZ-EAKIN. Let me pull out pieces of both of these
concepts, largely because it supports the testimony that we
submitted. The first is the notion of a public benefit. To the
extent that the activity that an entity is engaged in has such
broad public benefits that no single individual would be
willing to write the check, you would see very little data to
support that entity with sales. At the other extreme, if there
is really just a private benefit or transaction that makes
sense for the entity and the individual, you could support the
entity's activities with sales like revenues. In the same way
with charity, the ultimate of charity is to conduct a
transaction at below the regular price or even give it away for
free, and to the extent that you do that, you will be unable to
support the entity with sales. To the extent that you do not,
you will have a lot of sales. So, the index that we organized
our testimony around was what fraction of the income comes from
program revenue? How much does it look like a sales-driven
entity? That encompasses both the flip side of public benefits/
private benefits and the flip side of charity, collecting at
market prices. That is a continuum. It is not a bright line,
but it allows you to organize things, and they range greatly.
The hospital number we have is 92 percent of income comes from
program revenue in a hospital in the tax-exempt hospital
sector. Food, agriculture, nutrition, 8.5 percent. So, there is
an enormous diversity there.
Chairman THOMAS. Yes. We are using this only for
illustrative purposes because I think it is a good example and
it is a big segment, and if you are going to try to deal with
changing the law, you probably ought to start with the big
segment instead of dealing at the bottom end of you will never
get to the bulk of the questions in front of us. So, I don't
want anyone to think that I am focusing on a section for the
purpose of doing that. I just thought, based upon the
definitions you gave me and I began playing with them during
the testimony, that I had one I couldn't find an easy category
for and it turns out to be the biggest one right on top.
Mr. Walker, and then I will recognize the gentleman from
New York.
Mr. WALKER. Mr. Chairman, obviously, you are not going to
be able to decide on a definition today, but I think it
illustrates a very fundamental point. As has been testified by
a number of the individuals here, we have a number of different
types of 501(c) entities that have come into effect over the
last 100 years. If you look at the data that has been provided
by the Joint Committee on Taxation, of the 28 categories, five
have less than ten filers. Eleven have less than 1,000 filers.
We have basically created a fragmented and layered approach to
this area, like many other areas in the Federal government,
without adequate definitional guidance, without adequate
transparency, and without appropriate accountability, and I
would respectfully suggest that this is illustrative of a need
to step back and say, what are we trying to accomplish? Who
should benefit? We need some basic definitions so that we can
rationalize this area, and it is illustrative of a much broader
need, as well, I would suggest.
Chairman THOMAS. I thank the gentleman, but it seems to me
that donations sounds like a perfectly good way to define
charity if you need them, and then we run into a problem using
that definition. The idea of benefit to a defined population
sounds really good, but if you begin to apply it, you find out
that IRS walked away from that in the fifties and especially in
1969 with hospitals in terms of saying that charitable service
doesn't have to necessarily define the charity, or service to
the poor. So, all I am saying is we need help. It is obvious
that what we need is a degree of rigor and structure designed
to, if you only did this, it is a great improvement, as
somebody said. If you do this in addition, it is great. To
throw the whole area of 501(c) on us means we don't know how to
get out of the box. The gentleman from Florida just said this
sounds like a can of worms, and I am thinking it is a bucket of
worms rather than a can of worms. A quickly follow-up by Mr.
Walker.
Mr. WALKER. Mr. Chairman, very quickly, obviously, we are
in the fact-gathering business, and so if we can help this
Committee try to be able to obtain some facts with regard to
particular aspects of 501(c)(3) or organizations, we are happy
to do that.
Chairman THOMAS. Facts are valuable, but structure to
understand, analyze, and use the facts are probably more
important to us.
Mr. JOHNSON OF TEXAS. Would the gentleman yield?
Chairman THOMAS. The gentleman from Texas.
Mr. JOHNSON OF TEXAS. I would just like to point out,
concerning these hospitals, that we have now introduced
Medicare and Medicaid, which were not, I don't think, in the
law as heavily as they are now when the hospital charitable
contribution was initiated. Therefore, I think there has to be
a consideration of those items, as well, when you talk about
that.
Chairman THOMAS. That is partially true, but Medicare began
in 1965 and the definition I was referring to from the IRS was
1969 in which relief for the poor, distressed is not an
essential criteria for charity, so it was even after Medicare
was enacted into law. The gentleman from New York.
Mr. RANGEL. Thank you, Mr. Chairman. Mr. Cohen, you have
indicated that no matter what amounts of money we give to IRS
for oversight, that would probably go where they think they
could get the best savings, but I know because of your great
history in this area that the credibility of the system also is
important. Even though the money may not be in these 501(c)s,
if there is abuse and corruption, they have to send some type
of a signal that people cannot get under the radar just because
there is not a lot of money involved. Today, there is a lot of
talk about 501(c)(3)s that are set up as educational
institutions and that they are either violating the law or the
spirit of the law, and the question I would ask, I guess, Mr.
Hopkins, is that if some lobbyist wanted to influence the
conduct of Congress and they had clients, either domestic or
foreign, but it would violate the law if they approached the
Member directly, but yet the foundation would receive large
sums of money from the lobbyist and then invite the Members of
Congress to be educated by visiting with the country where
these businessmen came from or the locations where they had
their business, would that be legal under the law as you
understand it as a lawyer?
Mr. HOPKINS. This does not sound like a hypothetical
question.
[Laughter.]
Chairman THOMAS. I tell the gentleman that as long as we
stay in the hypothetical area, I don't believe it violates the
fundamental purpose of this hearing, but as soon as the
hypothetical becomes specific, then I think we will be dealing
with those issues with the IRS and others in front of us in a
more systematic way. However----
Mr. RANGEL. Mr. Chairman, I appreciate----
Chairman THOMAS. --given the background and experience, Mr.
Hopkins, of the panel members, you probably are the most
appropriate to respond to the hypothetical as outlined by the
gentleman from New York.
Mr. HOPKINS. Thank you, Mr. Chairman. The concept of what
is educational and the concept of what is legislative overlaps
a little bit, and I think, without getting into the details
here, by the way, the regulations are fairly comprehensive on
the point. If there is an attempt to objectively present facts
and information about a particular topic, that is educational.
If there is an advocacy element at some point, it can shift
over to lobbying or even political campaign activity. The
funding of it by itself shouldn't change the outcome. In other
words, you were talking about lobbyists contributing money to
an entity. It is the function, not the funding, if you will.
So, what we try to do in the law is separate the presentation
of objective material as contrasted with an efficacy----
Mr. RANGEL. I can understand that. My second and last
question to you would be, if the not-for-profit then hired
people that--strike that. If people that worked for the not-
for-profit also was in the consulting business as a lobbyist
and remainder under 501(c)(3), in your opinion, would that be a
violation of the law?
Mr. HOPKINS. Well, that is a different body of law. Now, we
are talking about educational versus private benefit, or in a
more technical sense, private inurement. What we are talking
about here is a situation where what looks to be educational on
its face is, in fact, a shifting of the resources of the
charity over to someone in an inappropriate manner. That would
be a private inurement or a private benefit situation. I am not
saying that is----
Mr. RANGEL. I am not either.
Mr. HOPKINS. It is hypothetical----
Mr. RANGEL. That would be an abuse of the system.
Mr. HOPKINS. If the resources were shifted unduly to
someone in their private capacity, the answer is yes.
Mr. RANGEL. Now let me ask Professor Hill a question. We
are getting more involved in not-for-profits being audited for
political activities and dealing with an organization has
historically been known, in the hypothetical, for its efforts
in the civil rights area and voter registration and things of
that nature. If an office of not-for-profit makes a statement
that is critical of the major parties and then the eve before
the election, the IRS says that there is going to be an
investigation, how would the IRS monitor, or how would the
Congress be able to monitor the IRS and at the same time seek
out to get rid of these abuses with subjective matters such as
the one that I described in the hypothetical?
Ms. HILL. Yes. Your hypothetical raises important issues of
conducting audits with respect to what is, in some of its
elements, constitutionally protected First amendment political
speech. When conducted through a 501(c)(3) organization, the
Supreme Court has said in taxation with representation that
lobbying in that case could be conditioned and those people
believed that the political prohibition in section 501(c)(3) is
constitutional and would be so held, and one did look to the
McConnell v. Federal Election Commission comments in that case.
The question that arises, and I am going to be a little
hypertechnical here and mention code sections, and I apologize
to anyone in the room whose eyes are going to glaze over, but I
am a professor and inherently boring, so here we go. Generally,
an organization is audited when it files its information
return, but we know that the information return is filed long
after an election and there is something of a mismatch in this
area between interdicting improper political activity of
501(c)(3) and the time at which the IRS can normally take
action. Congress enacted section 6852, in the larger scheme of
things quite recently, to provide that in the case of a
flagrant violation of the political prohibition of section
501(c)(3), Congress, the IRS could audit at that point in what
constitutes a version of a jeopardizing assessment. They could
close the taxable year and audit, but the violation has to be
flagrant.
Further, there has been for a time now in the Code section
7409 that allows the IRS, with careful procedural limitations,
to seek a declaratory judgment action in a court to interdict
the behavior immediately in the case of flagrant participation
in a political campaign in violation of the exempt status. I
don't believe the IRS has ever used 7409. When the IRS begins
to seek information, then, from a 501(c)(3) organization before
the filing of a return, the technical issue which is now
unaddressed is is that consistent or inconsistent with section
6852, especially if, hypothetically, the speech in question or
the other activity in question doesn't appear to be flagrant.
Passionate, maybe, but not flagrant. So, what we have here is a
technical issue of great importance to the administration of
the tax law and great importance to the conduct of our
elections, and that is where I think the law stands now.
Certainly the IRS may audit. It seems to be a requirement that
the activity in question be flagrant and that there be a
showing that it be flagrant. So, one would have to look case by
case.
Mr. RANGEL. Thank you, Professor. Thank you, Mr. Chairman.
Now that you have whetted my appetite as to the breadth of this
serious problem that would demand these hearings, can you share
with me as to when we can get to the rubber can hit the road
with the IRS, because this distinguished panel certainly has
laid out a blueprint of something that demands and screams out
for correction.
Chairman THOMAS. I tell the gentleman that we will, as we
normally do, based upon minority witnesses--as you were aware,
we worked with the staff in creating this particular hearing.
We will do additional ones, but as is usually the case with
this Committee, ultimately, a significant amount of the work
will be turned over to the Subcommittee. The Subcommittee on
Oversight has historically been the Subcommittee that reviews
it periodically. It may be worthwhile to bring it back to the
full Committee to take a look at this, because I do believe we
need to move expeditiously, one, because we should, but two, I
want to make sure that the press doesn't cover this as us
rushing belatedly to an issue that the Senate initiated for the
purpose of raising revenue, because I have been doing this for
22 years, as the gentleman from New York has. So, we will be
working together to plan and structure additional hearings, one
to look at theory and practice, but two, eventually, you have
to put theory and practice to the test and we will be dealing
with the IRS on some decisions they have made and querying them
as to why they thought they could do what they did when they
did it.
Mr. RANGEL. The reason I thought it was urgent, Mr.
Chairman, is because I thought some in the majority wanted to
pull up the tax code by its roots and start all over again, and
I--we have John, how many do we have here, the Ambassador--and
I wanted to ask the panel whether they would have any specific
recommendations that they could send in to us during this
period so that we could present them before Treasury and the
IRS. Of course, if we are pulling up the Code by the roots,
then we don't need any recommendations because we will start de
novo. Just in case you decide not to do tax reform this year or
next year, may I ask the panel to send what recommendations
they have for this complicated code and the one that would
follow this year or next year so that we can see what happens?
Chairman THOMAS. I tell the gentleman it might be most
fruitful if we get our staffs together so that we can structure
as a Committee the kinds of questions that we might want to
submit to this panel and others, frankly, to begin to collect
that kind of data so that we can, in the anticipation of the
old dandelion concept, you want to try to pull it out by its
roots and you don't and the root is still there and it grows
back, we may need to do some gardening. So, I am looking
forward to----
Mr. RANGEL. Could we get a statement from the IRS person as
to what he thinks the problem is so that we can tell staff what
we would be looking for in----
Chairman THOMAS. I think that will be useful in a
structured manner, but as this panel clearly indicates, there
is a lot of fruitful work that can be done conceptually to try
to figure out where we need to go and how we need to get there,
and then we can begin to apply it practically by dealing with
the current world.
Mr. RANGEL. Thank you, Mr. Chair.
Chairman THOMAS. I look forward to working with the Ranking
Member on that.
Mr. RANGEL. Thank you.
Chairman THOMAS. The Chair would only say for the record
that in propounding his hypothetical, it might have been more
appropriate if the hypothetical structure had included the fact
that there were complaints filed with the IRS, hypothetically,
and that the IRS examined 130 of those cases, hypothetically,
and the one that the gentleman hypothesized over was the one
that was publicly announced by the organization, meaning there
were 129 additionally hypothetically that were being examined,
as well. Does the gentlewoman from Connecticut wish to be
recognized?
Ms. JOHNSON OF CONNECTICUT. Thank you very much. My
question is going to go to Mr. Hopkins to enlarge on that
portion of his testimony that he alluded to, tax-exempt labor
organizations, because your testimony is very helpful. This
goes to the whole panel. Lots of you made very specific
recommendations as to how we go about it. I found that very
helpful. I thought that it was interesting that in addition to
your overall suggestions and your history, you did focus on one
area, and I want you to have a couple of minutes to enlarge on
that. I do want to, though, mention to Mr. Colombo, you may
have a living, live example of the public benefit of nonprofit
hospitals as we watch whole departments of delivering services
move from the nonprofit to the for-profit setting where they
can also earn more and be relieved of the responsibility to
cross-subsidize charitable services or to take part in the
mandates that govern the hospitals, that they must take anyone
who comes, and so on. So, sometimes, you can see through
people's behavior where the public benefit lies and where it
collides with the underlying need to get fairly compensated for
your work. Mr. Hopkins?
Mr. HOPKINS. Thank you very much. The reference in my
presentation to labor organizations is in there, sort of a
disconnect, I understand this, from the rest of the testimony.
It is in there because the Committee staff asked me to briefly
address the point. To put it in context, you have heard
testimony from a number of witnesses, including Mr. Cohen,
about how unbalanced the Code is today, and for example, he was
making reference to 501(c)(25), which is the multi-parent title
holding company provision which occupies about, what, three-
quarters of a page of the Internal Revenue Code and reflects
maybe four or five entities in the United States, contrasted
with labor organizations, which obviously involve millions of
individuals. There are two words in the Internal Revenue Code
describing tax-exemption for labor organizations and the two
words are ``labor organizations.'' That is all the Code itself
says about labor organizations. This category of exemption was
added to the Code back in 1909, so it precedes even the
constitutional law that Mr. Yin was referring to. The code
provision is silent on criteria for exemption, and in my view,
it is one of the examples of an area that should be remedied by
this Committee. Now, briefly, in the tax regulations, you will
find some law where it is provided that an exempt labor
organization is an entity that has as its objects the
betterment of the working conditions of its members, and to
some degree, it functions to develop among its members a higher
degree of efficiency in their occupations. The private
inurement doctrine does apply in this context. There is a major
regulation that was adopted a few years ago that makes it clear
that entities that have as their principal activity the
investing and management of funds associated with savings or
investment plans cannot be exempt. There are a very few court
opinions and IRS rulings on the subject. In this context, the
law is amplified a bit and illustrates the fact that the
exemption includes more than labor unions. It embraces entities
like collective bargaining Committees, certain forms of strike
fund entities, and publishers of labor newspapers. That is
about the substance of the law that we have today concerning
labor organizations.
Ms. JOHNSON OF CONNECTICUT. I thank the gentleman. I
believe my time is about to expire. I will yield back.
Chairman THOMAS. Mr. McCrery?
Mr. MCCRERY. Thank you, Mr. Chairman. Before I get to the
CBO Director on some of his comments about business activity,
tax-exempt business activity, just to give you a heads-up, I
want to get back to Professor Hill, Professor Colombo, on this
question of some sort of conceptual framework for determining
who should be tax-exempt, what entities should be tax-exempt,
and Professor Hill, you used the term public benefit. We need
to think in terms of the public benefit that is being served by
this tax-exempt entity. Then there was some conversation about
hospitals. I must admit, I am having a hard time
conceptualizing the public benefit of a tax-exempt hospital,
but I have to say in fairness, if I were to ask the not-for-
profit hospitals if they like their situation now, they would
say yes, and I would go to the for-profit hospitals and I would
say, well, do you like your situation now, oh, yes, sure. So, I
am not sure we would make either one happy if we were to change
the current arrangement. If there is some public benefit to be
served, and I suppose one could say that health care is a
public benefit and providing the lowest-cost health care would
be a public benefit, then we could justify, I suppose,
exempting hospitals, and all health care providers, for that
matter, from taxation. If that were the case, then we would
probably want to require all health care providers to be tax-
exempt and not-for-profit, I would assume. So, that gets into a
real sticky wicket. So, help us further define that public
benefit concept and how it would be applied in the real world.
Ms. HILL. I think that when one looks at the hospitals,
that really the conceptual hurdle is bigger than public
benefit. It is grasping exactly the idea that you have set out,
but it very well may be appropriate to have the same activity
conducted simultaneously by taxable and exempt entities, and
there may be not a problem with that. I suggest that because we
are living in a world now where, as you all know, there is a
great deal of convergence of activities in taxable entities and
tax-exempt entities. I teach at an exempt entity. I do not
think that taxable universities should be closed down or forced
to become tax-exempt. With respect to the hospitals, the idea
of looking at who is the benefited class and doing it in a way
that gets beyond simply the pricing structure of the provision
of the service, I think may help here. Certainly, the question
of the pricing structure of the service and whether it is any
different in taxable or tax-exempt entities, as Professor
Colombo notes in his testimony and as I believe to be the state
of the research in this area, the data are inconclusive on
pricing structure, whether there is a difference, and I think
that they are inconclusive as to sort of care provided to those
who cannot pay and under what circumstances and do we count
things like government payments to determine charity care. If
we think only of the provision of free medical care to people
who cannot pay, then, of course, hospitals have no--exempt
hospitals have a much weaker case. If that is our criterion,
then the question is, well, should they be partly exempt or
fully not exempt, and if we then make that conclusion, the
question is, what do we tax? In my previous comments, the
related issue previously raised, I suggested that we look at
how we determine whether taxable entities are making a profit,
distributing dividends to shareholders, and whether that
concerns us.
Frankly, I am not concerned that we have an economy in
which there is a choice in certain areas to be taxable or tax-
exempt, and whether Congress wishes to condition, for instance,
education on do we provide scholarships based on need? Is it
wrong to provide scholarships only on academic merit? Should
all our scholarships be on need, which I think would be the
analogous question? Should we provide care to people who cannot
pay it? Is that the only criteria for exempt status? I believe
that if we begin to ask those questions carefully, Congress
would provide a useful role here. If we simply dig in our heels
and become protective, we are not going to get very far.
Mr. MCCRERY. Thank you. I would be interested in hearing
any comments in writing from Professor Colombo on that subject
and also from Dr. Holtz-Eakin on the question of how do these
tax-exempt businesses conflict with tax-paying businesses? How
do they interact, and are tax-paying businesses hurt in certain
cases by the existence of tax-exempt. You don't have time right
now, but if you would like to point out something in your
testimony that is relevant, I will look at it. Thanks.
[The information follows:]
Thank you for your question about the Congressional Budget Office's
(CBO's) testimony presented at the Ways and Means Committee's April 20
hearing on the tax-exempt sector. As I understand it, you are
interested in how nonprofit entities that are exempt from Federal
income taxes compete with business entities that are subject to them,
and how equalizing the tax treatment would affect that competition.
It is useful to focus on activities that are tax-exempt as opposed
to entities that are tax-exempt. For that reason, CBO presented
fractions of income generated by sales activities. Nonprofit
organizations provide both goods and services that are not provided by
the private sector and ones that are, at subsidized prices (or no cost)
rather than at market prices. Many such entities have little sales
revenue and are probably not in competition with firms in the for-
profit sector. CBO's testimony focused on those tax-exempt entities
that have substantial sales to the public and that compete with private
firms.
The attached table identifies examples of that competition. The
health sector, particularly hospitals, is the primary example of
nonprofits that sell at market prices many of the same goods and
services provided by for-profit firms. As shown in the second column,
that sector receives almost 92 percent of its revenue from the sale of
goods and services and provides a relatively small portion at
subsidized prices to those with limited ability to pay. The entities in
the sector look very much like for-profit entities, which receive
almost all their revenue from sales.
The pervasiveness of competition offered by businesslike nonprofit
entities is greater than is suggested by the data in column 2. Even in
those categories where overall income from program revenue is very low,
substantial competition exists. The last column of the table estimates
the share of revenue earned by entities for which program revenue
exceeds 75 percent of their total revenue. For example, for the
category ``Environmental Quality, Protection, and Beautifcation,'' the
19 percent share of program revenue (shown in column 2) suggests that
those activities might offer little competition with those provided by
for-profit firms; however, almost 9 percent of total revenue in that
category comes from entities earning more than 75 percent of their
revenue from program sales (as shown in the last column). On the basis
of that metric, some of those entities may compete substantially with
for-profit entities.
Fully 65 percent of total revenue in the nonprofit sector is earned
by entities for which program revenue exceeds 75 percent of total
revenue. Those potential competitors with the for-profit sector are
found in all categories of nonprofit organizations.
Universities and museums are examples of entities that are in
competition with the for-profit sector and that are also engaged in
activities that provide public benefits. They have increasingly moved
into commercial activities in order to earn a surplus that can be used
to further their provision of public benefits. Many universities have
entered into research partnerships with for-profit firms that look very
much like business enterprises, and they also compete with professional
sports for advertisers' and sports fans' dollars. Museums have expanded
their gift shops, selling many items not related or only tangentially
related to their tax-exempt mission that are readily available from
for-profit firms. The Washington Post has had several articles in
recent weeks that detail the commercial activity of a range of
nonprofit entities.
CBO's testimony concludes that taxing currently tax-exempt
nonprofit organizations is not likely to level the competitive
playingfield. The efforts of for-profit firms to avoid paying taxes are
restrained by their need to deliver the surplus to shareholders. It is
the absence of those shareholders that primarily determines a nonprofit
organization's economic behavior: it is free to retain a surplus or
dissipate it by lowering prices or increasing costs. A nonprofit's
response to being taxed would be to shrink or eliminate the tax base by
retaining less of its surplus. That surplus would instead be used to
provide additional price reductions or to cover cost increases. If
nonprofits used formerly retained surpluses to further reduce prices,
competition with the for-profit firms might intensify in the short run.
But over a longer period of time, those nonprofits' reduction in
retained earnings might cause them to shrink.
Ultimately, the key to competition from tax-exempt entities is the
variety of state laws that determine an entity's ability to organize
itself as a nonprofit organization--not federal tax policy. Once an
entity is organized as a nonprofit, managers have greater latitude with
the uses of its surplus. That latitude, by itself, provides a
substantial ability to compete through lower prices. As I noted in my
testimony, the additional exemption from Federal income taxes
contributes to the overall surplus, but is not the primary source of a
nonprofit entity's ability to compete via lower prices.
I hope that you find this information useful. If you would like to
discuss it, please call me at 226-2700 or Dennis Zimmerman at 226-2683.
Mr. SHAW. [Presiding.] Thank you.
Mr. Levin, you may inquire.
Mr. LEVIN. Thank you for coming, all of you. I had the
benefit of taking a taxation course from the very gifted
professor, but I must say we did not spend very much time on
this particular provision, this section, so I am not quite sure
what is the purpose of this hearing except it does fill in some
gaps of our legal education. So, let me just ask you, go down
the row, and if you would, tell us what you think is the major
problem in this section of the Code. I know you may not like to
pick out one, but if you would do so. What do you think is the
major issue or the major problem? Yes, Mr. Colombo?
Mr. COLOMBO. Well, I can start with that. I think the major
problem is the lack of a core rationale for tax-exemption for
charitable entities and the detail about how that tax-exemption
is conferred. I think that is very important because this is a
significant and growing sector of our economy. There is more
and more money going into charitable organizations and more and
more money coming out of charitable organizations. That trend
has accelerated over the past years and I think it is just
going to accelerate further. So, we need to spend some time
thinking about an area that is growing very rapidly and for
which we don't have very good ideas about what the underlying
rules are.
Mr. LEVIN. Ms. Hill?
Ms. HILL. I think the core problem in this area is that one
of its very strengths, that the exempt sector is so dynamic and
so malleable and so easy to enter is inviting abuse of the
sector on all fronts and the IRS is incapable now at current
funding levels, current expertise levels, and the current state
of the law of stopping any of it. I simply want to express the
hope that as Congress addresses it, we don't make this sector
rigid and unable to function. The very creativity of it on all
fronts is meaning that it is far beyond hospitals, it is far
beyond universities, that charities are being used and abused
for activities that have nothing to do with the provision of a
public benefit. If you would like a more specific response in
writing with detailed lists, I would be glad to do that for
you, as well.
Mr. LEVIN. Okay. You can talk more in your answer about the
IRS, if you would.
Mr. Walker.
Mr. WALKER. If I had to pick one, I would say a lack of a
set of criteria or a clear definition of what should be tax-
exempt and what should not.
Mr. YIN. Mr. Levin, if you would define this area broadly,
I would suggest three areas that would be worth looking at.
Certainly one would be the one that Mr. McCrery was questioning
on just a moment ago. More broadly, I think the issue of
oversight and transparency in the exempt area, to what extent
do we have a handle on what is going on. Then, as I said, if
you take the term, this area broadly, I would include the
charitable contribution area as another area that is worth
looking at.
Mr. LEVIN. Thank you. Dr. Holtz-Eakin?
Mr. HOLTZ-EAKIN. With the caveat that this constitutes the
sum total of my legal education in this area----
[Laughter.]
Mr. HOLTZ-EAKIN. --it sounds to me that one of the major
things that is going on here is there is an attempt to apply a
bright-line exemption to entities when it is, in fact,
activities that are either public purpose or charitable in
nature, and these entities have a great mixture of activities
within them and it would be useful to distinguish between those
two things.
Mr. LEVIN. Yes, Mr. Cohen?
Mr. COHEN. You will excuse my irreverence, but this is a
perfect opportunity for my favorite quotation from Pogo. We
have met the enemy and it is us. It is your lack of attention,
our lack of attention. It is understanding that the Revenue
Service's capacity is greater than it is. For example, Mr. Yin
in good faith says we ought to have a five-year review of tax
exemptions because people are abusing it and, therefore, we
ought to look at it a second time. That is a wonderful idea,
but we don't have the personnel to look at it the first time.
Mr. LEVIN. I like your irreverence. Yes?
Mr. HOPKINS. Mr. Levin, on page six and seven of my
prepared statement, I have outlined in somewhat of a level of
priority 12 areas that I would encourage the Committee to look
at, and number one on the list, and you have heard this from at
least two of the other witnesses, is create law spelling out
the criteria for tax-exempt status. I think that seems to be a
consistent theme that you have heard today. I will work in one
more, which is the elements of the private inurement doctrine
because the private inurement doctrine from a pure law point of
view is the fundamental legal distinction between a nonprofit
and a for-profit. Those two areas, I think you would find,
would be very productive ones to look at very carefully.
Mr. LEVIN. Thank you.
Mr. SHAW. Mr. Camp, and I would like to announce that Mr.
Walker is going to have to leave following Mr. Camp's
questioning and he will be replaced by Mike Brostek of the
government Accountability Office. Mr. Camp?
Mr. CAMP. Thank you. I will direct my question, my first
question, to Mr. Walker, then. Do you think if we have greater
enforcement of our current law and better oversight by the IRS
that most of the abuses within the tax-exempt sector could be
eliminated?
Mr. WALKER. I think you are going to need additional
transparency and additional data sharing as a basis to have
more targeted and more effective enforcement, as well as some
supplemental intermediate sanctions to be made available to the
IRS to provide more appropriate accountability mechanisms
rather than merely pulling the tax-exempt status.
Mr. CAMP. Is that the timing issue that Professor Hill
talked about that you are referring to there, in terms of the
enforcement?
Mr. WALKER. I am not sure what----
Mr. Camp. Intermediate sanctions. Well, you mentioned----
Mr. WALKER. Well, that is, for example, in a prior life, I
was Assistant Secretary of Labor for Pensions and Health, and
there are tax-exempt entities that I had to deal with there,
for example, 501(c)(9) VEBAs, Voluntary Employee Benefits
Associations, also outside of 501(c), pension plans. It is
very, very important that you have adequate transparency and
intermediate sanctions other than pulling the tax-qualified
status. There need to be sanctions that are there, that if
people end up engaging in inappropriate or unacceptable
activities, that you can bring to bear. For example, as is the
case for foundations, I believe, you have prohibited
transactions. If certain kinds of transactions occur between
parties, then there can be excise taxes that can be imposed and
sanctions that can be imposed on the violating individuals
rather than necessarily the entity. That would be an example.
Mr. CAMP. It is my understanding that since 1996, the IRS
has had an intermediate sanctions available for--if there has
been a situation where there has been private inurement. Is it
your opinion that that has been ineffective, or perhaps I
should direct that to Mr. Yin, if that is not in your field.
Mr. WALKER. I will be happy to have him answer, but my
understanding is that doesn't apply universally. It doesn't
apply to all the 501(c) entities.
Mr. CAMP. All right. Mr. Yin, do you want to clarify that?
Mr. YIN. That is correct. It is likely directed at the
501(c)(3)s and the public charities within that. The private
foundations have a separate set of rules that are more
stringent than the public charities.
Mr. CAMP. What are the current restrictions and
requirements on private foundations?
Mr. YIN. On private foundations, the analog would be the
self-dealing rules, and essentially, they prohibit any kind of
transaction with an insider. In contrast to that, the
intermediate sanctions would allow a transaction with an
insider, but supposedly at arm's length rates and so forth.
Obviously the inquiry in the intermediate sanctions area is
much more difficult because there, you have to judge to what
extent is the inside transaction at fair, arm's length rates as
opposed to some kind of internal benefit going to the insider.
Mr. CAMP. Aren't there also other requirements, like
restrictions on holdings and----
Mr. YIN. In the private foundation area, that is correct.
Mr. CAMP. Yes.
Mr. YIN. I thought you were just addressing on the
intermediate sanctions point.
Mr. CAMP. I would like to know what are some of the other
requirements and restrictions on private foundations.
Mr. YIN. Well, there are restrictions on requiring them to
make certain amounts of distributions each year. There are
restrictions on--on ownership, exactly right. There are also
restrictions on excess benefit holdings. They can't hold too
much interest in the business.
Mr. CAMP. I would just like to comment briefly on your
report, the options to improve compliance and reform tax
expenditures, particularly with regard to conservation
easements, your statement there. I just want to say that in
Michigan, land conservation easements are becoming a really
prominent way to preserve valuable land and shoreline. I just
want to ensure that the highest standards are met in terms of
land conservancies, obviously, as everyone else does, but I am
afraid that the changes you suggest would make it virtually
impossible for a landowner to take advantage of these
provisions to, in effect, preserve their land forever, some of
this incredibly beautiful land. So, I wonder, do you think
stricter standards on appraisals and licensing for appraisals
and increased penalties for overstated appraisals in this area
might assist in this area?
Mr. YIN. I think that is a step in the right direction. In
fact, in the staff options, we do lay out some improvements in
the appraiser and the appraisal process. However, it would seem
that that is just a small step in terms of addressing the
underlying difficulty. The underlying difficulty is that for a
variety of reasons, easements are unusually difficult to
determine what the appropriate value is. It is just a partial
interest in the property. It is a property interest which is
crafted by the donor and, therefore, may have few, if any,
comparables. Then, at least in certain circumstances, perhaps
not the ones that you are describing, there are State and local
restrictions on the use of property already in existence and,
therefore, that would need to be taken into account in figure
out what the appropriate value of the easement right is.
Because of the difficulty of the value, it becomes a very
difficult both compliance problem for the donor and a very
difficult enforcement problem for the Internal Revenue Service.
If you put all of the change, if you will, into the appraisal
process, it really doesn't address the underlying issue, which
is that it is very difficult at the outset to figure out what
circumstances should be examined at all.
Mr. CAMP. Thank you, Mr. Chairman. I see my time has
expired.
Mr. SHAW. Mr. Cardin?
Mr. CARDIN. Thank you, Mr. Chairman. Let me thank all of
our witnesses for their testimony. It is clear to me in hearing
your testimony and looking at the material that has been
submitted that the issue of oversight and compliance needs some
attention.
Mr. Camp talked about, and Mr. Walker responded by perhaps
the sanctions are not as broad or as much discretion to IRS as
is needed in order to bring about more compliance with
Congressional intent. There is a question as to whether we have
enough exams. With the exam rates as low as they are, why would
there be much concern about even the sanction authority of the
IRS if the chances of sanctions being used are so minimal,
considering the number of exams? There is also the question of
political will, whether there really is a will of our Nation to
be more stringent on tax-exempt organizations. Then there is
the whole evolution of section 501. It has developed over a
long period of time, as you all have pointed out, and it is not
100 percent clear as to what the expectations are for tax-
exempt entities. So, do we need Congressional clarification?
Let me start with Mr. Cohen, because he is a former
Commissioner, and try to get his reaction as to how you would
suggest we get a handle on appropriate oversight and compliance
as to the role of the IRS and Congress as to trying to give
fair notice to the taxpayers, but also to develop consistent
oversight and compliance strategy on behalf of our Nation.
Mr. COHEN. I was fortunate, or unlucky, as the case may be,
to be the object of Congressional inquiry by Mr. Patman, who
ran several years of hearings, vigorous hearings, on tax-
exemptions, which led to much of the 1969 Act that restricted
them. So, I paid a lot of attention. He caught me. He had my
attention. I have to say to you, but for that, it would have
been a backorder. Before I came to the Revenue Service the
second time as Commissioner in 1965, it was a backorder, and
that is why he was taking on some fairly obvious problems. You
had some Members of this Committee during the late 19seventies
period that got involved in it again, but again, it has been an
area that not much attention certainly by the full Committee
and very little by the Oversight Committee. You just don't
spend the time. Therefore, it is not number one for the top
people down at 12th Street who mind this operation. Yes, in an
ideal world, everybody would be paying attention to everything,
but we know that is not the way the world works. The world
works, what is important today is what is important to you
folks.
Mr. Mr. CARDIN. Mr. Cohen, let me just interrupt you for a
moment. Our Tax Code depends upon voluntary compliance. We
depend upon--that is the hallmark of the American Tax Code. Is
this a satisfactory situation? Are we overreacting? Do we have
enough voluntary compliance? Maybe we have the right policy
today.
Mr. COHEN. We have just seen the Commissioner's new
research study, and we have not had a research study since
1988, so we have had the first report of that. It shows a tax
gap in the order of 15.5 to 16 percent. That is about 11 or 12
percent higher than it was the last time we did it about 11 or
12 years ago. So, surely, it is slipping. It is slipping, and
you can almost look at the numbers. As you see the audit levels
fall, you see compliance levels fall. People react to not
seeing the cop on the beat, in the city parlance. So, yes, we
need more compliance effort. The money is well spent. The
Commissioner generally has a rule that he won't ask for a
dollar unless he can bring in large multiples of that. Indeed,
the problem is that as you cut the Commissioner's budget and
personnel--personnel went from close to 120,000 down to about
95,000, between 95,000 and 100,000--you find that the
Commissioner--the first thing that is cut is not proportional.
It is compliance, because that is the only optional money he
has. He has to produce returns. He has to process returns. He
has to collect money. There are a number of functions that he
has to do, and so he has no leeway there. He can audit more
returns or less returns. He can audit the returns more
intensively or less intensively. Of course, what happens is he
slips off. You do some audits, but you do them less intensively
and therefore they are less effective. You and I react to the
fact that our neighbor is being audited. If a neighbor is being
audited and talks about it, he talks about it, it has an effect
on all of our behavior. It is like driving down a major
superhighway. If we don't see a traffic policeman, we tend to
go five or ten miles an hour above the limit. If we see a
traffic policeman, we go two miles above the limit. We all
chisel a little bit. Therefore, we need to see that audit to
have an effect on our behavior. Now, we are not seeing it, so--
--
Mr. Mr. CARDIN. I agree with that comment and I appreciate
your response. Thank you, Mr. Chairman.
Mr. SHAW. Thank you, Mr. Cardin. Mr. Herger?
Mr. HERGER. Thank you, Mr. Chairman. Mr. Yin, recently, the
Joint Committee on Taxation made a number of recommendations to
improve tax compliance, one of which would restrict the use of
conservation easements. I welcome this proposal and I believe
this is an area the Committee should focus attention on because
there has been a large amount of evidence that taxpayers are
taking inappropriate deductions related to conservation
easements. Consider a Washington Post article from December of
2003 which quotes a Florida business consultant as advising his
clients to purchase golf courses and prohibit building on the
fairways as a way in which to reap large tax benefits. He
refers to one investor who paid $2.4 million for a golf course
and received a $4.8 million tax deduction. This taxpayer
received a tax deduction worth twice what he paid for the
property. This article also mentions luxury homebuilders in
North Carolina who paid $10 million for a tract in the
mountains, developed a third of the land, and then claimed a
$20 million deduction. Evidence suggests these are not isolated
incidents. Perhaps this is not surprising, given the easements
are today held by various government agencies, national
environmental groups such as the Nature Conservancy, and
according to the Post article, about 1,260 local trusts. Mr.
Yin, my understanding is that your proposal would eliminate
charitable tax deductions relating to conservation easements on
personal residence and would limit the deductions related to
other properties. This proposal is scored as raising $1 billion
over 10 years, not an unsubstantial amount of money. My
question is simply this. Do we know how much fraud in dollar
terms currently exists with respect to conservation easements?
Two, does the Joint Tax Committee proposal go far enough to
eliminate the potential for fraud relating to golf courses and
other types of investments similar to what I mentioned earlier?
If not, what more can be done to ensure that the Federal
government, through the charitable deduction allowed for
conservation easements, is not subsidizing large amounts of tax
fraud?
Mr. YIN. Thank you, Mr. Herger. Obviously, it is very
difficult to provide estimates of fraud because fraud involves
a particular intention on the part of the taxpayer which would
have to be judged on a very highly factual determination. I
think that it is fair to say, however, that the IRS recently in
connection with the hearing over on the Senate side published
their letter which indicated the top areas of compliance
difficulty in the EO area, and one of the areas that they
clearly identified was the difficulty that they have in
enforcing the laws relating to easements. Now, how much of that
is fraud as opposed to simply overvaluation but not rising to
the level of fraud, I don't know if they know. I don't believe
we know, either. In terms of whether the Joint Committee
proposal goes far enough, obviously, that is going to be your
judgment and the Committee's judgment on those sorts of issues.
We did try to offer a balanced approach. I am comfortable
with--I am personally comfortable with the proposal as it is
offered, but obviously, that is not my judgment. It is going to
be your judgment.
Mr. HERGER. Thank you very much, Mr. Yin. I think we can
see enough and enough has been pointed out again through the
media, through yourselves, through these hearings, to indicate
that perhaps we are just beginning to see the tip of the
iceberg here. We all want to see legitimate deductions made,
but we are also very concerned about what is perceived as--even
if it may be within the law today, those exemptions that are
being made that clearly, I think, in most of our judgments are
not ethical, are not fair and not proper, and I would certainly
like to urge your continued involvement in this and I thank
you.
Mr. SHAW. Mr. Johnson?
Mr. JOHNSON OF TEXAS. Thank you, Mr. Chairman. I wonder if
Mr. Holtz-Eakin and Mr. Brostek could talk about this subject.
Almost 10 years ago, Congress put the immediate sanctions rules
into place that allow the IRS to punish tax-exempt entities
that break the private inurement rules. I would like to know
whether this type of sanction has been effective and whether
incremental change like this might serve as a model for reform
of the tax-exempt laws by this Committee.
Mr. HOLTZ-EAKIN. I could go first and hand it to Mr. Yin,
who I think knows a lot more about this than I do.
Mr. JOHNSON OF TEXAS. Okay.
Mr. YIN. Mr. Johnson, of course, as you do indicate, the
law, though it has been in effect for 10 years, it is still--on
the larger scheme of things, that is a relatively short period
of time, so our experience is still somewhat limited. In the
report that Mr. Camp referenced, the late January report by the
Joint Committee staff, we did provide some options to improve
the intermediate sanctions rules in areas where we felt that
they did seem to be a little bit on the lax side. We put in
some suggestions on modifying the initial contract exception
and also on the rebuttable presumption of reasonableness. Now,
these are relatively small changes in the procedure of how the
rules would work. I think we are not really yet in a position
of being able to give you guidance that they are completely
ineffective or completely effective, and so it is a little bit
early to make that----
Mr. JOHNSON OF TEXAS. Well, has the number of violators
increased or decreased?
Mr. YIN. Well, in terms of the number of violators, of
course, prior to the law, there wasn't a rule against it as
such. That is that--well, I take that back. The prohibition or
the penalty was to lose your tax exemption, and because that is
such a draconian outcome, that was rarely imposed and so it is
difficult to know, as comparison to what prior behavior is,
whether the current behavior is improved. Again, I would
suspect that, in time, we will get a better handle on how it is
working.
Mr. JOHNSON OF TEXAS. Yes, sir?
Mr. BROSTEK. I think the point that Mr. Yin is making is an
important one. IRS can apply those sanctions when it knows
there is a problem that needs to be corrected. One of the
things that IRS itself admits is that it doesn't have enough
information to know the various kind of noncompliance that are
occurring out there. They are trying to improve the Form 990
that gives them some of that type of information, but that will
need to be married up with greater transparency so the news
media and the public can help keep an eye on the entire
universe, and probably with some improved governing standards
to help ensure that within an organization, there is a check
and balance to ensure that this kind of abuse doesn't occur.
Mr. JOHNSON OF TEXAS. Transparency, you have all mentioned
that. It needs to be fixed. Let me ask one other question. I
brought up Medicare and Medicaid earlier. It seems to me that
there is plenty of appropriations from public funds for all
sorts of health care providers for helping the poor and the
elderly and it seems to me the absence of clear standards for
the community benefit provided for not-for-profit hospitals may
be a problem. In Texas, for example, we require a set
percentage for charity care--I think it is four or 5 percent--
and unreimbursed Medicaid costs in order to claim 501 status.
It seems to me a step in the right direction, and I might add
that hospitals in our district go way above that. A larger
concern, though, is that standards, once they have been met,
may breed a feeling of, we have crossed the line. We don't owe
anything else to anybody. The problem is complicated further
when one considers that some for-profit hospitals offer a
notable amount of charitable unreimbursed care. Do you have any
suggestions on ways to encourage a more equitable charitable
care across the board? I guess that is for GAO or CBO, as well,
or all of you, if you have a comment.
Mr. BROSTEK. Well, we don't have a position at this time on
that. We haven't looked at it.
Mr. HOLTZ-EAKIN. I think it is certainly the case that if
you look back, and I think Mr. Cohen would know the history
better than anyone on this, the notion of what constitutes
charity was heavily influenced by the existence of Medicare and
Medicaid and perhaps a false optimism that poverty would not be
a problem in the presence of these programs. So, if one would
like to come back and come up with a clearer standard of
performance, you would have to probably not leave it in the
hands of an administrative decision but actually have the
Congress develop a standard that they felt was appropriate.
Mr. JOHNSON OF TEXAS. Thank you.
Mr. COHEN. I was at the meeting, the cabinet meeting at
which the President decided to go for Medicare. It was
accidental. I was there to report on something else. I was also
Commissioner of Internal Revenue at the time that Medicare
began to pay out, and it led the Revenue Service to that 1969
ruling. That is, if Medicare was going to pay a good piece of
what used to be charity, then how are you going to deal with
the hospital system and how are we going to deal with health
care? The availability of health care is a public good, and
that is what we had to deal with.
Mr. SHAW. I am going to have to cut that off. Mr. Pomeroy,
then Mr. Beauprez. Mr. Pomeroy is going to share the time with
Mr. Thompson and then we are going to wind this hearing up
before this vote.
Mr. POMEROY. Thank you, Mr. Chairman. I will be very brief.
It seems to me that this hearing, which has been extremely
interesting, has highlighted basically two separate facets of
this question. One is the very confused state of the Tax Code,
which allows nonprofit status or tax-exempt status to be
achieved through any number of ways. Second, the whole
enforcement question, eyeballing whether or not those that have
qualified are actually appropriately conducting themselves for
purposes of maintaining that qualification. To that end, I
would like to speak of while this Committee grinds along on the
question of who has got this exemption and why, that is a long-
term proposition that is going to be tough sledding. I would
hope that we don't get distracted and not proceed on the
enforcement question, which we can do something about very
quickly through, among other things, resource commitment to the
IRS and some clarity in terms of directing them to take this
action. To that end, and underscoring the importance of taking
that action, a couple of issues, items in the recent press I
would like to put into the record, yesterday's Financial Times,
as well as a story from the Business section of Sunday's
Washington Post, both detailing abuses in trusts in this area.
Specifically quoting from the Financial Times article,
``Foundation directors and donors have come under fire for
excessive pay, insider dealing, alleged conflict of interest
between their foundations and their private business dealings,
as well as outright tax fraud.'' Then on the Washington Post
story, it is detailing how the founder of AmeriDebt, the
bankrupt Maryland credit counseling firm, took $70 million from
its operation between 1999 and 2003. I think this makes a
compelling case for why we need to help the IRS with its
enforcement activity. We need to raise their budget relative to
being able to completely audit this activity, and especially in
wake of passing the bankruptcy bill, we have got to, in the
Oversight Subcommittee, really bear down on nonprofits----
Mr. SHAW. Without objection, the documents are placed in
the record.
[The information follows:]
April 16, 2005 Saturday
FTC Moves to Freeze Assets; AmeriDebt Founder Transferred Money to
Offshore Trusts, Agency Says
Caroline E. Mayer, Washington Post Staff Writer
The founder of AmeriDebt Inc., the now bankrupt Maryland credit-
counseling firm, took $70 million from its operations between 1999 and
2003 and spent lavishly on his wife, girlfriend and himself, including
paying $179,000 to an interior decorator, $13,500 to a yachting company
and $2,500 on a restaurant tab.
That's what the Federal Trade Commission said in court papers as it
sought to freeze the assets of Andris Pukke. A hearing on the matter
was held yesterday in Federal court in Greenbelt. Those assets included
$18.3 million transferred to domestic and offshore trusts, and $2
million sent to an account in Latvia for his father, the agency said.
In 2003, the FTC sued Pukke, his wife, the nonprofit AmeriDebt, and
DebtWorks Inc., the for-profit private firm Pukke set up to process
AmeriDebt customer accounts. The suit alleged that the Pukkes and their
companies deceived financially struggling consumers seeking help with
their debts by charging high fees--hiding them by calling them
voluntary contributions. They operated falsely as a nonprofit
organization while siphoning off money through DebtWorks to make money
for the Pukkes, the suit said.
A recent filing in a related class-action lawsuit alleged that
Pukke and his girlfriend traveled to Tahiti, Bora Bora, San Tropez, Las
Vegas, Aspen, the Cayman Islands and Cabo San Lucas, that he gave her a
new Mercedes, and that he spent $15,000 for a mattress and $8,000 for
sheets for his Malibu mansion. He sold a Miami Beach home for $7
million, that suit said.
AmeriDebt, based in Germantown, was once one of the nation's
largest and most aggressively marketed debt-management firms,
advertising heavily on cable TV and the Internet. Also the target of
several lawsuits by state attorneys general, AmeriDebt is now bankrupt
and its accounts have been taken over by a third-party firm.
AmeriDebt is one of more than 50 nonprofit credit counseling firms
under investigation by the Internal Revenue Service for misusing their
tax-exempt status for the benefit of their operators. There is little
Federal regulation of the firms. The bankruptcy bill that passed
Congress this week contains a provision that requires debtors to seek
debt counseling before filing for bankruptcy protection.
Last month, the FTC settled its lawsuits with AmeriDebt, but its
case against Pukke and his wife continues, with the agency seeking $170
million in consumer refunds.
``An individual profiting $70 million on a fraudulent promotion is
certainly among the largest we have seen,'' said Joel Winston, the
agency's associate director for financial practices. ``The question is
where did it go? We're trying to freeze whatever money and property he
has, seek repatriation of the money he has put overseas and have a
receiver appointed by the court to audit his affairs and determine
where all of his money and assets are.''
John B. Williams, Pukke's attorney, did not return phone calls.
Previously he has said that evidence shows that AmeriDebt benefits to
all consumers far surpassed the $170 million that consumers paid the
credit-counseling firm because it was able to reduce interest rates and
get rid of late fees and interest charges for many of its customers.
In court papers opposing the freeze, Pukke's lawyers said the FTC
and the class-action plaintiffs have failed to prove consumers were
injured.
The monetary transfers, the papers added, occurred in the past
``when Mr. Pukke was in much better financial condition. Mr. Pukke now
has limited assets and all of his available income goes to the IRS, Mr.
Pukke's wife pursuant to court orders in a pending divorce case, and
personal living expenses which are not extravagant.''
In depositions with the FTC, Pukke invoked his Fifth amendment
privilege, the agency said.
U.S. District Judge Peter J. Messitte said he would rule next week
on the request to freeze his assets.
According to the FTC filing, ``Mr. Pukke has dissipated assets'' by
transferring money to the trusts, close friends and relatives and by a
``lavish lifestyle.'' The commission said that DebtWorks transferred
$200,000 to Pukke's girlfriend although she never worked at DebtWorks.
The girlfriend also used a DebtWorks credit card to pay $215,000 in
charges, including a $1,688 bill at a clothing store and a $2,165
three-night stay at the Viceroy Hotel in Santa Monica, the lawsuit
said.
Pukke's wife received $250,000 from DebtWorks although she never
worked for the firm, either, the FTC said, and another $150,000 through
the company's credit card.
The agency said that Pukke established the domestic and offshore
trusts, including one in Nevis and another on Cook Islands in 2002,
shortly after the FTC notified AmeriDebt and DebtWorks that they were
under investigation. ``Clearly,'' the agency said in legal papers,
``Mr. Pukke created these trusts in an effort to put his assets out of
reach of the FTC and other creditors.'' As of June 2004, the trusts
were valued at $18.3 million.
The class-action lawsuit said Pukke ``has hardly been skimping on
his domestic lifestyle. . . . His primary residence cost him $27,906
per month, including over $24,500 for mortgage, property taxes and
utilities and $1,400 for domestic help. This pales in comparison to the
monthly cost of operating his secondary home, which is $84,699.''
In July 2004, the lawsuit said, Pukke spent $8,119 for dining and
$6,583 for travel. His monthly car payment was $10,653. With other
personal and professional expenses and taxes of $75,000, Pukke claims
to spend more than $390,000 a month, it said.
In opposing a motion by the class-action lawyers to appoint a
receiver, Pukke lawyers argued that the plaintiffs were citing old
spending habits and were not likely to succeed on the merits of the
claim.
Mr. POMEROY. We have to bear down on these nonprofits. I
would like to finish my thought. We have to bear down on these
nonprofits that are providing credit card counseling and debt
counseling. I believe it is principally a scam and we need to
get to the bottom of it. I yield the balance of my time to Mike
Thompson.
Mr. THOMPSON. Thank you, Mr. Pomeroy. I want to align
myself with Mr. Camp. I believe that conservation easements are
critically important for protecting literally thousands of
acres throughout my district, in my district for critical
wildlife habitats, salmon and steelhead restoration. It is
responsible for clean air and clean water. At the same time,
Mr. Herger raised some valid issues. We need to make sure these
are legitimate procedures done by the right reasons and it is
something that benefits more than just the person making the
donation. Mr. Yin, you have commented on numerous occasions now
on these changes that I believe if they were taken at face
value would do irreparable harm to the whole idea of
conservation easements. So, I would like to ask that you do,
and if you have already done it, let me know, but do some more
work in this regard to see if we can't associate a value to the
good conservation easements done by the legitimate
contributors. These in many instances save governments a lot of
money. They don't just protect valuable, important properties.
So, before we rush into any reform in this regard, I haven't
seen anything other than anecdotal references to problems, so I
would encourage you to do and provide an analysis to this
Committee that looks at both the potential problems, but the
very specific values that these bring to the table.
Chairman THOMAS. [Presiding.] The gentleman from Colorado.
Mr. BEAUPREZ. Thank you, Mr. Chairman. I will be very quick
and very direct. Mr. Colombo, many have talked about your
comments, as well as many of the others on the panel, about the
need to define what is a charitable contribution, what
qualifies as a tax-exempt organization. I found your rather
straightforward definition to be pretty useful, that an
organization ought to be able to survive primarily on
donations. Then it crossed my mind that any number of business
entities out there that in a different environment we would
call it profit margins, net income, might say that is the
income that one who does business with that business entity
provides so that it is sustainable. Does that fit your
definition or not?
Mr. COLOMBO. The Internal Revenue Service and the courts
have developed pretty good tests about what constitutes a
donation and what doesn't. The test is generally what we call a
quid pro quo test, or the absence of a quid pro quo, and there
is not any question that normal sales transactions don't fit
that kind of model. So, I just don't see a problem, to tell you
the truth. We pretty much know what a donation is. At the
edges, we may get into a little bit of a problem, at the edges
of what donations are, but mostly, we know what it is, and
mostly, I know when we get one.
Mr. BEAUPREZ. All right. Very quickly, type three
supporting organizations. Mr. Yin, I am going to guess that you
might be the one to opine on this. I know that they have come
under intense scrutiny, especially in the other body, recently.
There has been some concern. From personal experience back home
in my own State, I know community foundations, private family
foundations seem to do an enormous amount of good, as well. Is
the abuse so rampant that we maybe are tempted to throw the
baby out with the bathwater, or is what we really need, as has
also been suggested here, more oversight and more
accountability, more transparency?
Mr. YIN. Well, Mr. Beauprez, as you know, supporting
organizations are granted public charity status as opposed to
private foundation status and some have argued that they more
closely resemble private foundations and should be more subject
to those rules. The type three that you referred to are
specifically the ones that have drawn the most attention
because they are least under the control, if you will, of the
organization that is being supported, and therefore least
subject to the same level of scrutiny that the charitable
organization which is being supported is normally subject to.
So, that is the reason why that is an area that has drawn some
attention recently.
Mr. BEAUPREZ. The solution would be, in your opinion?
Mr. YIN. Well, there are a variety of solutions. Obviously,
you would first have to determine there is a problem
sufficiently great enough to deserve a solution. Assuming that
you did, there would be a variety of solutions, one of which
would be to permit support organizations of type one and type
two but to not permit the type three.
Mr. BEAUPREZ. I thank the entire panel very much and am
sorry we have to rush.
Chairman THOMAS. The Chair would also like to thank the
panel. The Chair believes that perhaps the government witnesses
might want to get with staff. I think it would be very helpful
for Members if we prepare a glossary so that the terminology
that is being used, they understand the meaning of as we move
through these various structures. I want to thank the other
panelists, and I hope that you aren't thankful that this is the
only opportunity to assist the Committee, let me put it that
way, because we are going to continue to examine the area, but
we need to work on these fundamentals that we have talked about
before we get excited and think we can fly in making judgments
over real world events. So, I do want to thank you. The
Committee owes you a debt of gratitude and we expect to use you
more in the future. With that, the Committee stands adjourned.
[Whereupon, at 1:15 p.m., the hearing was adjourned.]
[Questions submitted from Representative Herger to George
Yin, and his response follows:]
Question Submitted by Representative Herger
Question: Mr. Yin, recently the Joint Committee on Taxation made a
number of recommendations to improve tax compliance, one of which would
restrict the use of conservation easements. I welcome this proposal and
I believe this is an area the Committee should focus attention on
because there has been a large amount of anecdotal evidence that
taxpayers are taking inappropriate deductions related to conservation
easements.
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\1\ Joint Committee on Taxation, Options to Improve: Tax Compliance
and Reform Tax Expenditures (JCS02-05), January 27, 2005, at section
VIII.F.
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Consider a Washington Post article from December of 2003, which
quotes a Florida business consultant as advising his clients to
purchase golf courses and prohibit building on the fairways as a way in
which to reap large tax benefits. He refers to one investor who paid
$2.4 million for a golf course and received a $4.8 million tax
deduction. This taxpayer received a tax deduction worth twice what he
paid for the property! This article also mentions luxury-homebuilders
in North Carolina who paid $10 million for a tract in the mountains,
developed a third of the land, and then claimed a $20 million
deduction.
Evidence suggests these are not isolated incidents. Perhaps this is
not surprising, given that easements are today held by various
government agencies, national environmental groups--such as the Nature
Conservancy--and, according to the Post article, about 1,260 local land
trusts.
Mr. Yin, my understanding is that your proposal would eliminate
charitable tax deductions relating to conservation easements on
personal residences and would limit the deductions related to other
property. This proposal is scored as raising $1 billion dollars over 10
years, not an insubstantial amount of money. My question is simply
this: Do we know how much fraud, in dollar terms, currently exists with
respect to conservation easements?
Does the Joint Tax Committee's proposal go far enough to eliminate
the potential for fraud relating to golf courses and other types of
investments similar to what I mentioned earlier? And, if not, what more
can be done to ensure that the Federal government, through the
charitable deduction allowed for conservation easements, is not
subsidizing large amounts of tax fraud?
Response:
Dear Mr. Herger:
This letter responds to your written request made in connection
with a hearing of the House Committee on Ways and Means regarding
charities and other tax-exempt organizations held on April 20, 2005.
You asked: (1) whether it is known how much fraud, in dollar terms,
currently exists with respect to conservation easements; and (2)
whether the recent proposal of the staff of the Joint Committee on
Taxation to limit the deductibility of certain contributions of.
conservation easements (the ``easement proposal'') is sufficient to
eliminate fraud relating to golf course easements and other abusive
easement donations, and what more could be done to eliminate such
fraud. You also asked these questions orally at the hearing.
The easement proposal was contained in a report that we prepared in
response to a request from Senate Finance Committee Chairman Grassley
and Ranking Member Baucus. The report contains options to improve lax
compliance and reform tax expenditures in almost all areas of the
Federal tax law. One of these options relates to the charitable
contribution of easements. As explained in the report, the charitable
contribution deduction for easements is an exception to the general
rule that prohibits a charitable deduction for a contribution of a
partial interest in property. This exception was enacted generally to
encourage landowners to contribute property rights to a qualified
organization in order to protect such rights in perpetuity for
conservation purposes.
The report makes a number of observations about the contribution of
easements and concludes that noncompliance concerns warrant
consideration of curtailing the tax benefits provided with respect to
such connibutions.\2\ In particular, the easement proposal notes that
the proper amount of the charitable contribution deduction is difficult
to determine because the valuation of the easement right being
contributed is often highly speculative. For example, there is
generally no ready market for such easements, the terms of which may
vary from donor to donor, and no available data regarding comparable
sales. This situation makes enforcement of the law very problematic, as
the mere identification of potential overvaluations may require
considerable administrative expense such as the cost of appraisals. A
serious challenge to a claimed deduction would entail a greater
commitment of resources. The easement proposal also raises the concern
that the current definition of ``qualified conservation contribution,''
which in most instances does not require that a contribution be
pursuant to a clearly delineated governmental conservation policy, is
not sufficient to ensure that conservation purposes are being served.
We note further that the often difficult issues of valuation and
assessment of the appropriate purpose of a contribution generally are
even more difficult in the easement contribution context because the
taxpayer retains an ongoing interest in the underlying property. To
address these concerns, the easement proposal limits the extent of
deductibility, modifies the definition of qualified conservation
contribution, and imposes additional requirements on appraisers.
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\2\ IRS Commissioner Everson has identified overvalU8(ion of
conservation easements as a top compliance concern of the IRS. See
Lercel-fi ``om JRS Commissioner'' Mark W Everson to The Honorable
Charles E. Grassley, March 30, 2005; Written Stateement of Mark W.
Everson, Commissioner of Internal Revenue, Before the Committee 011
Finance, United Stales Senate, Hearing on Exempt Organizations:
Enforcement Problems, Accomplishments, and Future Direction, April 5,
2005.
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Regarding your first question, as discussed above, a primary
compliance concern addressed by the easement proposal is overvaluation.
An easement may be overvalued as a result of fraudulent intent on the
part of the donor or because of more innocent reasons. In addition, an
easement may be overvalued even if the easement serves a legitimate
conservation purpose. The easement proposal is intended to reduce
claimed overvaluations for purposes of the charitable deduction
regardless of the reason or circumstances of the overvaluation. As a
practical matter, even with a detailed review of taxpayer returns
showing information regarding easements, we would be unable to
determine whether an easement serves legitimate conservation purposes,
or whether the contribution results from fraudulent intent on the part
of the donor, without making an independent assessment of the
circumstances surrounding each contribution. As a result, we are unable
to determine the amount of fraud, in dollar terms, that exists with
respect to conservation easements. However, because we are concerned
that the current definition of conservation purpose is not adequate to
address noncompliance, the easement proposal suggests, among other
things, that the requirement that the conservation contribution serve
clearly delineated governmental conservation policy -- currently
applicable only 10 a limited class of conservation contributions--be
extended to all forms of conservation contributions. The intent is that
such a change in the law would improve the integrity of the tax system
by providing tax incentives only for donations that serve identified
conservation or preservati on purposes.
With regard to your second question, the easement proposal to curb
noncompliance in easement donations in a number of ways. Your request
gives two specific examples of potentially abusive conservation
easement donations: (1) golf Oillse easements; and (2) easements placed
on a parcel of land to be developed by a builder of luxury homes. Such
examples raise questions about the legitimacy of the conservation
purpose purportedly served by the easement donation and the accuracy of
the claimed value of the easement. The easement proposal was designed
to address each of these concerns. For most conservation easements, the
easement proposal seeks to ensure that a legitimate conservation
purpose is served by requiring a showing that an easement donation is
pursuant to a clearly delineated governmental conservation policy--a
showing that may be particularly difficult to make, for example, in the
case of a golf course easement. In the absence of such a showing, no
deduction would be allowed. In addition, even where a clearly
delineated governmental conservation policy purportedly exists, the
easement proposal would address the overvaluation of easements of the
type you describe by: (1) denying a deduction where the property has
been used or is reasonably expected to be used as a personal residence;
(2) denying a deduction for 67 percent of the appraised value of a
conservation easement where the property has not been used and is not
reasonably expected to be used as a personal residence; and (3)
imposing additional requirements on appraisers who value such
easements. In short, we believe that the easement proposal would limit
significantly noncompliance in connection with easement donations,
particularly noncompliance involving the valuation of easements.
I hope this information is helpful to you. If we can be of further
assistance in this matter, please let me know.
______
[Submissions for the record follow:]
Statement of of America's Community Bankers
America's Community Bankers (``ACB'') \1\ is pleased to submit this
written statement in connection with the Committee's hearing on ``An
Overview of the Tax-Exempt Sector.'' ACB commends the Chairman for
calling this important hearing to examine tax-exempt entities.
Providing tax-exempt status to charitable, educational and other non-
profit organizations can further important societal goals, but not in
every instance.
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\1\ America's Community Bankers is the member driven national trade
association representing community banks that pursue progressive,
entrepreneurial and service-oriented strategies to benefit their
customers and communities. To learn more about ACB, visit
www.AmericasCommunityBankers.com.
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Congress and the American taxpayers deserve to know whether the
substantial tax benefits that have been granted under section 501(c) of
the Internal Revenue Code are being used for the purposes intended by
Congress and whether these benefits are being abused in ways that harm
organizations and people that do pay federal income tax. ACB believes
that it is also important for the Committee to examine whether the
rationale used for granting specific tax exemptions continues to be
valid.
ACB Position
ACB strongly believes that the rationale for the tax-exempt status
of complex credit unions is no longer valid and gives credit unions an
unfair government-created competitive advantage that harms community
banks that compete against them. The strength of our economy is built
on free and fair competition. However, the free market is frustrated by
those credit unions that compete head-to-head with taxpaying community
banks, particularly those banks and savings associations that are
mutual in form.
We believe that the original policy rationale for granting credit
unions tax-exempt status is no longer valid, particularly with regard
to large, complex credit unions that are indistinguishable from
taxpaying banks and savings associations. Approximately 100 credit
unions have assets of $1 billion or more. At the same time, there are
8,378 banks and thrifts that have assets of less than $1 billion. Small
community banks are competing against billion-dollar credit unions that
are full-service financial service providers that compete in all
aspects of the financial services market. Because of the tax-subsidy,
these credit unions are able to grow faster than the community banks
with which they directly compete.
The credit union tax exemption means that credit unions have a 40
percent price advantage over taxpaying banks and savings associations.
According to the Congressional Budget Office (``CBO''), between 2006
and 2015, the credit union tax exemption will cost the federal
government a cumulative total of $15.2 billion. The CBO said on this
issue, ``With their current tax advantage, credit unions can use their
retained earnings to expand and thus displace the services of other
thrift institutions--even though the latter may provide those services
more efficiently.'' Furthermore, the median American family pays $4,038
in federal income tax, while the entire $662 billion credit union
industry pays $0. Credit unions should not be permitted to be full-
service financial services providers at the expense of tax-paying
depository institutions and the American taxpayer.\2\
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\2\ Special Report No. 119, The Tax Foundation.
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Credit Unions Are Not The Only Cooperatively Owned Financial
Institutions.
Many cooperative banks, savings associations, and savings banks are
cooperatively owned--just like credit unions. Mutual savings
institutions do not have shareholders. Their profits are reinvested in
the institution, returned to members in the form of higher rates on
deposits or lower rates on loans, or given to the community.
Mutual institutions have existed in this country for more than 100
years, well before credit unions. Mutual banks and associations lost
their tax exemption in 1952, when Congress determined that they had
reached a sufficient degree of maturity, were very ``bank-like,'' and
competed with other taxpaying financial service providers. At that
time, mutual banks and associations could not even offer checking
accounts, much less business loans. Yet, many of today's credit unions
look more like commercial banks than the mutuals of 53 years ago--
offering share draft accounts (checking) and small business loans.
Contrary to credit union industry statements forecasting that
taxation will lead to their untimely demise, mutual savings
institutions have not collapsed under taxation. Despite the revocation
of their tax exemption in 1952, mutual savings institutions continue to
experience growth. Last year, the nearly 700 mutual savings
institutions (from the smallest with $20 million in assets to the
largest with $8 billion in assets) paid nearly $900 million in
corporate taxes. By contrast, the credit union industry, which has over
2.5 times as many assets as the mutual institutions, paid $0. Just as
Congress determined that the safety and soundness argument was not
persuasive in the context of expanding the tax on mutual savings
institutions decades ago, the assertion that today's credit unions
cannot withstand taxation should also be rejected. And, as Congress
concluded in 1952 about mutual institutions, complex credit unions have
matured to be ``bank-like.''
Credit Unions Are Not Fulfilling Their Mandate to Serve Persons of
Modest Means.
Congress chartered credit unions in 1934 to serve persons of modest
means. In return, credit unions were exempted from taxation. However,
an October 2003 General Accounting Office (``GAO'') report indicates
``that credit unions served a slightly lower proportion of low- and
moderate-income households than banks.'' Similarly, a 1991 GAO report
found ``no evidence that today's credit union members are for the most
part of small means.''
Further, the credit union industry has vehemently opposed efforts
to require credit unions to engage in special efforts to serve low-
income customers or neighborhoods like banks and savings institutions.
In fact, in a March 30, 2005 editorial the Credit Union Times, by Mike
Welch, stated: ``ACB apparently thinks credits unions' first obligation
is to serve communities in which they operate. Wrong. CUs' number one
obligation is to serve the changing financial needs of the members who
own it. Of course, the community will also be served as a by-product.''
The comment is self-serving and ignores the substantial federal safety
net provided to credit unions through the National Credit Union Share
Insurance Fund, in addition to the substantial tax subsidy under
discussion today. This would be like a bank saying that serving
shareholders is sufficient and serving the bank's community is a mere
afterthought. Credit unions' not-for-profit status is no excuse for an
exemption from community reinvestment responsibilities. Banks and
savings institutions have Community Reinvestment Act responsibilities
regardless of whether they make a profit.
Sophisticated Credit Unions Hide Behind the Small Credit Union Image.
Over the years, two distinct credit union industries have emerged.
The first adheres to its statutory mission. The other hides behind the
small credit union image to preserve its federal tax exemption. Even
the National Credit Union Administration recognizes that the expansion
that it has allowed to occur within the credit union industry now makes
many credit unions indistinguishable from banks and savings
associations. At a November 18, 2004 NCUA Board meeting, Board Member
Deborah Matz observed that many legislators consider small credit
unions to be the symbol of all credit unions. As a result, she
reasoned, it is important to preserve small credit unions so that the
entire credit union industry will not be taxed.
We see no value in subsidizing credit union conglomerates that
offer diverse, high-end financial products and services to the general
public. It is a common misperception that credit unions offer only
basic banking services to local hospital employees, schoolteachers, and
government workers. In reality, many credit unions have evolved into
complex financial institutions that do not have meaningful membership
restrictions.
For example, credit unions offer commercial loans, stocks, mutual
funds, margin and option accounts, trust services, and other
sophisticated products. Furthermore, many credit unions do not have a
distinct field of membership and offer financial products and services
to the general public. For instance:
LA Financial Credit Union's field of membership includes
all of Los Angeles County and its 10.1 million residents. Los Angeles
County is home to more than 25% of California's population and more
people than reside in 42 of this nation's 50 states.
Suncoast Schools FCU in Tampa, FL caters to persons in 14
counties and has assets of over $4 billion.
Citizens Equity First CU in Peoria, IL serves over 14
counties and employees of over 550 select companies.
Rhode Island-based Greenwood Credit Union advertises that
membership ``is open to all responsible people who want to be
members.''
$800 million Greylock Federal Credit Union in
Massachusetts recently ran radio advertisements telling listeners if
they ``have a pulse,'' they are probably qualified to join Greylock
Federal Credit Union.
CUSOs Contribute to Credit Union Growth.
Many credit unions have formed subsidiaries known as credit union
service organizations (``CUSO''s) that have contributed significantly
to the dramatic growth of complex credit unions. CUSOs offer
sophisticated products such as trust administration and investment
services. CUSOs also provide non-traditional financial services such as
real estate brokerage, pre-paid legal service plans, and travel agency
services. In many cases, CUSOs are established to offer services not
permitted by a credit union's charter. Income generated from bank-like
products and non-traditional financial services offered through CUSOs
should not be exempt from taxation.
Federal Credit Union Income Should Be Transparent.
We urge the Committee also to examine a more narrow issue--the
credit union exemption from filing a Form 990, Return of Organization
Exempt from Income Tax. Under current law, all organizations exempt
from tax under section 501(a) are required to file a Form 990 with the
Internal Revenue Service (``IRS''). This form discloses items of gross
income, receipts, disbursements and other information required under
the tax regulations. In Revenue Ruling 89-94, the IRS exempted federal
credit unions from filing these annual information returns under the
theory that a federal credit union is an ``instrumentality of the
United States.'' Financial disclosures were required prior to 1989.
Federal credit unions should not be given the same rights and
privileges that are afforded to the federal government. Federal credit
unions are not owned by the United States, nor do they possess any
special governmental attributes or purpose that would justify an
exemption from these disclosure rules. In fact, credit unions are
profitable, retail financial service organizations whose activities
should be appropriately disclosed in order to efficiently administer
the tax laws. Therefore, we believe that if federal credit unions
remain tax-exempt, they should be required to file a Form 990.
Conclusion.
We reemphasize that our concern remains with the sophisticated
credit unions that have grown beyond their common bond and are as bank-
like as mutual institutions that are taxed. From a competitive
perspective, these credit unions have become tax-free community banks,
creating situations in which a billion dollar, tax-free credit union
sits opposite a $50 million, non-stock, taxpaying mutual savings bank.
We commend the Committee for undertaking an examination of the tax-
exempt sector, and we look forward to working with the Committee on
this important issue.
Taxes and Authorities: A Comparison of Credit Unions and Other Depository Institution
----------------------------------------------------------------------------------------------------------------
2005 Federal Savings
Issue 2005 Credit Unions 1952 Mutual Savings Associations 2005 National Banks
Associations Including Mutuals
----------------------------------------------------------------------------------------------------------------
Income tax liability $0 Lost exemption in $7.5 billion.\4\ $30 billion.\6\
2003 Would have paid $1.32 1952. Federal mutual
billion if taxed at savings associations
the same rate as paid over $285
banks and savings million in 2003. All
associations.\3\ federally insured
mutuals paid $1
billion.\5\
----------------------------------------------------------------------------------------------------------------
CRA obligations No CRA obligations. Predated the CRA. The CRA requires Same as federal
Mutual savings insured depository savings
associations worked institutions to associations.
to maintain and serve and help
foster the economic foster growth in
strength of each of the
communities they communities they
served. serve, including low-
to moderate-income
areas within their
communities.
----------------------------------------------------------------------------------------------------------------
Interest on consumer Federal credit unions No. Checking accounts Federal savings Same as federal
checking accounts may pay interest on were not permitted. associations may not savings
both consumer and pay interest on associations.
business checking business checking
accounts. accounts. Offering
interest bearing NOW
accounts to
individuals and
nonprofit
organizations is
permissible.
----------------------------------------------------------------------------------------------------------------
Field of membership Federal credit unions Mutual savings Not applicable. Not applicable.
may serve only associations were
persons within their authorized to lend
field of membership. within their
Over the years, communities, which
membership generally was
restrictions have defined to comprise
been liberalized a 50-mile radius.
legislatively and by
regulation. In 2003,
the NCUA greatly
expanded its field
of membership rules.
At a minimum, the
new rules will allow
56 million
additional people to
qualify for credit
union membership.
Separately, some
states have very
liberal field of
membership
interpretations.
----------------------------------------------------------------------------------------------------------------
Lending limits A federal credit Historically, mutual Lending limits track The single borrower
union may lend to savings associations those for national limit generally is
any one member up to could lend up to a banks. Federal 15% of the bank's
10% of its deposits. percentage of savings associations capital and surplus
assets, generally also have an on an unsecured
between 15-20% of additional lending basis. An
assets to a single limit authority for additional 10%
borrower, depending residential limit is available
upon loan type. development loans. if collateralized
with fully
marketable
securities.
----------------------------------------------------------------------------------------------------------------
Business lending Federal credit unions No. Federal savings National banks have
authority may make business associations may general commercial
loans of up to make commercial lending authority.
12.25% of total loans in an
assets. However, a aggregate amount
recent rule adopted totaling 20% of
by the NCUA allows total assets, 10% of
credit unions to which must be in
exclude purchases of small business
participation loans loans.
and non-member loans
from the statutory
cap if approved by
the NCUA.
----------------------------------------------------------------------------------------------------------------
Unsecured consumer Yes (12-year term No. Yes. Yes.
loans limit).
----------------------------------------------------------------------------------------------------------------
Insurance/securities Yes. No. Yes. Yes.
powers
----------------------------------------------------------------------------------------------------------------
\3\ Banks and savings associations pay approximately 40% of their income in federal and state taxes each year.
According to the NCUA's 2003 Annual Report, Federal credit unions had a net income of $3.3 billion, 40% of
which is $1.32 billion. President Bush's FY 2005 budget estimates that credit unions' federal tax exemptions
will cost a cumulative total of $7.88 billion between 2005 and 2009.
\4\ SNL Database.
\5\ Id.
\6\ Id.
Statement of American Association of Debt Management Organizations
About The American Association of Debt Management Organizations
The American Association of Debt Management Organizations (AADMO)
is an industry trade association representing the nation's independent
debt management organizations. Founded in 2001, AADMO's focus has been
on industry education with an emphasis on regulatory and compliance
issues affecting its members.
AADMO is the credit counseling and debt management industry's
largest trade association and has as its mission to promote and ensure
the continued operation and viability of credit counseling and debt
management organizations. AADMO provides its members and the consumer
public with information about the credit and debt counseling industry.
AADMO members are debt management organizations, personal finance
educators, credit and debt information publishers, credit counselors,
consumer lawyers and many others.
AADMO is the only trade association to have held state law
compliance workshops with the New York State Banking Department and the
California Department of Corporations prior to enactment of their
respective laws governing credit counseling. AADMO is also the only
trade association for the industry to publish a formal summary of state
laws that has been reviewed by state regulators.
Copyright 2005 AADMO
Table of Contents
Introduction
Overview Credit Counseling Agencies' Commitment to Education
Educational Aspects of the Debt Management Plan
Identifying the Beneficiaries of Debt Management Plans
Volunteer Staffing and the Credit Counseling Process
The Potential Impact of IRS Revocation of Credit Counseling's 501(c)(3)
Tax-Exempt Status on Credit Counseling Agencies and American Consumers
Recommendations
Introduction
Since their creation, non-profit credit counseling agencies (CCAs)
have provided invaluable assistance and education to American consumers
in financial distress. For over twenty-five years, the Internal Revenue
Service and the courts have recognized the educational work of CCAs by
confirming their tax-exempt status pursuant to Section 501(c)(3) of the
Internal Revenue Code. The explosive growth of unsecured consumer debt
over the last fifteen years has increased the need for credit
counseling, and the need for debt management plans (DMPs) which CCAs
administer. This explosive growth has caused change and growth within
credit counseling; it has also created an opportunity for abuse by some
CCAs. The now notorious conduct of a few CCAs has caused the IRS to
consider revoking tax-exempt status to all CCAs, including those who
continue to fulfill their educational purpose. Such blanket revocation
would be a drastic overreaction. Blanket revocation would fail to
recognize the continued educational work of credit counseling, and the
important role credit counseling plays in assisting financially
distressed and vulnerable American consumers and in protecting all
Americans from an epidemic of bankruptcy filings such as has never been
seen.
Overview
Over 1.6 million Americans filed for personal bankruptcy in 2003
\1\ and another 1.6 million through the period ending September 30,
2004. Generally, the number of consumers declaring bankruptcy has
increased by nearly 10% each year over the last several years.\2\ These
are alarming statistics. Of even greater concern for policymakers are
the millions of Americans and American families on the verge of
bankruptcy, or at a point of financial distress where there appears to
be little hope and few options. The well-being of our national economy
is threatened if these people choose bankruptcy in ever-growing
numbers. Most consumers do not want to choose bankruptcy, but they need
real help with their immediate financial distress and their long-term
ability to understand and manage their finances. Whether they succeed
or fail affects not only the debtors themselves but their children,
their employers, their communities, and the national economy.
---------------------------------------------------------------------------
\1\ http://www.uscourts.gov/Press_Releases/fy04bk.pdf
\2\ http://www.uscourts.gov/Press_Releases/603b.pdf
---------------------------------------------------------------------------
Increasingly, financially distressed families have turned to non-
profit credit counselors for relief from financial distress. In 2001,
nearly 2.5 million consumers sought the assistance of credit counseling
agencies. In 2004, it is estimated that closer to seven million people
sought assistance from a credit counseling organization.\3\ These
numbers dwarf the already high numbers of bankruptcy filings, and make
two facts undeniably clear: a substantial number of American families
are in serious financial distress, and a substantial number of those
distressed Americans are primarily burdened by unsecured credit card
debt. If these Americans are abandoned, we risk a bankruptcy
catastrophe.
---------------------------------------------------------------------------
\3\ According to the Executive Office for U.S. Trustees, ``The
credit counseling industry handles approximately $6 billion annually,
more than the amount distributed from chapter 7 and chapter 13
bankruptcy cases combined.''
---------------------------------------------------------------------------
Historically, the non-profit status and eligibility for 501(c)(3)
tax exemption of credit counseling agencies was confirmed by the IRS
and the courts in a series of early decisions. At that time, the model
for credit counseling agencies reflected the nature and magnitude of
the problem: small, community-based agencies who could provide helpful
advice and general education to the many and tangible assistance to the
few. The helpful advice and general education included one-on-one
sessions or lectures to groups on subjects such as family budgeting,
expense reduction, and balancing a checkbook. The tangible assistance
took the form of the debt management plan, which is discussed in
greater detail below. Debt management plans provided financial
resources to the CCA in the form of creditor ``fair share'' (again,
discussed in greater detail below), but because the problem was small,
a CCA would look for and receive funding from other sources as well; a
commonly cited example is the United Way.
The past thirty-five years have seen an explosive growth of
consumer credit. Between 1970 and 2004, consumer debt in the United
States increased from 131 billion to over 2.05 trillion dollars.\4\
Consumer credit is an essential element of the consumer-driven American
economy, and the availability of credit is essential to the stability
and self-improvement of millions of Americans. At the same time, the
aggressive marketing of credit cards to consumers has become an
accepted part of the credit card issuer's business model. With
unsecured consumer debt being higher than ever and more concentrated
than ever on less-than-perfect American consumers, that part of the
American financial spectrum populated by consumers in financial
distress tied directly to unsecured debt has grown substantially.
---------------------------------------------------------------------------
\4\ http://www.federalreserve.gov/releases/g19/hist/cc_hist_mh.html
---------------------------------------------------------------------------
Over this time, credit counseling agencies grew in size and in
number to meet the increased demand for their services, and in
particular the increased demand for the tangible assistance of a debt
management plan. CCAs developed new practices to reflect the new
economies for credit counseling, and their increased role as financial
trustees dictated that many CCAs took on a more professional business
approach, departing further from the ``church basement'' model of a
charitable organization. As more consumers came to CCAs needing the
tangible assistance of a debt management plan, the ``fair share''
payments by creditors slowly displaced charitable support from other
groups such as the United Way. CCAs moved increasingly toward a
telephone-based counseling relationship, which permitted consumers to
obtain counseling from home and on the consumer's schedule, without the
need to take the day off work and arrange day care for children. CCAs
also generally found that to the extent these distressed American
consumers were embarrassed or ashamed at having gotten into such
trouble with consumer debt, telephone counseling was less humiliating
to these consumers, encouraged greater candor, and created a more
productive platform on which to base counseling and educational
efforts. Clearly, the move by CCAs toward a telephone-based counseling
relationship also permitted CCAs to reach larger geographic regions.
Creditors also made adjustments, reducing their ``fair share''
contributions to reflect the economies of scale now common at CCAs.
Credit card companies also encouraged CCAs to develop modern business
practices, including computerized client data management systems and
electronic payment systems.
Unfortunately, the rapid growth and reshaping of credit counseling
also permitted the emergence of some of the worst-behaving entities in
credit counseling. These worst entities abandoned any commitment to
education, and moved fully into the mode of indiscriminately marketing
Debt Management Plans to the general public. At one end of the consumer
spectrum, they invited American consumers who were otherwise able to
pay their credit card debt, at the contractual rates of interest, to
use the debt management plan as a means of paying less than the agreed-
on rate. This indiscriminate marketing of the debt management plan
offended credit card companies, who historically had made substantial
concessions to consumers on debt management plans--slashing interest
rates or eliminating interest altogether, waiving accrued fees and
penalties, and re-aging a consumer's delinquent account as a current
debt.
Credit card companies responded to the indiscriminate marketing of
debt management plans by limiting their concessions and further
reducing their ``fair share'' contributions. Both of these moves had
the unintended effect of hurting legitimate CCAs more than they hurt
the worst players (who had no resources devoted to genuine education
and counseling, who would always operate more leanly than legitimate
CCAs, and who were constantly increasing their ``market share'' through
aggressive and dishonest marketing). Where the worst CCAs had never
committed to education, many legitimate CCAs struggled to meet their
educational commitments with reduced creditor support. More
significantly, the reduction in creditor concessions came to mean that
the debt management plan provided a less substantial benefit to those
Americans who desperately needed it. This fact did not matter to the
worst CCAs, who have shown a willingness to aggressively market Debt
Management Plans by promising what they cannot deliver.
At the other end of the consumer spectrum, the worst CCAs marketed
their Debt Management Plans to consumers who were so deeply in
financial distress that bankruptcy was the only reasonable solution.
These worst CCAs did not care that these consumers would be squeezed
for their last few dollars before seeking bankruptcy protection; they
did not care that the consistent failure of these consumers would
eviscerate the CCA's retention rates for its Debt Management Plan. All
the worst CCAs cared about was signing consumers up and getting
exorbitant startup and monthly fees for as long as they could,
regardless of the long-term effects on the consumer, the creditors, or
the economy.
Not all the worst CCAs were ``home-grown'' products; a number of
them were escapees from other legitimate attempts at consumer-friendly
regulation. The Credit Repair Organizations Act and the National Do Not
Call Registry are two examples of laws which prohibit certain predatory
and/or deceptive practices, but which do not apply to non-profit
organizations. It is widely claimed that a number of predatory and
dishonest business entities took on the mantle of non-profit status in
order to escape the application of these laws.
The primary source of regulatory oversight of credit counseling has
been the various states. Some states do not regulate credit counseling
at all.\5\ Of the states that do, their laws often lack clarity and
uniformity. Banks issue consumer credit on an interstate basis, and
consumers freely move from state to state taking their unsecured debt
with them. The growing need for credit counseling is not a local
problem, and the growth of credit counseling has lessened the local
quality of many credit counseling agencies. Nevertheless, these
agencies still must contend with the divergent and/or redundant
requirements of the various states' laws (including various
requirements as to licensing, bonding, insurance, disclosure, and other
compliance issues). At the same time, enforcement of these various
states' laws is insufficient, ineffective, or altogether absent. What
this means is that CCAs that intend to comply with the applicable laws
have been burdened with exhaustive legal compliance costs,\6\ while the
worst CCAs were able to ignore legal compliance without fear of
effective enforcement.
---------------------------------------------------------------------------
\5\ For example, see Alaska and Colorado
\6\ The New York State Banking Department announced in December
2004 to allocate all of the Department's operating expenses to its
regulated entities--such as ``budget planners'' (i.e. non-profit credit
counseling).
---------------------------------------------------------------------------
In a climate of explosive growth, rapid development, and
ineffective regulatory oversight, the conditions were ripe for the
worst CCAs to take a controlling position in the world of credit
counseling. For every dollar that a legitimate CCA spent on genuine
education and counseling, the worst CCAs had a free dollar they could
spend on marketing. Nevertheless, other CCAs grew in size and
geographic range, moved toward a telephone-based counseling
relationship, and adopted a more professional business approach, yet
remained true to their fundamental educational and charitable purposes.
Regrettably, it was the worst CCAs who of course finally caught the
attention of the public, the IRS, and other regulators. These worst
CCAs had a number of features that were shared by other CCAs which had
grown and developed over time: they were large, telephone-based, they
followed a professional business model, and they aggressively marketed
their services. These are features that would not have been found the
last time the regulators looked meaningfully at credit counseling
agencies. Yet these features were not the ones that cried out for
regulatory action against these worst CCAs: it was the fact that the
worst CCAs were dishonest, predatory, and abusive to consumers. Their
commitment to education was non-existent. Their marketing was
widespread and dishonest. These worst CCAs promised what they could
never deliver, then failed to deliver even what they could. They
charged exorbitant upfront fees, which reflected a business model that
focused on signing new consumers up for services, and did not focus as
much (if at all) on actually providing those services. These worst CCAs
not only failed to be legitimate 501(c)(3) educational or charitable
organizations; they failed to even be legitimate businesses.
The current challenge to the IRS is to immediately address the
status of these worst CCAs without letting the conduct of these few
entities cloud IRS' understanding of the explosive growth of consumer
debt and the corresponding growth and development of non-profit credit
counseling.
As the IRS steps back in to provide regulatory oversight and
guidance to these agencies, it must recognize that the core values and
practices which originally justified 501(c)(3) exempt status for credit
counseling still exist in modern CCAs. The fact that specific practices
have changed or developed reflects changes and developments in our
world, not an abandonment of those core values and practices.
Credit counseling agencies still provide low cost or free financial
education and counseling to the public and still provide tangible
assistance in the form of debt management plans to those American
consumers for whom such plans are appropriate. Credit counseling
agencies still provide a positive option to collection actions,
lawsuits, and bankruptcy. The ability of legitimate credit counseling
agencies of any size to carry on their educational and charitable
purposes still depends on their continued status as 501(c)(3)
organizations. Without this tax status, credit counseling agencies will
no longer be able to provide financially distressed consumers with the
affordable and reliable services they desperately need. A decision by
the IRS to revoke 501(c)(3) status to all CCAs based on the abusive
practices of the worst CCAs would be factually and historically
baseless, and would have disastrous unintended consequences on American
consumers and the American economy.
Credit Counseling Agencies' Commitment to Education
From their inception in the 1950s, credit counseling organizations
have engaged in public education and have provided consumers with
access to financial literacy programs. This commitment to education has
always been, and should always be, an essential component to the
maintenance of the 501(c)(3) tax-exempt status granted to credit
counseling organizations. Credit counseling agencies seeking to obtain
and retain 501(c)(3) status should devote a preponderance of available
resources to the development, procurement and dissemination of client
and community oriented financial literacy programs.
Each year, millions of financially distressed American households
use the credit counseling and debt management services of CCAs,
inclusive of their educational components. With proper oversight and
guidance from the legislative and regulatory community, non-profit
credit counseling organizations will continue to rehabilitate and
educate financially distressed consumers.
Educational Aspects of the Debt Management Plan
It is difficult to teach long-term financial accountability to
people in short-term, immediate financial distress. Distressed
consumers typically seek immediate relief from their financial crisis,
but what they really need is long-term behavioral change. Behavioral
change is undeniably an educational goal. A debt management plan, when
used appropriately, can serve both these short-term and long-term goals
and is the best available educational tool for credit counseling.
In the short term, the debt management plan provides a ``safe
harbor'' for the distressed consumer, who is otherwise consumed by
fears over unpayable bills, creditor calls, collection agency calls,
legal actions, late fees, over the limit fees, ``default'' credit card
interest rates and, more generally, the fear of being financially out
of control, in free fall, and on the verge of bankruptcy. This ``safe
harbor'' permits the distressed consumer to look past ``quick fixes'':
avoidance behavior (i.e. avoiding calls from creditors or collection
agents), problem-shifting behavior (i.e. shifting old credit card debt
onto new credit cards, or shifting unsecured credit card debt into
secured home equity loan debt), or ultimately hopeless behavior
(bankruptcy). This ``safe harbor'' gives the consumer the short-term
practical stability necessary to begin to take long-term responsibility
for the consumer's financial situation, with hope for the future. This
stability extends to all aspects of the consumer's life, including the
consumer's family and employment.\7\
---------------------------------------------------------------------------
\7\ http://www.csus.edu/indiv/a/andersenj/Research/
FinancialProblems.pdf
Substantial research has concluded that financial problems are
stressors that affect marital quality and satisfaction.
---------------------------------------------------------------------------
In the long term, the debt management plan can provide education
that is both informational and practical. The informational aspect
begins with the first counseling session. A distressed consumer often
does not have a working budget of personal income and expenses. A first
counseling session should accomplish this goal (and must accomplish
this goal if the CCA is going to claim that it only recommends a debt
management plan to appropriate consumers). The informational aspect
should continue throughout the debt management plan and beyond, and
should touch on a wide range of issues in personal finance. Whether it
does continue is a measure of the commitment to education of the
individual CCA. The practical aspect is the consumer's exercise of
living within a budget and incrementally paying down credit card debt
with a long-term goal of paying the debt off. The CCA works with the
consumer to understand how the debt management plan will work; to
encourage the consumer to stay on the plan; to assist the consumer when
new challenges make it difficult to stay on the plan; and to share the
consumer's sense of accomplishment as steady, incremental payments
begin to produce substantial reductions in the consumer's debt, a goal
which the consumer once felt incapable of reaching.
By the end of a successful debt management plan, the consumer has
learned from the practical experience of living within a budget. The
consumer has accomplished the goal of reducing his or her debt. The
consumer has gained factual information, ongoing access to educational
resources, and a better understanding about budgeting and debt. The
informational and practical aspects of education through the debt
management plan combine to encourage the consumer's long-term
behavioral change and to ensure that these consumers, and their
children, will not only get out of financial distress, but will not get
into financial distress again.
Identifying the Beneficiaries of Debt Management Plans
Public benefit is simply the sum total of private benefits, when
the benefits are numerous and broad in scope. For example, a halfway
house for recovering drug addicts can narrowly be said to only provide
private benefits to recovering drug addicts, a particularly narrow
target audience, yet it takes very little consideration to realize that
the families of these individuals also benefit, as does the community
at large. Often the best way of identifying who benefits from a
solution is to identify who is affected by the problem.
The American economy is a consumer-driven economy. The easy
availability of credit to American consumers has become a necessary
component of our economy, and credit card issuers have been largely
unregulated in their marketing of credit to consumers. It is a
predictable side effect of the easy availability and constant marketing
of credit that some American consumers will end up in financial crisis
because they overuse credit. As consumer credit card debt has exploded,
the number of consumers in financial distress has predictably followed
suit. When these distressed consumers cannot pay their credit card
debts, it is not only the creditors that are affected. The distressed
consumers are affected, by the wide range of negative financial events
including higher fees, collection actions, legal actions, and
bankruptcy. The consumers' families are affected, as it is known that
financial distress is one of the leading causes for the breakup of
families. The consumers' employers are affected, as employers recognize
that financial difficulties are a leading cause of decreased employee
productivity, increased absenteeism, and increased turnover.
Responsible consumers at large are affected, as creditors increase the
cost of consumer credit to account for the cost of bankruptcies and
write-offs. Ultimately the economy as a whole is affected, as the
increased cost of credit discourages consumer activity.
Credit counseling agencies are asked by consumers to assist and
intervene in a pre-existing contractual relationship between the
consumers and their creditors, where the creditors already have a
contractual claim for repayment of a large and growing amount of debt.
When administering debt management programs, credit counseling agencies
fulfill a four-part role; acting as the agent, advocate, counselor and
educator of financially distressed households. The immediate tangible
benefits that a credit counseling agency can provide to its client, the
consumer, can be measured by the concessions that the CCA obtains from
the consumer's creditors, i.e. the agreement by the creditors to accept
less from the consumer than that to which the creditors are otherwise
entitled pursuant to their contracts with the consumer.
To treat the creditor's acceptance of less than the contractual
amount as a benefit to the creditor is arbitrary. A CCA which asked a
consumer's creditors to accept nothing, i.e. to simply write off a
consumer's debt entirely, would be rejected by the creditors, and would
be unable to provide any real benefit to the real beneficiary--the
consumer.
Often the notion that a debt management plan confers a substantial
private benefit on creditors is coupled with the accusation that CCAs
are merely ``collection agents'' for the credit card industry. Anyone
making this accusation has not been through a collection process, and
does not understand it. In collection, the creditor writes off a debt,
and writes off the consumer. The collection agent buys the debt, for
pennies on the dollar. The collection agent does not work with the
consumer to create a budget or to address the full range of the
consumer's debts. The collection agent has no concern about the impact
on the consumer of the collection process, and devotes no time to
addressing the consumer's underlying financial management issues. In
collection, various collection agents compete with each other to get a
greater share of blood from a stone. The stone is the consumer.
Collection is a degrading process.
While creditors do make a business decision to participate in debt
management plans, the CCAs administering those plans are focused on the
current and future financial well-being of the consumer.
The long-term educational work of credit counseling agencies,
directed at clients on debt management plans, at non-DMP clients, at
high school and college students who have not yet taken on credit card
debt, and at the public at large, is substantially funded by creditor
payments. These are often called ``fair share'' payments. As noted, the
creditors who have aggressively marketed consumer credit share some
responsibility for the explosive increase in the number of consumers in
financial distress.
It is perfectly appropriate for these credit card issuers, as
opposed to the public at large or charities such as the United Way, to
take financial responsibility for funding the efforts of credit
counseling agencies. The voluntary agreement by credit card issuers to
take financial responsibility for a side effect of the product they
market is certainly preferable to the approach of others, for example
the tobacco industry, who denied the existence of a problem caused by
their product, and let the public pick up the tab until they were
forced to take responsibility.
The explosive growth of consumer credit caused the attendant growth
in the numbers of consumers in financial distress and the number of
consumers seeking the assistance of credit counseling. Undeniably,
because the problem is large the numbers involved are also large. Large
amounts of money are paid to creditors through debt management plans,
and large amounts of money are paid by creditors to CCAs through ``fair
share'' payments. Large numbers, however, do not equate with a
fundamental change in the educational mission of credit counseling
agencies, any more than the explosive growth in the number of colleges,
and the larger amounts of money involved in college education, has
changed their fundamental purpose.
When CCAs were first approved for 501(c)(3) status, CCAs were
heavily controlled by creditors, creditor representatives sat on CCA
boards of directors, and creditor ``fair share'' payments were
typically set at 15 per cent of revenues paid through debt management
plans. Today, credit counseling agencies are more independent of
creditors, creditor representatives do not sit on CCA boards, and
creditors pay ``fair share'' that is not only at an historic low
percentage, but also based on a wider range of factors more directly
focused on the CCA's commitment to education. While the numbers have
gotten larger, the commitment to credit counseling's educational
purpose has remained the same and, at least at the better CCAs, only
gotten better.
Consumer credit, just like banking, is a public concern made up of
millions of private concerns. Legislators and regulators sometimes
prefer to treat banking issues and financial issues as private issues
until such time as the private issues fester into public crises, like
the Great Depression or the savings and loan scandal. Consumer debt
today threatens to become another crisis. The proponents of bankruptcy
reform recognize this fact.
Credit counseling is not the problem. It is part of the solution,
and benefits all Americans. It is worthy of continued 501(c)(3) status.
Increased regulatory oversight is of course appropriate; revocation of
501(c)(3) status is not.
Volunteer Staffing and the Credit Counseling Process
At one time, a consumer's issues with unsecured debt typically
involved no more than three credit cards. Today, it is not surprising
for a consumer to come to a CCA with twenty or more credit cards; the
average is approximately ten. The range of issues relating to these
credit cards has increased and become more complex, and the range of
other consumer issues has changed in the same way. As a single example,
thirty years ago the relationship between credit and divorce was not
the issue that it is today. Moreover, the increased extension of
unsecured credit card debt means that a consumer is often coming to a
CCA with tens of thousands of dollars in unsecured debt. There is
simply more at stake.
Because the size of and complexity of the problems have grown, a
reliance by CCAs on volunteers would be not only impractical but
irresponsible. Errant financial analysis or advice given by a well-
meaning volunteer could have disastrous consequences for a consumer
already on the brink of bankruptcy. Many CCAs rigorously train and
educate their counselors. Indeed, many states require counselors to be
certified as having demonstrated certain financial literacy skills.\8\
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\8\ For example, see California and Virginia
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Moreover, many CCAs following best practices attempt to establish
ongoing, long-term relationships between clients and individual
counselors, because experience supports the belief that the client
benefits more with a counselor who knows the client's story and
progress. Reliance on part-time volunteers would diminish these
benefits. Finally, effective credit counseling is based on a consumer
providing detailed financial information to the counselor. Given
current real concerns over privacy and identity theft, it is
unreasonable to entrust such information to volunteers.
The Potential Impact of IRS Revocation of Credit Counseling's 501(c)(3)
Tax-Exempt Status on Credit Counseling Agencies and American
Consumers
Financially distressed American consumers are in great need of
short-term assistance and long-term education. They are also extremely
vulnerable to the predatory practices of unethical organizations. As
recent history makes clear, credit counseling is not immune from
invasion by unethical organizations looking to make a quick buck at the
expense of those who desperately need help. Greater regulatory
oversight and effective enforcement is clearly needed. However, IRS
revocation of credit counseling's 501(c)(3) tax-exempt status will not
accomplish these goals. Instead, revocation will hurt legitimate credit
counseling agencies, hurt vulnerable consumers, and hurt the American
economy.
Revocation will hurt legitimate credit counseling agencies by
giving an immediate unfair advantage to the CCAs that have abused their
non-profit status and disregarded their educational mission. The
organizational and operative decisions of these agencies have been
geared to maximizing profit. These are the agencies that have caught
the attention of the IRS, the FTC, the Congress, and other regulators.
Yet in the for-profit world of credit counseling that IRS revocation
would mandate, the practices of these very agencies would necessarily
become the industry standard for any agencies that remain.
Moreover, many of these very agencies are already largely
structured to operate as for-profit businesses, while legitimate CCAs
may find it difficult or impossible to complete a successful transition
of their operations and assets from a non-profit to a for-profit
structure while meeting all state laws applicable to the winding up of
a non-profit organization.
There has been no indication that IRS has made provision for such
transitions, or for working with all the state regulatory entities to
coordinate such transitions. Most legitimate CCAs will simply not
survive the cost and service interruption occasioned by such a
transition.
In a for-profit world, a CCA which commits time and resources to
public education cannot compete with a CCA which does not. Public
education will have to be abandoned. In a for-profit world, sign up
fees will not be limited by regulation or by concern over the
consumer's welfare, but instead will only be limited by ``what the
market will bear''. In a market where the consumer base is financially
distressed, ``what the market will bear'' typically equates with
predatory practices; consider, for example, ``what the market will
bear'' in payday lending rates.
Revocation will hurt vulnerable consumers. There is currently no
``consumer-friendly'' alternative to non-profit credit counseling
agencies. Consumers in financial distress will be left to collection
agents, payday lenders, predatory home equity lenders, litigation, and
bankruptcy. Consumers currently enrolled in debt management plans with
legitimate CCAs may find themselves without a plan if revocation ends
or seriously disrupts the CCA's operations.
Further, revocation of the tax exempt non-profit status of credit
counseling organizations would create an immediate dilemma for the
hundreds of thousands of American families who are currently enrolled
in debt management programs and who reside in States that require non-
profit and/or 501(c)(3) tax exempt status as a condition of the
licensing or legal \9\ operation of a credit counseling agency.
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\9\ For example, see Kentucky, Maine, Oregon and Rhode Island
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Revocation will hurt the American economy. Bankruptcy filings will
certainly double. The most recent versions of Congressional bankruptcy
reform legislation contemplate that non-profit credit counselors will
play a role in stemming the tide of bankruptcy filings. IRS revocation
would be contrary to the expressed intent of Congress and will mean
that non-profit credit counselors are not available to fill this
important role. The social costs associated with financial distress
will increase: broken families and loss of employment productivity are
simply two examples of these social costs.
Without non-profit credit counseling, more Americans will turn to
the high-risk option of taking out home equity loans to pay off high
credit card debt. This practice is already a significant problem, and
is only going to grow because a large number of these loans are
adjustable-rate loans destined to increase as interest rates climb.
Thus, in addition to bankruptcies, revocation of credit counseling's
501(c)(3) status will increase the number of home foreclosures. Home
ownership is recognized as a powerful stabilizing force in the American
consumer economy, and any measure that increases home foreclosures is
perilous.
Finally, the costs of revocation detailed above will impact on all
aspects of the American economy. As financially distressed consumers
file for bankruptcy in increased numbers, the cost of credit will
increase for all consumers, including those who use credit responsibly.
As those costs increase, the consumer spending decisions of all
Americans will be impacted. While non-profit consumer counseling
assists the percentage of Americans who suffer ill consequences
associated with a ready stream of available consumer credit, all
Americans will suffer if increased costs turn that stream into a
trickle.
Recommendations
1. AADMO recommends that the Internal Revenue Service complete its
comprehensive review of the credit counseling industry, properly
sanction those who have abused the 501(c)(3) status conferred upon them
by the IRS and provide the industry with immediate and ongoing guidance
relative to the application of the tax code to the credit counseling
process.
2. AADMO encourages the IRS to treat credit counseling
organizations fairly when making recommendations to Congress vis-a-vis
the future look and feel of the credit counseling process. Legitimately
operating credit counseling organizations are well aware that there are
bad players in their midst. Unfortunately, these players have operated
freely for far too long; long enough to seriously eclipse long
established, well-intentioned and legitimate organizations through
their negative actions. The tax laws and the rules and regulations
necessary to properly supervise and control the non-profit segment of
our economy, including non-profit credit counseling organizations, are
already in place. All that is needed now is regular review, consistent
guidance and fair enforcement of existing federal and state codes by
the regulatory sector.
3. Enlightened legislative interaction is also needed. AADMO
recommends and supports the passage of a uniform, pre-emptive federal
statute to replace the myriad of conflicting state laws now in use to
regulate credit counseling and debt management service providers. We
respectfully suggest that model credit counseling and debt management
agencies should be involved in the legislative drafting process and
that credit counselors should be regulated through statutes developed
solely for the credit counseling and debt management process.
4. Credit counseling and debt management are unique services as
compared to debt collection and debt settlement. A single, pre-emptive
federal credit counseling statute will create an even playing field for
service providers and guarantee consumers equal access to quality
products and services regardless of their state of residence.
5. AADMO encourages the legislative and regulatory community to
allow time for recent increases in state and federal oversight
activities, media scrutiny and IRS actions to have their impact on the
credit counseling process. We recommend that those charged with
oversight responsibility study the impact of recent actions taken by
regulators against CCAs, determined to be abusing their 501(c)(3)
status, on the consumers enrolled in the DMP programs of said
providers. A cooling off period is needed to assess impacts of actions
already taken and to guarantee millions of American households that
they will not be thrust into deeper financial chaos as a result of
hastily enacted and ill-advised regulatory schemes.
Statement of David Hayes, Independent Community Bankers of America
The Independent Community Bankers of America represents the largest
constituency of community banks of all sizes and charter types in the
nation, and is dedicated exclusively to representing the interests of
the community banking industry. Founded in 1930, ICBA is celebrating
its 75th anniversary year. For more information, visit ICBA's website
at www.icba.org.
On behalf of the 5,000 members of the Independent Community Bankers
of America, I am pleased to submit written testimony for the Ways and
Means Committee hearing on the Overview of the Tax-Exempt Sector. The
ICBA commends you and the Committee members for undertaking this
important hearing and for examining the current state of the tax-exempt
sector.
Credit Union Tax Exemption Warrants Committee Examination
As part of the examination into the current status of tax-exempts,
the ICBA requests the Ways and Means Committee closely examine the tax
system inequities posed by the rapidly growing $655 billion tax-exempt
credit union industry. The origins of the credit union tax exemption
reach back to the Great Depression, a time when basic financial
services were limited. Over time, the tax-exempt credit
union industry has dramatically changed to support the same customer
base as taxpaying financial institutions.
Today there are more than one hundred credit unions with $1 billion
or more in assets providing sophisticated banking products and services
to wealthy and middle-income members while benefiting from tax-exempt
status. Another noteworthy aspect of today's tax-exempt credit union
industry is that corporate credit unions have been set up to provide
the same wholesale services as taxpaying correspondent banks. For
example, U.S. Central Credit Union in Lenexa, Kansas holds more than
$35 billion in assets and is owned by 72 member credit unions.
Research Indicates Tax Exempt Credit Unions Not Serving Special Purpose
A growing body of research from the Congressional Budget Office,
the General Accountability Office and the Tax Foundation indicate that
there is little or no evidence that today's tax-exempt credit unions
are better serving the moderate and low-income individuals their tax-
exempt status was intended to foster. Instead, tax-exempt credit unions
continue to push the envelope on expanding their commercial lending
business.
The credit unions recently sought and won regulatory approval to
increase their business lending through the Small Business
Administration (SBA). Notably, these SBA loans are not subject to the
legal 12.25 percent of assets business-lending cap Congress
specifically placed on the credit unions. Credit unions continue
aggressive measures to skirt the legal 12.25 percent business-lending
cap, notably the advancement of the ``Credit Union Regulatory
Improvement Act'' (H.R. 3579) in the 108th Congress. The bill would
raise the current statutory limit on business lending by tax-exempt
credit unions to 20 percent from 12.25 percent, double the size of
loans that would be excluded from the cap from $50,0000 to $100,000 and
exclude certain other business loans from any limit.
This Ways and Means Committee hearing on tax-exempts provides a
solid opportunity to examine such credit union activities and the
ongoing justification for the special tax treatment the credit union
industry enjoys.
Tax-Exempt Credit Unions Compete Directly With Taxpaying Community
Banks
Today, tax-exempt credit unions compete aggressively against
taxpaying community banks and continue to expand their financial
service power, size, and scope. The top federal income tax rate applied
to C corporation community bank income and S corporation community bank
income allocated to shareholders is 35%. Additionally, income generated
by C corporation community banks is subject to double taxation when
distributed in the form of dividends or capital gains, creating a
combined tax burden exceeding 57%.
In sharp contrast, tax-exempt credit unions pay no federal income
tax yet compete directly with taxpaying community banks. The dramatic
tax burden differential between taxpaying commercial banks and tax-
exempt credit unions places community banks at a severe competitive
disadvantage and highlights a specific example of where the tax code is
extremely unfair. A fair and unbiased tax system would apply the same
tax treatment to similar industries and economic actions and
transactions.
Tax Foundation Credit Union Study Shows $31 Billion Tax Loss
The ICBA would like to call to the Committee's attention the most
recent independent research conducted on the credit union industry.
Notably, a new Tax Foundation study concluded that credit unions have
used their tax-subsidized status to greatly expand in size and scope.
The nonpartisan Tax Foundation estimated that the rapidly growing
credit union tax subsidy will cost $31 billion in lost Federal revenue
to the U.S. Treasury over the next decade.\1\ This study noted how
large, multi-group and geographic-based credit unions have far exceeded
their original tax-exempt statutory mission and unfairly use their tax-
free status to compete with taxpaying community banks.
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\1\ ``Competitive Advantage: A Study of the Federal Tax Exemption
for Credit Unions,'' by Professor John A. Tatom, Ph.D. Tax Foundation,
2005. www.taxfoundation.org
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Other important finding of the independent Tax Foundation's
research into the tax-exempt credit union industry include:
Who benefits from the credit unions' tax exemption?
Corroborated by other studies of credit unions and banks, the
direct and indirect evidence gathered for this study shows that the
equity holders of credit unions receive the tax saving as unusual
returns. These unusual returns do not show up as relatively high
dividends, however. Instead, they occur as unusually large retained
earnings accumulated as net worth in their credit unions. The
shareholders' extra
income reinvested in the credit union provides new capital that allows
the credit union to grow faster than other institutions.
Of the 50 basis points in subsidy that the tax exemption provides,
at least 33 basis points accrue to owners in the form of larger equity
and larger assets. Approximately 6 basis points may accrue to credit
union borrowers through lower interest rates, and not more than 11
basis points are absorbed by higher labor costs. There is little or no
effect on deposit rates or other costs.
Today credit unions continue to grow faster than banks, have little
practical limitations on membership, and make business loans that
increasingly have no limits on who can borrow, how much or for what
purpose.
Little justification for credit union tax exemption.
Today the principal justification for the tax exemption would seem
to be that it already exists and, therefore, removing it could
adversely impact thousands of institutions and their customers. Under
current law, as it is being enforced, there is no good policy argument
based on equity or efficiency for maintaining the tax exemption. And
these institutions and customers are perceived, incorrectly, to be
relatively lower income or associated with the economic security and
progress of lower income people.
Tax exemption no longer linked to special mission or
meaningful restrictions.
Credit unions are among the most rapidly growing financial firms in
the country.
Congress eliminated the tax exemptions for savings and loans and
mutual savings banks decades ago on the grounds that they were similar
to profit-seeking corporations. Since then, large credit unions have
come to resemble large thrifts and banks. The looser field of
membership requirements also has allowed credit unions, especially
large ones, to expand their growth opportunities, reinforcing the
competitive advantage obtained from their tax advantages.
Tax reform and credit unions.
Fiscal neutrality would require removing the special tax treatment
of credit unions.
Taxing some financial institutions that offer the same consumer
deposits and loans while not taxing others, in particular credit
unions, distorts the allocation of resources. It promotes the
employment of deposit and credit resources in the tax-free credit union
sector at the expense of their competitors, banks, thrift institutions
and finance companies.
Tax reform of credit union income taxation is a ``no-brainer'' when
viewed in a broad tax neutrality context. It is also compelling when
either the size of the revenue loss or the ineffectiveness of the tax
break for achieving any social goal is considered.
This study could not find any net benefit to members that could not
or would not be available in the absence of tax-subsidized credit
unions. Most notably, the credit union subsidy, by its very nature, has
largely failed to deliver financial services to low-income people.
Credit unions are not compelled by regulators to meet a higher
standard in the service of low- and moderate-income customers, and
there is no evidence that they do so voluntarily. The $650 billion
credit union industry may have outgrown in size and scope its original,
tax-exempt mission.
Conclusion
These points from the Tax Foundation's study make a clear case that
the Ways and Means Committee re-assess the tax-exempt status of the
rapidly expanding credit union industry as part of the review of tax
exempts. Community banks play a vital role in the U.S. economy as a
critical source of lending for individuals, small businesses and farms
across America. The ICBA respectfully requests the Ways and Means
Committee further examine policies that would help make the tax code
more equitable as it is applied to tax-exempt credit unions and
taxpaying community banks. As the Ways and Means Committee examines the
tax-exempts, we urge a fresh policy evaluation of the estimated $31
billion in lost tax revenue from the tax-exempt credit union industry.
We sincerely appreciate the opportunity to offer our comments for
this important hearing and to highlight areas where the tax code is
unfair. The ICBA looks forward to working with the Committee and we are
encouraged by your ongoing efforts to fairly assess the standing of
tax-exempt entities such as the credit union industry.
Submission of the American Bankers Association
The American Bankers Association (ABA) appreciates the opportunity
to comment to the Ways and Means Committee on the tax-exempt sector.
Our comments focus on the evolution of traditional credit unions
serving ``people of small means'' to full service, financially
sophisticated institutions that compete head-to-head with tax-paying
banks.
ABA on behalf of the more than two million men and women who work
in the nation's banks, brings together all categories of banking
institutions to best represent the interests of this rapidly changing
industry. Its membership--which includes community, regional and money
center banks and holding companies, as well as savings associations,
trust companies and savings banks--makes ABA the largest banking trade
association in the country.
This statement addresses three central points:
I. A new breed of credit unions has emerged that offers products
and services virtually indistinguishable from tax--paying banks. These
``morphed'' credit unions are a far cry from traditional credit unions,
whose tax subsidy was intended to benefit individuals with limited
resources who might not otherwise have access to financial services.
II. Being a non-profit cooperative does not, alone, justify a tax
exemption. Fairness dictates equal tax and regulatory treatment for
similarly situated institutions.
III. Congress has repeatedly recognized that there are limits to
tax exemptions and has acted to eliminate them for entities that stray
from their intended public policy goals.
I. A New Breed Credit Unions Has Emerged
As Chairman Thomas recently stated, ``Tax-exemption is an important
benefit and the Congress has a responsibility to oversee and assure the
American taxpayer that the tax-exempt sector is living up to its legal
responsibilities.'' ABA supports this view and would like to recommend
that Congress examine certain credit unions' tax-advantaged status.
While many credit unions remain true to their original mission, today
growing a number of credit unions have abandoned their roots and
inappropriately taken advantage of their tax-exempt status to gain
ever-increasing market share.
Traditionally, credit unions were based on a simple concept: permit
a closely-knit group of people to pool their resources and to provide
small loans for one another. The focus was on individuals with limited
resources who might not otherwise have access to financial services.
Membership was limited to people with close bonds because familiarity
was critical to the ``character'' loans made by credit unions. The
commonality of interest among members--their common bond--was the
essence of credit unions. It gave them a special and unique place in
our financial system.
As the industry matured, however, a new breed of institution
evolved that bears little resemblance to a traditional credit union.
With the freedom to seek new markets almost without restriction and to
offer a full range of banking and financial products, many aggressive
credit unions have leveraged their tax advantage to grow rapidly.
Today, there are 99 credit unions with assets greater than $1 billion.
In nearly half the states in this country, a credit union would rank
among the top ten banks in terms of size. As Gene Portias, president of
the Credit Union Association of Oregon, stated: ``In a lot of places,
credit unions are the major financial institution.'' \1\
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\1\ ``CUs, Banks Put Up Dueling Bills in Oregon,'' American Banker,
March 25, 2003.
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These complex, aggressive institutions increasingly dominate the
industry, yet still try to hide behind the veil of a ``traditional''
credit union. In spite of their metamorphosis into highly competitive
financial institutions virtually indistinguishable from banks, these
morphed credit unions enjoy the tax-preferred status conferred on the
industry when it was comprised of small self-help organizations.
Continuing the special tax treatment for institutions that look and
act like tax-paying banks has public policy consequences. The size of
the ``tax expenditure'' as the Office of Management and Budget calls
it, is already big--more than a billion dollars per year. And basic
economics tells us that it will get bigger as tax-favored
firms take business away from taxpaying firms. Simply put, as these
morphed credit unions get larger, so does the tax expenditure.\2\
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\2\ Tax expenditures are defined in the law as ``revenue losses
attributable to provisions of the federal tax laws which allow a
special exclusion, exemption, or deduction from gross income or which
provide a special credit, a preferential rate of tax, or a deferral of
liability.''
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Not only is the credit union tax expenditure growing, but it is
being misdirected to subsidizing financial services for individuals who
clearly don't need it. The credit unions' own surveys suggest that
their image of serving moderate--and lower-income people is no longer
valid. The typical credit union member has higher than average income,
more years of education, and is more likely to own a home than non-
credit union members. And now with an aggressive push by credit unions
into business lending, businesses can get taxpayer-supported financial
services.
New Breed of Credit Unions Serving Wealthy, Not ``People of Small
Means''
The rapid growth of the credit union industry has been accompanied
by significant changes in membership demographics. The focus on
``people of small means'' was clearly enunciated in the preamble to the
Federal Credit Union Act. This vision has gradually diminished as the
metamorphosis to big, wealthy and sophisticated credit unions has
progressed.
Think Federal Credit Union exemplifies how that focus has changed
in its 2003 Annual Report when it stated: ``Yesterday our challenge was
to provide financial services to members who could not get services
elsewhere. Today our challenge is to provide financial services to
members who can get services anywhere.''
The profile of the average credit union member today--higher than
average income, better educated, and more likely to be in a
professional occupation than his or her non-member counterpart--is not
one typically associated with people needing taxpayer-supported
financial services. According to a recent demographic survey conducted
by the Credit Union National Association (CUNA), the average household
income of credit union members is 20 percent higher than nonmembers--
$55,120 versus $45,790.\3\
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\3\ CUNA National Member Survey, 2002.
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A recent study by the GAO came to the same conclusion. Their
analysis showed that 64 percent of households that primarily use a
credit union are middle and upper income, as compared to 58 percent of
households that primarily use banks. The fact is that bank customers
are more likely to be from low- and moderate-income households than are
credit union customers--yet credit unions continue to enjoy the tax
expenditure purportedly because they serve people of modest means. As
Bruce Shawkey of Credit Union Management magazine stated, ``--[C]redit
unions' `bread and butter' members are middle-aged white males with
mid-to-upper-incomes.''
Even some credit union executives seem disturbed by the fact that
credit unions have strayed so far from their original mandate to serve
people of small means. Citing CUNA's numbers on the average household
income of members served by credit unions, Armando Cavazos, president
of Credit Union One in Ferndale, Michigan, said, ``We should almost
feel guilty about serving people of affluence.'' \4\
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\4\ ``How to Head Off Coming Under CRA Dominates Debate at CUNA
Convention,'' American Banker, October 14, 1994, p. 9.
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Jim Blaine, CEO of State Employees CU in Raleigh, NC, conceded
``Maybe we've gotten so sophisticated we don't want to get our hands
dirty with poor folks any more. That's what we were created to do, and
sometimes I think we're forgetting that.'' \5\
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\5\ ``Are Credit Unions Dodging Their Responsibilities? One CEO
Thinks So.'' Credit Union Journal, December 2, 2002, p. 11.
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And, Ed Gallagly, president/CEO of Central Florida Credit Union,
says, ``There's no question that subconsciously--and even consciously--
some credit unions are trying to run-off unprofitable members. I hate
to use that term run-off but that's what's happening.'' \6\
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\6\ ``Are Members Really Leaving Credit Unions? CEOs Offer Their
Take,'' Credit Union Times, April 14, 2004, p. 42.
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Communities are not being served, either. Credit unions, unlike
banks, are not required to meet the obligations set forth in the
Community Reinvestment Act (CRA). In a study of Virginia credit unions,
professors Murphy and O'Toole found that ``banks and savings
institutions in Virginia are putting a greater percentage (88 percent)
of their deposits back into the community in the form of loans than are
credit unions (76.3 percent). In other words, tax treatment of credit
unions has not resulted in a higher proportion of loans going to better
meet the credit needs of the communities they serve.'' \7\
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\7\ A Study of the Evolution and Growth of Credit Unions in
Virginia: 1997-2002, by Neil Murphy and Dennis O'Toole, November 2003.
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Is the tax benefit being passed on fully to credit union members?
In more and more cases, the answer is no. In some case, it is going to
build elaborate corporate headquarters like Golden 1 Credit Union's new
200,000 square foot headquarters in Rosemont, California, costing more
than $30 million and GTE Federal Credit Union's new 125,000 square-foot
headquarters located on a 12.5 acre campus in Tampa, at a cost of about
$22 million.
And Digital Credit Union in Massachusetts paid $5.2 million for the
naming rights for an arena in Worcester (MA) in 2004. Is this an
appropriate use of the credit union tax exemption?
Business Lending--Extending Tax-Subsidized Services to Commercial
Entities
In addition to serving a wealthier customer base, the new breed of
credit unions is looking for profitable opportunities in commercial
lending, thus further extending the tax exemption beyond its original
purpose. Business lending by credit unions grew by almost 50 percent in
2004. More than 420 credit unions have at least 5 percent of their
total loans in business loans and almost 240 have at least 10 percent
of their loan portfolio in business loans. Nearly 200 credit unions are
designated guaranteed lenders by the Small Business Administration
(SBA), and approximately 300 credit unions have either purchased or
participated in business loans made to non-members.
``Successfully banking the small-business owner is one of the keys
to increased credit union profitability,'' the Credit Union Executive
Society noted. And many credit unions are following this course to
boost profits. Jean Faenza, EVP for Telesis Community CU, describing
her credit union's pursuit of business owners, stated: ``Remember,
every business owner is a consumer who has other accounts--small
business are employers. We're greedy--we want all of those accounts.''
\8\
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\8\ ``Show of Hands Indicates CU Interest in Biz Lending,'' Credit
Union Journal, September 15, 2003, p 11.
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Lending by credit unions is big business. For example:
Less than one year after commencing operations, CU
Business Group, LLC said it had processed more than $50 million in
business loans--with the average-sized loan worth more than $600,000.
Larry Middleman, CU Business Group's President/CEO, noted that the
``[l]oan packages are much larger than we anticipated.'' \9\
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\9\ Credit Union Journal, September 1, 2003.
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The average business loan outstanding at Florida's Vystar
Credit Union is $487,000; at California's Telesis Community Credit
Union, it is $769,000.
Coastal Federal Credit Union with $1.4 billion in assets
has ventured into complex commercial real estate transactions where the
average size loan exceeds $4 million.\10\
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\10\ Credit Union Times, March 30, 2005, p. 23.
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Texans CU's credit union service organization, Texans
Commercial Capital, LLC, has approximately $214 million in business
loans on its book and funded Prism Hotel's acquisition and construction
financing of the 280-room Radisson Memphis Hotel in Tennessee.\11\
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\11\ ``Texans CU's Business CUSO Taking Off; LoansRange from Multi-
Million to Just Thousands,'' Credit Union Times, February 2, 2005, pp.
1, 36.
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OmniAmerican CU has established a $10.5 million line of
credit and $2 million for working capital to Wide Open Spaces LLC for a
real estate development project.
These are loans for which any bank would compete.
Subsidizing a ``Super Competitor''
Competition in financial services occurs on the local level. The
fact that the banking industry as a whole is much larger than the
credit union industry has no bearing on head-to-head competition in the
local market. The credit union tax exemption adversely affects tax-
paying banks. It gives credit unions a significant price advantage over
tax-paying banks that offer the same products and services and enables
credit unions to grow much more rapidly.
The fact is that in more and more communities, it is the credit
union that is many times larger than the local banks. For example,
In North Carolina, State Employees Credit Union (SECU),
which has assets of over $12.1 billion and 176 branch locations,
competes directly with almost one hundred community banks, but is 44
times larger than the average-sized community bank.
The Credit Union of Texas, with $1.5 billion in assets,
is almost seven times larger than the 17 community banks it competes
with in its market.
Visions FCU with $1.6 billion in assets boasts that it
was the largest mortgage lender in Broome County (NY) for 2003.
Some aggressive credit unions are now so large that they dominate
the deposit market in their areas, competing head-to-head with large
and small banks alike. For example:
With $2.9 billion in assets, Vystar Credit Union in
Northeast Florida dominates its market area with more deposits than
First Alliance, Wachovia and Bank of America combined.
With $5.3 billion in assets, Boeing Employees' Credit
Union in WashingtonState dominates its market area with more deposits
than Washington Mutual and Bank of America combined.
With $1.8 billion in assets, ENT Federal Credit Union in
Colorado dominates its market area with more deposits than Wells Fargo
and World Savings Bank combined.
It is obvious that the tax subsidy provides credit unions a very
large pricing advantage. For example, professors Murphy and O'Toole
found that ``--credit unions are enabled to offer a 67 basis point
advantage in loan pricing and deposit pricing over banks as a direct
result of the fact that credit unions do not pay state or federal
taxes. In a highly competitive industry, the 67 basis point government
subsidy is substantial.'' \12\
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\12\ A Study of the Evolution and Growth of Credit Unions in
Virginia: 1997-2002, by Neil Murphy and Dennis O'Toole, November 2003.
---------------------------------------------------------------------------
And the competition is not just banks versus credit unions, but it
is these morphed credit unions pitted against traditional credit
unions. Lorraine Ratoni, CEO of Sacramento County Grange Credit Union
noted: ``We're losing members to larger credit unions. We're having a
harder and harder time competing.'' \13\
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\13\ ``Friendly Foes: Once Allies, Credit Unions Now Compete for
Customers,'' by Barbara Marquand, Sacramento Business Journal, May 24,
1999.
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Laura Bruce, writing for Bankrate.com, states
``To say credit unions don't compete with one another or with
banks just doesn't ring true anymore. There's competition. Some of it's
for sheer survival; some of it's for market share. Not all credit
unions have jumped into the fray. Some employment or organization-based
credit unions may have a very successful niche and be able to stay
small and survive, maybe even thrive--but they're part of a shrinking
minority.'' \14\
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\14\ ``The Changing Face of Credit Unions'' By Laura Bruce,
Bankrate.com, December 19, 2003
Should traditional credit unions be allowed to be squeezed out by
larger, aggressive credit unions?
Policies Fuel Credit Union Consolidation and Unlimited Growth
Through pro forma approvals of multiple common bonds, rapid
approvals of community charters beyond any reasonable definition of
``local,'' and liberal interpretations facilitating expansion of
business lending and other service offerings, NCUA has fueled the
evolution towards larger, more complex credit unions. Today, a single
credit union can serve thousands of unrelated groups, or huge
geographic areas with millions of people.
Mergers and acquisitions have also played an important role in the
expansion of many large credit unions. The result is fewer, but larger,
credit unions. Over the last 4 years, nearly 1,100 small credit unions
have disappeared.\15\
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\15\ http://www.ncua.gov/news/speeches/2005/matz/463,20,Slide 20.
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Community charters are the fastest growing segment of the credit
union industry. Federal law permits a credit union to serve anyone in a
``well-defined, local community, neighborhood or rural district.'' \16\
In fact, the number of federal credit unions with community charters
has more than doubled from 464 in 1999 to 1,051 as of year-end 2004.
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\16\ Public Law No.: 105-219.
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The use of the term ``community'' has reached absurd proportions.
NCUA and various state regulators have approved community expansions
that include some of the largest cities in the country, entire
Metropolitan Statistical Areas (MSAs), multiple counties across state
lines and even entire states as part of a credit union's field of
membership. The result, according to GAO, is that the average size of a
community charter approved by NCUA jumped almost three-fold from a
population of 134,000 people in 1999 to 357,000 in 2003.\17\ And this
growth occurred in spite of NCUA's acknowledgment that when Congress,
in 1998 legislation, added the requirement that community credit unions
be ``local,'' it intended to limit the size of such credit unions.
---------------------------------------------------------------------------
\17\ Credit Unions: Financial Condition Has Improved, but
Opportunities Exist to Enhance Oversightand Share Insurance Management.
General Accounting Office, October 2003 (GAO-04-91), p 35
---------------------------------------------------------------------------
As Scott Waite, Senior Vice President and Chief Financial Officer
of the $3 billion-plus Patelco Credit Union, said on the credit union's
expansive community charter in Northern California: ``[I]f you walk
past our front door, you can join.'' \18\
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\18\ Bankrate.com
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A few of the many other examples that illustrate just how far the
definition of ``local community'' has gone include:
NCUA approved a community charter application for LA
Financial CU to serve the 10 million plus residents of Los Angeles
County--larger than the population in 42 states and a geographic area
equivalent in size to the states of Rhodes Island and Delaware
combined.
Wescom Credit Union's field of membership includes the 16
million people living in Los Angeles, Ventura, Orange, Riverside, and
San Bernardino Counties.
In 1999 and 2000, Meriwest Credit Union added the three
million residents of Alameda and Santa Clara Counties and expanded its
reach into Contra Costa and San Mateo Counties with a combined
population of 1.7 million, and into the City and County of San
Francisco--representing another 750,000 people.
Boeing Employees CU in Washington State amended its field
of membership to include the whole state of Washington.
To evade field of membership limitations, credit unions have been
forming charitable foundations. Anyone who makes a donation to the
foundation is eligible to join the credit union. For example, $1.9
billion GTE FCU advertises on its website: ``You can join GTE FCU even
if you are not eligible for membership through your employer or a
family member. GTE FCU sponsors a non-profit educational financial
club, CUSavers.''
And some credit unions do not even go through the pretense of
having a common bond. As Greenwood CU in RhodesIsland states,
``membership . . . is open to all responsible people who want to be a
member.''
II. Being a Not-for-Profit Cooperative Does Not Justify the Tax
Exemption
As morphed credit unions stretch their fields of membership across
ever-larger geographic areas and venture into new business activities,
an important justification for their tax exemption has disappeared.
With the focus on people of small means displaced by marketing efforts
to affluent individuals, another justification for the tax subsidy no
longer applies.
Since morphed credit unions no longer embody the traditional
characteristics that justify continuing their tax exemption, they have
been forced to offer a new justification. According to Dick Ensweiler,
Chairman of the Credit Union National Association, ``Credit unions have
the tax status that they do because they are not-for-profit,
cooperatively owned, democratically governed, and generally led by
volunteers from among the membership.'' \19\
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\19\ American Banker, April 2, 2004.
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But being a not-for-profit cooperative does not justify being tax
exempt.
In fact, most financial institutions that had traditionally been
described as ``cooperative, member-owned and not-for-profit'' are now
subject to federal taxation. Those institutions include mutual
insurance companies, mutual savings banks, and mutual savings and loan
associations. Each of these financial institutions lost their tax
exemption years ago--mutual insurance companies in 1942, and mutual
savings banks and mutual S&Ls in 1951. Why?
In the 1951 decision, Congress determined that:
These cooperative and mutual institutions were in
``active competition'' with taxable institutions and continuing their
tax exemption would be ``discriminatory;'' and,
They had evolved into institutions whose ``investing
members are becoming simply depositors, while borrowing members find
dealing with a savings and loan association only technically different
from dealing with other mortgage lending institutions in which the
lending group is distinct from the borrowing group.'' \20\
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\20\ 56 Stat. 798.
Thus, Congress determined that mutuality alone was not sufficient
to continue the tax exemption for these institutions. This conclusion
is particularly telling because of the similarities between mutual
savings institutions and credit unions, as noted by the U.S. Treasury
Department: ``Mutual thrifts are the federally insured depository
institutions most similar in structure to credit unions, because like
credit unions, mutual thrifts generally do not have corporate stock,
are not-for-profit entities, and are owned by their depositors, or
members, rather than by shareholders.'' \21\
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\21\ Comparing Credit Unions with Other Depository Institutions,
United States Department of the Treasury, January 2001, p.25.
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The tax preference originally provided to credit unions was a way
to subsidize financial services for individuals with low and moderate
income. Many traditional credit unions still dedicate themselves to
this purpose. But the metamorphosis to wealthy and sophisticated credit
unions shows how quickly this goal can be abandoned.
If the tax exemption is no longer conditioned upon the policy goal
of serving low- and moderate-income individuals, can the special tax
treatment for morphed credit unions be justified?
III. Congress Has Acted to Limit Tax Exemption
Financial entities that have retained their tax-exempt status are
generally subject to limitations that restrict either their size or the
breadth of their membership. Moreover, their tax-exempt status remains
based on narrowly crafted congressional directives relating to the
service of niche markets or to achieving limited policy goals. With the
erosion of both the common bond and the easing of limits on credit
union products and services, credit unions' are free to stray from
their original mission.
The question of where the line should be drawn to control the
taxpayer expenditure needs to be answered. Every expansion of a morphed
credit union expands the tax expenditure. OMB estimates that the credit
union ``tax expenditure'' will exceed $7.5 billion over the next five
years.\22\ And most of the tax subsidy goes to the most aggressive
credit unions--those that are least likely to embrace traditional
credit union principles. In fact, the largest 100 credit unions absorb
40 percent of the tax expenditure--quite a contrast with the 29 percent
of just 6 years ago.
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\22\ OMB, February 2005, for the fiscal years 2006 through 2010.
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This is a substantial subsidy and, with no restraints, it will grow
rapidly. Basic economics tells us what happens when a tax-exempt firm
and a taxpaying firm offer the same products: the tax-exempt firm grows
at the expense of the taxpaying firm. As business flows to the tax-
exempt firms and away from taxpaying institutions, the size of the tax
expenditure will grow.
As mutual insurance companies and mutual savings banks became
similar to, in the words of the Congressional Budget Office, ``profit-
seeking corporations'', Congress eliminated their tax exemption.\23\
The public deserves a thorough review to assure that the tax
expenditures are being appropriately spent and not disadvantaging
competing businesses that carry out the same activities on which they
pay taxes.
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\23\ Budget Options, CBO, March 2003, p. 218.
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Credit unions that have adhered to the traditional principles
should continue to benefit from the tax preferences. Morphed credit
unions that no longer serve a tight-knit group of people, that do not
focus on people of limited resources, and that actively compete with
tax-paying entities, however, should assume the same responsibilities
to the public that other financial institutions do.
Congress needs to ask: ``At what point do these diversified credit
unions cease to be the type of institutions the Congress envisioned to
be worthy of a tax exemption?''
Conclusion
Complex, aggressive credit unions, which have evolved into full-
service financial institutions serving the general public, are a far
cry from the small, traditional credit unions that served distinct
groups of ``people of small means'' that Congress sought to assist when
it provided tax subsidies to credit unions in the 1930's.
Many credit unions continue to serve an important purpose in our
financial system. They have maintained a limited common bond of
membership and have focused on providing services to moderate and lower
income individuals as laid out in the preamble to the Federal Credit
Union Act. For many other credit unions, however, this focus has been
abandoned, and expansionist policies have enabled the conglomeration of
hundreds of unrelated groups within a single credit union. The focus
has vanished for many credit unions adopting so-called community
charters. These morphed credit unions are indistinguishable from tax-
paying banking institutions.
The growing size of the tax expenditure, the increasing evidence
that credit unions are serving the affluent, and the competitive
implications for taxpaying institutions raise the question of whether
continuing the special tax treatment for all credit unions can be
justified. There may be reasons to preserve special tax and regulatory
treatment for the many credit unions that have remained true to the
spirit of the original credit union charter. But, for many other
morphed credit unions with community charters or hundreds of unrelated
groups, which offer products and services identical to banks, the
question must be asked: Are their special tax and regulatory treatments
still appropriate?
Statement of John H. Graham IV, American Society of Association
Executives
Testimony is submitted on behalf of the American Society of
Association Executives (``ASAE''), 1575 I Street, NW, Washington,
DC20005. The core purpose of ASAE is to advance the value of voluntary
associations to society and to support the professionalism of the
individuals who lead them. ASAE's more than 22,000 members manage more
than 12,000 trade associations, individual membership societies and
philanthropic organizations in the U.S. and in 50 countries around the
world. The number of people who belong to associations represented by
ASAE totals more than 200 million.
BACKGROUND:
According to the Internal Revenue Service (IRS), there are more
than 1.8 million tax-exempt organizations in the U.S. Trade and
professional associations, business leagues, and chambers of commerce
comprise a relatively small percentage of that overall population.
Slightly more than 86,000 501(c)(6) organizations are listed on the IRS
exempt organization master file for fiscal year 2004. To meet the
requirements of Section 501(c)(6), an organization must possess the
following characteristics:
a) It must be an association of persons having some common
business interest and its purpose must be to promote this common
business interest;
b) It must be a membership organization;
c) It must not be organized for profit;
d) No part of its net earnings may inure to the benefit of any
private shareholder or individual.
While the number of 501(c)(6) organizations has grown in recent
years--from 82,706 in fiscal year 2001 to just over 86,000 in fiscal
year 2004--that growth has been moderate in comparison with charities
and foundations organized under Section 501(c)(3) of the tax code.
Because of the services and benefits derived from associations,
Congress has determined they should benefit from tax exemption. The
first integrated federal income tax statute, enacted in 1913, provided
exemptions for business leagues, as associations were known at that
time. The 1913 Act also provided exemptions for charitable, scientific,
or educational organizations.
As tax-exempt entities, associations are barred from accumulating
equity appreciation for private benefit. Instead, these organizations
undertake programs or initiatives to benefit members and the public
rather than private individuals. Their earnings, therefore, must be
dedicated to furthering the purpose for which they were organized.
Congress first gave associations favored tax treatment largely in
recognition of the benefit the public derives from their activities.
The legislative history also indicates that the exemption was based
upon the theory that the government is compensated for any loss of tax
revenue by its relief from the financial burden that would otherwise
have to be met through appropriating public funds. In simple terms,
associations earn their exempt status by meeting many of the needs of
their members and the general public that the government would
otherwise have to meet.
In the case of trade associations and professional societies,
advocacy activities to assist public decision-making constitute a part
of many association agendas. Associations promote and encourage civic
activism and involvement, providing their members with the tools they
need to speak effectively on the issues they believe in. Associations
make significant contributions to the democratic process by serving as
a bridge between elected officials and voters.
However, associations are engaged in much more than ``special
interest'' advocacy. In fact, trade associations spend three times more
on professional development and public information campaigns than on
direct lobbying.
Ninety-five percent of associations offer educational programs to
their members, making associations the primary professional development
resource for America's workforce post-college. This responsibility is
significant and staggering.
Associations are the originating source for codes of ethics and
professional and safety standards that govern a host of professions and
disciplines in this country. As an example, dentists hold positions of
trust in our society because organizations like the American Dental
Association (``ADA'') hold their members to principles of ethics and
codes of professional conduct that reflect a commitment to high
standards of care. Quality education and academic freedom in this
country is assisted by organizations like the American Association of
University Professors (``AAUP'') that define fundamental professional
values and standards for instructors of higher education, and whose
procedures on academic due process remain the model for professional
employment practices on campuses across the nation.
Businesses and the government depend heavily on associations for
their research and statistical information, which is often not
available elsewhere. As an example, when lawmakers were looking to keep
our markets moving and investors trading after the tragedy of Sept. 11,
2001, they consulted the Security Traders Association (``STA'') about
the possibility of reducing fees investors pay to the Securities and
Exchange Commission (``SEC'').
Associations also promote volunteerism, logging nearly 200 million
volunteer hours in community service per year, according to the most
recent survey completed by ASAE.
The impact of association activities on segments of the economy is
equally significant. Association-sponsored meetings and conventions now
account for more than 26 million overnight stays in hotels each year.
Associations drive the $102 billion U.S. meetings industry. Ninety-two
percent of associations hold meetings accounting for 67 percent of the
total meetings business, according to a study by the Convention
Industry Council (``CIC'').
STATUTORY REQUIREMENTS & EXISTING OVERSIGHT:
Trade and professional associations qualify for exempt status only
if they meet strict statutory requirements that they be organized and
operated in furtherance of their primary exempt purpose. Entities must
submit an application to the IRS to obtain tax-exempt status and
provide supporting evidence including Articles of Incorporation,
Articles of Association, or other organizing documents; financial data;
and a full description of the purposes and activities of the
organization. The IRS can approve or deny the application. In fiscal
year 2004, the IRS received 86,964 applications for Section 501(c)
exempt status. The IRS approved 69,302 applications, and denied 1,049.
The remaining 16,715 applications were not approved for various
reasons, mostly because they were withdrawn by the organization or they
were incomplete. Of the 86,964 applications in FY 2004, 1,813 were
filed for Section 501(c)(6) trade association status; 1,489 were
approved.
Upon receiving tax-exempt status, associations must annually file a
Form 990 to disclose their financial transactions and activities for
the year if annual gross receipts are more than $25,000. Those that
have less than $100,000 in gross receipts and year-end assets of less
than $250,000 may file Form 990-EZ. In addition to entities with less
than $25,000 in receipts, certain types of exempt organizations such as
churches and religious organizations are not required to file. All tax-
exempt organizations that file must make their last three Form 990s
widely available for public inspection as well, either in person or
through posting on a Web site.
Since 1950, associations have also paid unrelated business income
tax (``UBIT'') on net income earned from any activity unrelated to the
organizations' exempt purpose. Passive income such as dividends,
interest, and income from certain research activities are not treated
as unrelated business income. The courts and the IRS have developed
standards over the years for determining when an activity will be
treated as a trade or business regularly carried on by an exempt
organization.
In addition to the statutory requirements to receive and maintain
exempt status, the IRS maintains oversight of the exempt community
through the Tax-Exempt and Governmental Entities (``TE/GE'') Division.
As mentioned earlier, the number of exempt applications filed with the
IRS Exempt Organization (``EO'') Division has steadily increased each
of the last five years. Despite this growth, EO staffing levels have
not kept pace in previous years and were insufficient to maintain
adequate oversight of the exempt sector, according to IRS Commissioner
Mark Everson. Everson said in a statement April 5, 2005, that the
agency's enforcement presence ``faded'' in the late 1990s. The U.S.
Government Accountability Office (``GAO'') submitted a report to this
committee at its April 20, 2005 hearing stating, in part, that staffing
levels for the TE/GE Division at the IRS have been essentially flat
since 1974: 2,075 agents in 1974 versus 2,122 in 2004. The 2004 IRS
Data Book states that 863,494 returns were processed from tax-exempt
organizations in calendar year 2003, and the number of returns examined
by the IRS in fiscal year 2004 was 5,800. More recently, the IRS
followed through on its commitment to hire more than 70 additional
Exempt Organization Division examination agents in fiscal year 2005 and
improve its current training for agents and examiners.
The EO Division also continues to consider modifications to the
Form 990 filed by tax-exempt groups. The goal appears to be to improve
the scope and quality of the Form 990 and ensure more accurate and
complete reporting from exempt organizations.
The IRS is also moving forward with implementing new regulations
requiring certain large corporations and tax-exempt organizations to
electronically file their income tax or annual information returns
beginning in 2006. For tax year 2005 returns that are due in 2006, the
regulations require that corporations with total assets of $50 million
or more file their Forms 1120 and 1120S electronically. In addition,
tax-exempt organizations with total assets of $100 million or more will
be required to file their tax year 2005 Form 990 electronically.
Beginning in 2007, the electronic filing requirement will be expanded
to include the tax year 2006 tax returns of corporations and tax-exempt
organizations with $10 million or more in total assets. In addition,
private foundations and charitable trusts will be required to
electronically file their Form 990-PF electronically, regardless of
their asset size.
NONPROFIT GOVERNANCE:
The tax-exempt community has been proactive and largely self-
regulating in considering issues related to governance in recent years.
More than a year ago, ASAE and its members gathered for a first-
ever National Consensus Conference on Nonprofit Governance in New York,
Jan. 12-13, 2004. The discussion among the roughly 150 nonprofit
executives in attendance focused on how, and to what extent, nonprofit
organizations can voluntarily strengthen their governance principles
and practices. The conference proved to be a good starting point for
developing and disseminating guidelines for nonprofit governance. Among
the principles considered were: the role of the nonprofit
organization's governing board in setting policy and providing
oversight; the independence of the governing board from management; the
presence, composition and role of an audit committee, or at least a
committee fulfilling the audit committee function; codes of
organizational conduct for nonprofit governance; chief executive
compensation review; accurate and complete financial disclosures;
policies and procedures for investigating complaints; and policies and
procedures for document destruction.
In considering the applicability of corporate governance provisions
to nonprofits, however, it is important to note the diverse nature of
the tax-exempt community, and recognize there is no ``one size fits
all'' blueprint for governance standards. As pointed out earlier in
this document, the nonprofit community is diverse, ranging from
fraternal societies and small social clubs, to charities and scientific
societies to trade associations and chambers of commerce. The size and
resources of various nonprofit organizations impact the necessity for,
as well as their ability to implement, certain governance practices.
Despite their complexity, tax-exempt organizations are not
precluded, nor should they be excused, from responsible governance. The
development of ``best practices'' for nonprofit governance requires
realistic cost-benefit analysis, and careful attention that the
essential work of these exempt organizations, and the value they bring
to society, continues unabated by unnecessary and burdensome compliance
measures.
Organizations representing the interests of the 501(c)(3)
charitable community, such as Independent Sector, have also been
working to enhance compliance and accountability in the nonprofit
sector.
The Panel on the Nonprofit Sector, comprised of leaders of
nonprofit organizations and convened by Independent Sector, released an
interim report March 1, 2005, that lists recommendations in 15 major
areas, including actions to be taken by the nonprofit sector itself, by
the IRS, and by Congress. The panel encourages the nation's 1.3 million
charities and foundations to adopt and implement a conflict of interest
policy; ensure its board includes individuals with financial literacy
skills; and develop specific practices and procedures to encourage and
protect whistleblowers.
The panel also is supporting stronger disclosure rules, such as:
suspension of exempt status of any organization that fails to file
required Form 990 returns with the IRS for two or more consecutive
years; a requirement that chief executive officers certify that their
Form 990 returns are correct and complete; mandatory electronic filing
of Form 990 to improve the accuracy and timeliness of information; and
a requirement that charitable organizations conduct an independent
audit of their finances if they have annual revenues of $2 million or
more.
CONCLUSION:
ASAE appreciates the committee's consideration of the legal history
of the tax-exempt sector, as well as its size, scope and impact on
society, and agrees that tax exemption is an important benefit, and
that Congress has a responsibility to oversee and assure that the tax-
exempt sector is accountable and deserving of public trust.
ASAE believes that disclosure and transparency benefit both
nonprofit organizations and the communities they serve. By their very
nature, tax-exempt nonprofit organizations are organized for a ``higher
purpose,'' often to provide a valuable role or function that might
otherwise fall to the government, as earlier stated. The performance
and long-term survival of these organizations is highly dependent on a
measure of public confidence. While not untouched by isolated instances
of fiscal mismanagement or ethical abuse, the vast majority of
nonprofit organizations have embraced their responsibility to institute
governing practices that ensure public trust.
Countless association activities today not only further the exempt
purpose of the organization, but also contribute to improving the
general welfare of communities across the country. ASAE urges the
Committee, in its continued examination of the tax-exempt sector, to
consider the important, growing role associations play in American
society, and how changes to current statutory requirements might impact
an enormous number of programs and services now offered by
associations.
Association of the Fundraising Professionals
Cleveland, OH
April 26, 2005
The Honorable Bill Thomas
U.S. House of Representatives
2208 Rayburn House Office Building
Washington, DC20515
Dear Congressman Thomas:
I am writing to urge you to protect the charitable sector from
unnecessary and overly burdensome regulations such as those presented
by the Senate Finance Committee, particularly those proposals that
would modify the tax rules regarding non-cash charitable contributions
(known as ``in-kind'' contributions).
The new proposals include recommendations to completely eliminate
or substantially modify deductions for in-kind contributions. Many
charities heavily rely upon non-cash donations, and there is no
legitimate reason to attack this lifeline. I work for Cleveland State
University as a Major Gifts Officer. I have helped the Fenn College of
Engineering secure equipment gifts to upgrade laboratories and software
gifts valued at $1,000,000 (discounted educational value). In-kind
gifts have enabled Cleveland State to offer some of the latest
technological advances to our engineering students, especially during a
time when the state of Ohio continues to cut funding for higher
education and funds are not available for lab equipment and software
upgrades!
Changing the in-kind contribution rules would unfairly compel
charities to divert valuable time and resources to new valuation
compliance schemes. The inability of the Internal Revenue Service to
address improper donor behavior should not result in penalties for
charities and the communities and populations that they serve.
Significant revision of the in-kind contribution rules would greatly
diminish my organization's ability to provide altruistic services.
Furthermore, these proposals are not based on any credible evidence
of wide-spread abuse. In fact, empirical data indicates that there is
NOT widespread abuse among the charitable sector and that proposals are
unnecessary. Reports collected by the FBI, the Federal Trade
Commission, State Attorneys General and even watchdog groups like the
Better Business Bureau show that reports of charity fraud are less than
1 percent of all complaints of fraud. This is consistent with every
single year's annual findings in the annual report on Fraud in the
United States published by the FTC.
It appears that many of the suggestions are driven by a desire to
raise federal revenues from the charitable sector. Such an effort is
completely inconsistent with the notion of tax-exempt status, and I
hope you will strongly oppose such proposals.
The Senate Finance Committee's proposals to alter the non-cash
charitable gift incentives come at a precarious time for charities.
Americans are a generous people, but many charities are still
recovering from the past several years when charitable giving has been
flat and even decreased for many organizations.
At the same time, we understand that your committee seeks to gather
information on the size, scope, and impact on the economy of the
nonprofit sector; the need for congressional oversight; IRS oversight
of the sector; and what the IRS is doing to improve compliance by the
sector with the law. These are laudable objectives. We are interested
in assisting the committee in identifying appropriate areas for further
study as well as criteria and standards to better define and outline
the sector and its players.
Again, I urge you to oppose changes to the in-kind contribution
rules as well as any unreasonable and burdensome legislation that would
harm the charitable sector. I very much appreciate your support.
Thank you for your consideration.
Sincerely,
Deborah S. Miller
President, Association of Fundraising Professionals
Greater Cleveland Chapter
Statement of David C. Jones, Association of Independent Consumer Credit
Counseling Agencies
Mr. Chairman and members of the Committee, the Association of
Independent Consumer Credit Counseling Agencies (AICCCA) welcomes this
opportunity to submit comments for the Committee's consideration on the
important topic of the proper policy and enforcement mix for the tax-
exempt sector. While credit counseling agencies are members of that
broad sector they do have a unique role, responsibilities, and
regulatory structure. This makes it important that Congress
differentiate between them and other tax-exempt entities and adopt
appropriate policies going forward. A ``one size fits all'' approach to
tax-exempt organizations is not the right policy prescription.
Ongoing Federal and State Oversight and Regulation
We were privileged to have our testimony heard at the November 20,
2003 hearing held by your Subcommittee on Oversight regarding Non-
Profit Credit Counseling Organizations. At that hearing, we described
the difficult challenges and regulatory issues that our industry faced.
We also expressed strong support for the consumer protections that the
credit counseling industry must implement and enforce to protect some
of our most vulnerable citizens: Individuals and families that have
become burdened by unmanageable levels of debt. AICCCA continues to
strongly support these consumer protections; we continually demonstrate
our commitment by undertaking strong self-regulation for our
Association members.
The consumer credit counseling sector continues to receive intense
government scrutiny due to the practices of a few rogue agencies. On
April 13, 2005, the Senate Permanent Subcommittee on Investigations
(PSI) issued a bipartisan Subcommittee report on abusive practices
committed by certain ``bad actor'' credit counseling agencies. This
report incorporated information from a PSI hearing held in March 2004
and associated staff investigations; AICCCA applauded that
investigation and provided written testimony in support of that
hearing. The PSI's report contains five important recommendations for
the nation's creditors, the FTC and IRS, and the credit counseling
industry. AICCCA supports the intent of all five of these
recommendations.
Those PSI recommendations are:
1. Complete elimination of abusive practices through ongoing IRS
audits and FTC enforcement actions.
2. Establish regular periodic review of an agency's tax-exempt
status.
3. Ensure that each tax-exempt agency provides affirmative
financial counseling and education programs.
4. Continue creditor support of and standards for the credit
counseling sector, including a requirement to maintain accreditation
within the industry.
5. Clarification of IRS and FTC standards regarding tax-exempt
status and acceptable trade practices in regard to accreditation;
independent boards; assurance of public benefits; full disclosure of
relationships with creditors and for-profit service providers;
reasonable fees; and controls on improper incentives for client
enrollment or referrals.
While AICCCA supports the broad scope of all these recommendations,
we do believe that certain clarifications and fine-tuning are required.
For example, we applaud the PSI's recognition of the key role that
agency accreditation plays in assuring consumer protection. However, we
believe that PSI erred in only mentioning the standards of the Council
on Accreditation (COA). While the AICCCA accepts COA accreditation, it
believes that accreditation through the International Standards
Organization (ISO) to specific credit counseling sector requirements is
considerably more rigorous. For example, ISO accreditation employs more
frequent compliance audits.
The AICCCA also supports the credit counseling provisions included
in section 106 of S. 256, the bankruptcy reform legislation signed into
law by the President on April 20, the same day as your hearing. That
legislation requires every consumer to consult with an approved credit
counseling agency before filing for bankruptcy, and to complete an
approved financial education course before receiving their bankruptcy
discharge from debt. The new powers vested in the Justice Department's
Executive Office for United States Trustees (EOUST) are intended to
enforce minimum standards for non-profit credit counseling agencies
approved to provide pre-bankruptcy counseling to the nation's
consumers. Once issued, these standards will be in addition to the many
and varied existing state regulations as well as the powers of the IRS
to audit and regulate the industry to assure compliance with tax-exempt
status requirements. For many consumers, a counseling agency's
participation in the pre-bankruptcy counseling program as an EOUST-
approved agency will become a critical stamp of approval when they seek
financial advice and assistance.
States continue to have the lead role in regulating the credit
counseling sector, and they have been quite active on two fronts.
First, many states have revised and strengthened their existing state
laws in response to the well-publicized abuses of a few rogue agencies.
Second, the states are engaged in the process of promulgating a new
model law for statehouse consideration. On April 7th through 9th, 2005,
the National Conference of Commissioners for Uniform State Laws
(NCCUSL) met under the guidance of bankruptcy Judge William Hillman to
consider the final draft of the model Uniform Debt Management Act. Over
the past two years, the AICCCA has participated continuously with the
NCCUSL in this drafting effort, and we support the great majority of
the provisions of this proposed uniform law intended for adoption by
all states beginning with the 2006 legislative sessions.
Joint Committee on Taxation Proposal
On January 27, 2005, the staff of the Joint Committee on Taxation
issued JCS-02-05, Options to Improve Tax Compliance and Reform Tax
Expenditures. While this large report covers the non-profit universe as
well as other tax and enforcement matters, it includes specific
recommendations regarding the treatment of the credit counseling
industry. These recommendations appear on pages 327 through 337 in
section L. entitled, Establish Additional Standards for Credit
Counseling Organizations (sec. 501(c)(3) and 501(c)(4)). This report
suggests that additional legislation is required and proposes the
enactment of a number of specific requirements beginning on page 331
entitled, Description of Proposal, Additional requirements applicable
to all credit counseling organizations. Some of these proposals are
eminently reasonable and are consistent with current regulation as well
as AICCCA self-regulatory standards. For example, requirements (1)
through (8) on pages 331 and 332 are in alignment with AICCCA standards
and the Code of Practice requirements for our members; agree with,
expand, or restate current laws and regulations; and represent
reasonable regulatory application.
However, there is one unrealistic recommendation that threatens the
viability of the non-profit credit counseling sector and its ability to
carry out the critical new ``gatekeeper'' role assigned to it by the
new bankruptcy reform legislation. The section entitled, Additional
requirements for charitable or educational organizations, on page 332,
is poorly conceived and represents an alarming lack of understanding of
the credit counseling industry. This section would require that, ``(4)
the aggregate of the agency's debt management plan services (measured
by time, resources, effort expended by the agency, and any other
factors prescribed by the Secretary) during the four-year period that
includes the agency's current taxable year and the immediately
preceding three taxable years does not exceed 10 percent of the
agency's total activities during such four-year period;''.
On page 336, the report also refers to an IRS counsel memorandum
released in July of 2004. This memorandum also suggested a 10% limit on
debt management plan (DMP) activities and is the likely source for the
Joint Committee on Taxation's proposed provision. It states that, ``The
10-percent limit applicable to charitable and educational organizations
comports with the traditional levels of such activity before the
dramatic growth in the industry.'' While this may or may not have been
true far in the past, the statement completely ignores the fact that
even 15 years ago consumers did not have the broad access to credit or
carry the large levels of indebtedness that have become common today.
The fact is that consumer debt, and the stresses that accompany it,
have grown much faster than the credit counseling industry. As a
result, the number of consumers for whom a DMP is an appropriate
alternative to filing bankruptcy has grown so large that no agency
could limit DMPs to 10% of total activities and even begin to meet the
needs of consumers. Further, the thrust of the newly enacted bankruptcy
reform bill is at complete odds with this unrealistic ceiling. That new
law will send at least 1.5 million additional consumers through the
doors of approved credit counseling agencies on an annual basis, and
some significant percentage is expected to opt for entering into a DMP
as an alternative to bankruptcy. How can Department of Justice-approved
counseling agencies fulfill their role and recommend a DMP where it
appears to be the suitable course for a given consumer if that
recommendation risks jeopardizing the agency's tax-exempt status?
AICCCA believes that, if enacted, this provision would eliminate
all non-profit credit counseling agencies without exception. Even
though legitimate credit counseling agencies typically enroll in debt
management plans only between 10% and 25% of those they counsel, those
who are enrolled must receive continuing support as they repay their
debts over a three-to-five-year period. Many of these support
activities are mandated by current state laws that have compelled all
reputable credit counseling agencies to devote an ever-increasing
portion of their activities to DMP support. This means that a large
part of any agency's activities involve continuing efforts (education,
re-budgeting, re-counseling, monthly payment processing) to assist
consumers that are in the process of repaying their debts under
structured plans. While credit counseling and education are the primary
activities of any legitimate credit counseling agency, activities
necessary to support those who qualify for debt management plans will
always constitute far more than 10% of an agency's work, especially
given current levels of consumer indebtedness. This JCT proposal is
unnecessary, unrealistic, and at total odds with state regulation and
the new bankruptcy reform bill. The level of resources devoted to DMP
support can and does vary significantly between legitimate counseling
agencies. AICCCA strongly recommends that this inflexible and misguided
JCT recommendation be rejected in favor of flexible oversight of an
agency's activities to assure that they meet all applicable standards
and serve the best interests of clients.
There are other JCT recommendations that are also cause for serious
concern. For example, also on page 336, the report refers to the IRS
memorandum suggestion that income from DMP activity could be considered
unrelated business income in some cases and therefore taxable. However
the report makes no proposal of its own on this subject and relies on
present law to determine this issue. As this issue was decided by the
federal district court in the 1976 Consumer Credit Counseling Service
of Alabama decision, the AICCCA concurs that reliance on present law is
appropriate. This income flows from activity that is an integral part
of a non-profit's overall mission. Credit counseling agencies should
not be asked to operate under the threat that a judicial decision on
which they have relied for more than a quarter century may be reversed
by regulatory fiat or ill-considered legislation.
Finally, while projected revenue raising should not be the primary
focus of any proposed reform of the tax treatment of credit counseling
agencies, AICCCA would note that the JCT's estimate for increased
revenue flowing from full adoption of its credit counseling
recommendations is both minor and unrealistic. JCT projects that
adoption would generate $100 million over a ten year period, or only
$10 million a year. Even this modest figure is wildly optimistic, as
adoption of the ten percent DMP activity limit would cause credit
counseling agencies to lose their tax-exempt status and become
ineligible to provide services in most states, or to participate in the
pre-bankruptcy counseling program established by the new reform bill.
They would thus be forced to cease their operations, and defunct
entities generate no tax revenues.
Federal Regulation
The AICCCA trusts that the Congress will consider carefully any
legislation designed to regulate the credit counseling industry.
Whatever Congress does, it must recognize that the Tax Code is not an
efficient mechanism for direct regulation of activities. Once a credit
counseling agency has met and maintains reasonable criteria for tax-
exempt status, any further regulation of its activities should be done
directly. And, before taking such a step, Congress must recognize that
counseling agencies already operate in a complex federal and state
regulatory environment.
Well-meaning but poorly conceived attempts to protect citizens from
headline-grabbing abuses have had an opposite and unanticipated effect
in many states. For example, Maryland has passed a law with such high
bonding requirements that most legitimate small-to-medium-sized
agencies cannot comply with it. Unfortunately, Kansas and New York have
passed similar laws. In contrast, Georgia enacted a law that does not
require high bonding levels but that nonetheless protects its citizens
by requiring appropriate insurance coverage that is within the
financial reach of responsible credit counseling agencies.
In another area of ongoing debate, Virginia recently passed a
provision that allows for-profit credit counseling firms to serve their
citizens. AICCCA believes that the credit counseling sector should
remain non-profit, and observes that the profit motive was clearly at
the heart of all of the recent abuses of rogue agencies that received
wide media coverage. If the JCT's ill-advised DMP activity limit were
adopted it would drive legitimate non-profit agencies out of business
and leave the credit counseling function wide open to participants for
whom profit maximization is the primary goal.
AICCCA is gratified that no direct federal regulation of credit
counseling, beyond the EOUST standards for pre-bankruptcy counseling
eligibility, are being contemplated at this time. If a federal
regulation statute were enacted, it would impose yet another layer of
rules on an industry that is struggling to support consumers who are in
serious need of unbiased advice and expertise. The counseling industry
is also in the process of preparing for its considerable
responsibilities under the new bankruptcy reform law. If new regulation
is to be imposed it would be far more preferable for the states to
enact the uniform law that is undergoing final NCCUSL review and
approval.
Conclusion
The abuses that have been the focus of the many hearings and
investigations into the credit counseling industry over the past
several years--and which have caused complaints and lawsuits, generated
many new state laws, and fed unending negative press coverage--are the
result of a relatively few maverick agencies. The AICCCA believes that
appropriate IRS oversight and the enforcement of existing law are in
the process of proving their ability to protect consumers from those
abuses that have occurred. In addition, both the AICCCA and the
National Foundation for Credit Counseling have long-established and
rigorous consumer protection standards that accredited member agencies
must meet and maintain.
If the members of the Ways and Means Committee decide that new tax
legislation that affects credit counseling is worthy of consideration,
the AICCCA stands ready to provide any assistance or insight that is
requested. Our members are dedicated to serving the best interests of
consumers in need of counseling and personal finance education
nationwide. As you go forward, we ask you to differentiate between
credit counseling agencies and the great number of other types of tax-
exempt entities. We also implore you to refrain from adopting ill-
conceived and unrealistic requirements for agencies to qualify for and
retain tax-exempt status that could undermine their ability to survive
and serve the financial assistance needs of millions of Americans in
economic distress.
Central Arkansas Area Agency on Aging, Inc.
North Little Rock, AR 72119
May 2, 2005
The Honorable Bill Thomas
U.S. House of Representatives
2208 Rayburn House Office Building
Washington, DC 20515
Dear Congressman Thomas:
I am writing to urge you to protect the charitable sector from
unnecessary and overly burdensome regulations such as those presented
by the Senate Finance Committee, particularly those proposals that
would modify the tax rules regarding non-cash charitable contributions
(known as ``in-kind'' contributions).
The new proposals include recommendations to completely eliminate
or substantially modify deductions for in-kind contributions. Many
charities heavily rely upon non-cash donations, and there is no
legitimate reason to attack this lifeline. [Please insert a sentence or
two here about how your organization relies on in-kind gifts.]
Changing the in-kind contribution rules would unfairly compel
charities to divert valuable time and resources to new valuation
compliance schemes. The inability of the Internal Revenue Service to
address improper donor behavior should not result in penalties for
charities and the communities and populations which they serve.
Significant revision of the in-kind contribution rules would greatly
diminish my organization's ability to provide altruistic services.
Furthermore, these proposals are not based on any credible evidence
of wide-spread abuse. In fact, empirical data indicates that there is
NOT widespread abuse among the charitable sector and that proposals are
unnecessary. Reports collected by the FBI, the Federal Trade
Commission, State Attorneys General and even watchdog groups like the
Better Business Bureau show that reports of charity fraud are less than
1 percent of all complaints of fraud. This is consistent with every
single year's annual findings in the annual report on Fraud in the
United States published by the FTC.
It appears that many of the suggestions are driven by a desire to
raise federal revenues from the charitable sector. Such an effort is
completely inconsistent with the notion of tax-exempt status, and I
hope you will strongly oppose such proposals.
The Senate Finance Committee's proposals to alter the non-cash
charitable gift incentives come at a precarious time for charities.
Americans are a generous people, but many charities are still
recovering from the past several years when charitable giving has been
flat and even decreased for many organizations.
At the same time, we understand that your committee seeks to gather
information on the size, scope and impact on the economy of the
nonprofit sector; the need for congressional oversight; IRS oversight
of the sector; and what the IRS is doing to improve compliance by the
sector with the law. These are laudable objectives. We are interested
in assisting the committee in identifying appropriate areas for further
study as well as criteria and standards to better define and outline
the sector and its players.
Again, I urge you to oppose changes to the in-kind contribution
rules as well as any unreasonable and burdensome legislation that would
harm the charitable sector. I very much appreciate your support.
Thank you for your consideration.
Sincerely,
Ann C. Leek
Vice President, Development
Statement of Gary Kohn, Credit Union National Association
Credit unions are exempt from federal and most state taxes
because--unlike many other insured financial institutions--credit
unions are member-owned, democratically operated, not-for-profit
organizations generally managed by volunteer boards of directors and
because they have the specified mission of meeting the credit and
savings needs of consumers, especially persons of modest means.
Congress itself came to the above conclusion just seven years ago,
when it passed the Credit Union Membership Access Act (PL 105-219).
Since 1998, nothing has changed in the structure and focus of credit
unions.
The Credit Union National Association (CUNA), and the 86 million
members of the credit unions in the United States, urges you to leave
the tax status of credit unions unchanged, recognizing that the tax
exemption is sound public policy, based on the following:
The original justification for the tax exemption still
holds;
Credit unions serve those of modest means at reasonable
costs;
Over 86 million credit union members receive substantial
benefits;
The tax exemption ensures the cooperative alternative is
available;
Credit unions of all sizes benefit their members; and,
There is no evidence of market disruption from the tax
exemption.
The following pages detail each of these six points:
Original justification for the credit union tax exemption still holds
Since inception, the credit unions tax exemption has had absolutely
nothing to do with either field of membership restrictions or the
extent to which credit union service offerings were limited. Rather,
the original reason for the tax exemption was based solely on the
cooperative structure of credit unions. The U.S. Treasury Department
underlined this fact in its most recent comprehensive report on credit
unions outlining the rationale for the tax exemption for federal credit
unions:
Two reasons were given for granting this exemption (in 1937): (1)
that taxing credit unions on their shares, much as banks are taxed on
their capital shares, ``places a disproportionate and excessive burden
on the credit unions'' because credit union shares function as
deposits; and (2) that ``credit unions are mutual or cooperative
organizations operated entirely by and for their members . . .'' Thus,
the tax exemption was based primarily on the organizational form of
credit unions . . . (Quotes within this excerpt are from H.R. REP. NO.
1579, 75th Cong., 1st Sess. P. 2.) \1\
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\1\ U.S. Department of the Treasury ``Comparing Credit Unions and
Other Depository Institutions'', January 2001. Page 28.
Similarly, the rationale for the tax exemption for state chartered
credit unions hinges on their cooperative structure. In a 1991 report,
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the GAO found:
Under current law, state credit unions are exempt from tax under
Internal Revenue Code section 501(c)(14)(A). This section states that
credit unions that are (1) operating on a nonprofit basis, (2)
organized without capital stock, and (3) operating for mutual purposes
can qualify for exemption.\2\
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\2\ GAO, July 1991. Page 292.
Today, credit unions continue to operate as democratically
controlled mutual institutions, serving their members on a non-profit
basis. Rather than distributing net income among stockholders (as do
banks), the bulk of it is returned to members in lower loan rates and
fees, or higher yields on savings. The balance is retained by the
credit union to comply with statutorily mandated net worth requirements
that protect the federal share insurance fund and the taxpayer from
loss. These retained earnings are not accumulated for the benefit of
management or stockholders. They exist only for the benefit of members
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in the future by providing for the stability of the credit union.
As indicated at the outset, Congress recently reaffirmed the tax
treatment of credit unions in the findings to the Credit Union
Membership Access Act of 1998. Specifically, the findings read:
The Congress finds the following: . . .
(4) Credit unions, unlike many other participants in the
financial services market, are exempt from Federal and most State taxes
because they are member-owned, democratically operated, not-for-profit
organizations generally managed by volunteer boards of directors and
because they have the specified mission of meeting the credit and
savings needs of consumers, especially persons of modest means.\3\
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\3\ Pub. L. No. 105-219. August7, 1998.
By way of contrast, mutual savings banks lost their tax exemption
because they competed with taxed institutions AND because they engaged
in widespread proxy voting schemes and were not democratically
controlled (voting was based on the size of each member's deposit not
on the basis of one-member-one-vote as is the case with credit unions).
The U.S. Treasury underlined this fact in its recent comprehensive
report on credit unions. The report states: ``In 1951, however,
Congress removed the thrift tax exemption because these institutions
had evolved into commercial bank competitors, and had lost their
``mutuality,'' in the sense that the institutions' borrowers and
depositors were not necessarily the same individuals.
The significance of the credit union tax exemption is well
understood by public officials. Last year, both President Bush and
Senator Kerry wrote letters affirming their appreciation for the
important service that credit unions provide to their 86 million
members, and indicating their support for the continuation of credit
unions' tax exemption. Their support was added to that of a number of
members of Congress, including: Senate Banking Committee Chairman
Richard Shelby, House Majority Leader Tom DeLay; House Majority Whip
Roy Blunt; House Minority Whip Steny Hoyer; and nearly 200 other
members of Congress.
Credit unions serve those of modest means at reasonable costs
A recently published study found that: ``Households that use a bank
only have higher median incomes than those who use a credit union
only'' and ``Among households that use both a bank and a credit union,
those that use a bank primarily have higher median incomes than those
that use a credit union primarily.'' \4\
---------------------------------------------------------------------------
\4\ Jinkook Lee and William Kelly, Who Uses Credit Unions, Third
ed. Filene Research Institute, 2004. Page 15.
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A significant way credit unions provide value to America's working
class and modest income consumers is through the pricing of their
services. Numerous studies and reports show that credit unions charge
fewer and lower fees than do banks for the same kinds of services.\5\
In particular, minimum balances to avoid fees are typically much lower
at credit unions than at banks. Lower rates on loans, especially on
used cars and small loans are another way credit unions serve those of
modest means. Credit unions also serve America's low and moderate-
income households with member business loans. The Treasury reported in
1999 that 45% of credit union member business loans were to borrowers
with household incomes below $50,000.\6\ In addition, Home Mortgage
Disclosure Act (HMDA) data consistently shows that low income or
minority applicants are significantly more likely to have their loans
approved at a credit union than at any other type of lender.
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\5\ 2004-2005 Credit Union Fees Survey, Credit Union National
Associa1tion. Big Banks, Bigger Fees 2001, US Public Interest Research
Group. New Jersey Department of Banking and Insurance, various surveys.
The Money Talks Personal Finance Advice website at www.moneytalks.org.
\6\ US Department of the Treasury. Credit Union Member Business
Lending. January 2001.
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Throughout most of their history, credit unions have actually been
hamstrung in their efforts to serve members of modest means because
field of membership rules generally restricted eligibility to
occupational groups. Four years ago, the National Credit Union
Administration adopted an expedited program known as Access Across
America to permit federal credit unions to add underserved areas to
their fields of membership. Since the beginning of 2001, over 92
million potential members from underserved areas have been added to
credit union fields of membership. Credit unions acknowledge it will
take some time to reach out to and serve members in these communities.
However, in the three years ending December 2003, credit unions that
added such underserved areas experienced membership growth over three
times that of other credit unions (17.4% vs. 5.2% over the three year
period.)
86 million CU members receive substantial benefits
Credit unions provide substantial, tangible benefits to members
that far exceed the amount of the tax exemption. These benefits are
realized in the form of lower fees, lower loan rates, and higher yields
on savings. CUNA has estimated that these benefits total over $6
billion a year.\7\ That is the additional amount that credit union
members would pay if they were to conduct all the business they do at
banks instead of credit unions. That is about four times the roughly
$1.5 billion that credit unions would pay in federal income tax.
---------------------------------------------------------------------------
\7\ The Benefits of Credit Union Membership. CUNA Research and
Policy Analysis White Paper, 2004.
---------------------------------------------------------------------------
The tax exemption is leveraged as it is for the benefit of credit
union members because of the cooperative structure of credit unions.
When comparing banks to credit unions, the amount that banks pay in
dividends to stockholders is more significant than is the tax
exemption. Further, credit unions either do not compensate directors
(as is the case with federal credit unions), or (in the case of state-
chartered credit unions) generally compensate only the board Treasurer
or reimburse incidental expenses incurred by other directors. The
savings realized in not compensating all directors are then passed on
to members. Finally, credit unions ratios for expenses and loan losses
compare very favorably to similarly sized banks.
Tax exemption keeps the cooperative alternative available, and supports
safety and soundness
Credit union regulation, which is much more restrictive than that
for other financial institutions, includes: limits on who the credit
union can serve, limits on business lending, lack of access to capital
markets, higher capital requirements than other depository
institutions, etc. The tax exemption is the incentive that encourages
credit union CEOs and boards to continue to operate as credit unions
rather than shedding those restrictions by converting to a bank
charter. Such conversions would only limit the range of choices
available to America's consumers, especially those of modest means.
Because the tax exemption is an important part of the reason credit
unions remain cooperatives, it serves to protect taxpayers from losses
to the share insurance fund. There are two important connections
between the stability of NCUSIF and credit unions' tax exemption.
First, the primary buffer for a deposit insurance system is the capital
or net worth maintained in insured institutions. Because credit unions
have no access to capital markets, their only source of capital is the
retention of earnings. A tax on net income would thus disincent credit
unions from retaining earnings, weakening protection for NCUSIF. In
fact, the cost to the taxpayer of FSLIC's losses far exceeded the total
taxes paid by FSLIC insured institutions prior to FSLIC's failure.
Second, as cooperatives credit unions have a systemic inclination
to avoid risky activities. In their 1996 study of the National Credit
Union Share Insurance Fund, Edward Kane and Robert Hendershott show
that the cooperative structure of credit unions presents credit union
decision makers with incentives that are strikingly different from
those faced by a for-profit financial institution, making it less
feasible for credit union managers to benefit from high-risk
strategies.\8\ This is an especially useful trait for federally insured
depository institutions.
---------------------------------------------------------------------------
\8\ Edward Kane and Robert Hendershott, The Federal Deposit
Insurance Fund that Didn't Put a Bite on U.S. Taxpayers Journal of
Banking and Finance, 20(September, 1996), pp.1305-1327.
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Large credit unions stand out in providing credit union benefits
There is no relation between the size of an institution and the
absence or presence of reasons to justify the tax exemption. Members of
large credit unions relate to the institutions to which they belong in
exactly the same way as do members of smaller credit unions. Regardless
of the size of the credit union, each credit union member has one equal
vote, and thus an equal say, in the direction of the credit union.
Large credit unions are democratically controlled, not-for-profit
cooperatives in every way that are smaller credit unions. The boards of
directors of large credit unions are composed of volunteers just as
they are at small credit unions. A large credit union may be more
likely to offer a broader array of services, and to be a greater
presence in a local market. But neither activity makes it less a
cooperative than a smaller credit union. No one suggests that as soon
as the congregation of a church, synagogue or mosque exceeds a certain
size, it should no longer be tax exempt. Likewise, it would be
ludicrous to say the American Heart Association should lose its tax
exemption simply because of its size while a small local charity should
not.
Because of their size and efficiency, large credit unions are often
more able to provide the benefits of the cooperative to members, such
as lower loan rates and fees and higher dividend rates. Larger credit
unions are also more able to offer special programs benefiting low- and
moderate-income households. In a survey conducted in 2002, when asked
how many of up to 18 services geared to low/moderate income households
were offered, only 6% of credit unions with assets below $20 million
offered at least half of the services. Fully 42% of credit unions with
assets over $500 million offered that many of the services. Large
credit unions are also more likely than small credit unions to
participate in outreach activities to attract low/moderate income
members, and to have added underserved areas to their fields of
membership under NCUA's Access Across America program.\9\
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\9\ 2003 Serving Members of Modest Means Survey Report. CUNA.
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No evidence of market disruptions from credit union tax exemption
There is no evidence that the credit union tax exemption adversely
affects banks or thrifts; other financial institutions continue to
thrive in the presence of credit unions. In fact, the FDIC recently
reported that banks recorded record profits for the fourth year in a
row.\10\ Aggregate bank return on assets (ROA) has exceeded 1% for the
past 12 years, averaging 1.23%. And credit unions are only growing
marginally faster than banks. In the decade ending in 2004, total
banking institution assets grew at a compound annual rate of 7.25%
compared to 8.4% for credit unions. Credit unions now account for 6.2%
of the combined assets of all depository institutions. At the growth
rates of the past decade, it will take until the year 2053 for the
credit union share to climb to just 10%. And, although more credit
unions have become interested in recent years in business lending to
their members, credit unions as a whole hold a very small portion of
the market: Less than 1% of the business loan market in the U.S.
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\10\ Federal Deposit Insurance Corporation, Quarterly Banking
Profile, Fourth Quarter 2004.
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The health of the banking industry over the past decade has not
been confined to just large banks. In a 2003 conference, Federal
Reserve Gov. Mark Olson said: ``The year that just ended was one of
record profits for the industry as a whole, and for community banks in
particular'' and ``Community banking has a long history of strength and
success and a bright future. The past year was a good one for community
banks. Once again the vitality and adaptability of the community
banking franchise were amply demonstrated.'' \11\ Two Federal Reserve
economists have recently described the strong performance of the
nation's smaller banks. They found that ``small banks have grown
considerably more rapidly than large banks and have tended to meet or
exceed them in some measures of profitability.'' \12\
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\11\ Comments before the 2003 Chicago Federal Reserve Bank
Conference: Whither the Community Bank?
\12\ William F. Bassett and Thomas F. Brady. The Economic
Performance of Small Banks, 1985-2000. Federal Reserve Bulletin,
November 2001.
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As Federal Deposit Insurance Corp. Chairman Donald E. Powell told
the convention of the Independent Community Bankers of America March
12, ``In the banking business, times are surely good.''
Summary.
America's credit unions continue in their long tradition of
providing members affordable financial services driven by their
cooperative, not-for-profit structure. As a result, 86 million members
receive significant benefits from their credit unions even while the
rest of the financial services industry thrives. The public policy
rationale for the credit union tax exemption is just as valid today as
it was at credit unions' inception.
The Credit Union National Association--the nation's largest credit
union trade association representing 90 percent of the nation's 9,000
credit unions--is pleased to offer these comments and suggestions to
the Ways and Means Committee as it conducts its overview of the tax-
exempt sector. We look forward to working with the Chairman, Members
and staff of the committee as it continues its overview, and stand
ready to answer any questions or expand on or otherwise further explain
our remarks.
Fair Housing Center
Toledo, OH 43624
April 26, 2005
The Honorable Bill Thomas
U.S. House of Representatives
2208 Rayburn House Office Building
5Washington, DC 20515
Dear Congressman Thomas:
I am writing to urge you to protect the charitable sector from
unnecessary and overly burdensome regulations such as those presented
by the Senate Finance Committee, particularly those proposals that
would modify the tax rules regarding non-cash charitable contributions
(known as ``in-kind'' contributions).
The new proposals include recommendations to completely eliminate
or substantially modify deductions for in-kind contributions. Many
charities heavily rely upon non-cash donations, and there is no
legitimate reason to attack this lifeline. [Please insert a sentence or
two here about how your organization relies on in-kind gifts.]
Changing the in-kind contribution rules would unfairly compel
charities to divert valuable time and resources to new valuation
compliance schemes. The inability of the Internal Revenue Service to
address improper donor behavior should not result in penalties for
charities and the communities and populations which they serve.
Significant revision of the in-kind contribution rules would greatly
diminish my organization's ability to provide altruistic services.
Furthermore, these proposals are not based on any credible evidence
of wide-spread abuse. In fact, empirical data indicates that there is
NOT widespread abuse among the charitable sector and that proposals are
unnecessary. Reports collected by the FBI, the Federal Trade
Commission, State Attorneys General and even watchdog groups like the
Better Business Bureau show that reports of charity fraud are less than
1 percent of all complaints of fraud. This is consistent with every
single year's annual findings in the annual report on Fraud in the
United States published by the FTC.
It appears that many of the suggestions are driven by a desire to
raise federal revenues from the charitable sector. Such an effort is
completely inconsistent with the notion of tax-exempt status, and I
hope you will strongly oppose such proposals.
The Senate Finance Committee's proposals to alter the non-cash
charitable gift incentives come at a precarious time for charities.
Americans are a generous people, but many charities are still
recovering from the past several years when charitable giving has been
flat and even decreased for many organizations.
At the same time, we understand that your committee seeks to gather
information on the size, scope and impact on the economy of the
nonprofit sector; the need for congressional oversight; IRS oversight
of the sector; and what the IRS is doing to improve compliance by the
sector with the law. These are laudable objectives. We are interested
in assisting the committee in identifying appropriate areas for further
study as well as criteria and standards to better define and outline
the sector and its players.
Again, I urge you to oppose changes to the in-kind contribution
rules as well as any unreasonable and burdensome legislation that would
harm the charitable sector. I very much appreciate your support.
Thank you for your consideration.
Sincerely,
Michael P. Marsh, CFRE
Vice President, Development and Public Relations
International Community Association
San Diego, 92121
May 5, 2005
Chairman Bill Thomas
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
On behalf of the International Community Foundation (ICF) and our
Board of Governors, I am calling attention to the fact that the Senate
Finance Committee staff had recommended that no grants from donor
advised funds to foreign organizations be permitted unless the foreign
organization is on a list specifically approved by the IRS. Here, ICF
concurs with your Panel's recommendation that no special rules be
created specific to international grants through donor advised funds.
ICF believes that an approved IRS list of foreign nonprofits will
be difficult and costly to effectively administer. Without clear multi-
lingual guidelines on how a foreign nonprofit can get listed, otherwise
worthy groups could be precluded from receiving support leading to a
potential chilling effect in overseas grantmaking by U.S. public
charities at a time when there is a need for expanded goodwill
initiatives originating from our country overseas. Yet, according to
USA Giving, in 2002 international giving amounted to less than 1.9% of
total charitable gifts. Of this amount, less than $843 million in
grants were made to overseas nonprofits.
It is the opinion of ICF that so long as public charities engaged
in international giving through donor advised funds provide full public
accountability and disclosure, ensure good governance and undertake the
proper due diligence and controls with their overseas grantmaking
(including pre-grant evaluations, site visits and follow up reporting),
the current IRS requirements are more than satisfactory. As your report
recommends, to the extent that current law does not provide adequate
safeguards against potential abuses in overseas grantmaking, such
abuses can be specifically targeted through rules applicable to all
charities.
If your Panel has specific questions about ICF's views on your full
report or would like additional clarification on our foundation's
position specific to proposed changes in rules for grants to foreign
grantees, we would welcome the opportunity to speak to you in person.
Sincerely,
Richard Kiy
President & CEO
Statement of John McCarthy, International Health, Racquet & Sports Club
Association
This is in response to your request for statements at the April 20
Committee hearing regarding an Overview of the Tax-Exempt Sector. IHRSA
is the business association representing the nation's 6,000 private
fitness club entrepreneurs. Our members employ more than 100,000
workers and provide a needed service to our communities and clients,
all the more important given a new awareness of the public health and
economic costs of obesity and poor physical condition.
IHRSA members are largely small businesses, and are proud of their
ability to compete and provide service demanded by our clients.
However, it is clear that for many of our members their, major
competitors are operating under a different set of competitive factors
due to tax competition. When tax exempt facilities provide adult
fitness services, they are clearly competing in a commercial arena with
tax-paying small-businesses. We want to be clear. There is plenty of
room for competition, and we salute those exempt providers who truly
serve their entire community across geographic, age and income
categories. But we clearly see the inadequacy of the current tax exempt
legal, reporting and enforcement structure. It does not assure that
such competition from tax exempt providers is fair or consistent with
their exempt purposes. A tax exemption is a privilege, not a right, and
does not include a license to compete in commercial markets.
IHRSA regularly meets with state tax and Internal Revenue Service
officials on these issues. Their response, particularly in recent
years, has been consistent--they are highly sympathetic with our
concerns but are hard pressed to address the situation due to limited
enforcement resources and guidelines.
IHRSA congratulates the Ways and Means Committee for its review of
the basic policy issues behind tax exemption. Whatever the original
justification of some of our largest exempt organizations, it cannot be
denied that in the current hyper-competitive business environment, the
distinctions between the services offered by certain exempt
organizations and our fully taxed proprietary small business members
are barely noticeable. As appears to be the case in some other service
sectors, tax-exempt providers of adult fitness services too often
appear to be, in the phrase of the Congressional Budget Office's
statement at this hearing, simply part of ``the untaxed business
sector.''
IHRSA strongly endorses your call for additional Ways and Means
Committee hearings to look into basic issues underlying the rationale
for tax exemptions. The law today, largely unchanged in several
generations, may not be adequate to appropriately treat, to use a
charitable term, the clearly very mixed commercial and public
activities pursued by highly competitive exempt organizations.
In addition to hearings looking into fundamental issues regarding
the rationale for tax exemption, we would like to suggest the Ways and
Means Committee take three actions, which would advance progress on
this difficult issue.
1. The Committee should hold oversight hearings focused on unfair
competition by tax exempt organizations with commercial businesses, and
particularly in the provision of adult fitness services.
2. The Committee should encourage the IRS to immediately adjust
990 reporting forms to elicit more specific information about the
actual use by all elements of the local community of exempt
organizations' adult fitness services.
3. The Committee should support enhanced enforcement capability
for IRS and a prioritization of commercial competition problems.
IHRSA stands ready to support the Committee in these efforts and
appreciates your interest in these key tax issues.
Statement of Barbara R. Levy
As a member of the Association of Fundraising Professionals and a
thirty plus year fundraiser, I am alarmed at the proposal to eliminate
the deduction of non-cash contributions to charity. For so many
charities, this proposal would slash income drastically. It has the
potential of causing some charitable organizations to close their
doors. Congress has done enough to make life difficult for the not-for-
profit sector, please don't make this ``the last straw.''
Instead, Congress should support every aspect of the non profit
sector as they are fulfilling the services that many governments offer
their citizens. With education budgets and medical coverage being
slashed, let's give our tax paying citizens an opportunity to help
themselves and their communities through charitable acts.
Let the IRS scrutinize tax returns a bit more carefully and
collectively help the nation and the taxpayers.
Statement of Brad Thaler, The National Association of Federal Credit
Unions
Introduction
Chairman Thomas, Ranking Member Rangel and Members of the
Committee, the National Association of Federal Credit Unions (NAFCU),
the only national trade association that exclusively represents the
interests of our nation's federal credit unions, appreciates this
opportunity to submit comments for the record of today's hearing which
is an overview of the tax-exempt sector. NAFCU represents approximately
800 federal credit unions--financial cooperatives from across the
nation--that collectively hold approximately 66 percent of total
federal credit union assets and serve the financial needs of
approximately 26 million individual credit union members.
The universe of tax-exempt entities is very large; there are over
1.8 million federal income tax-exempt organizations, not including
churches and religious organizations, under Sec. 501(c) of the Internal
Revenue Code. Credit unions constitute a very small portion of that
universe of federal income tax exempt organizations. In fact, our
nation's approximately 9,000 credit unions account for merely one-half
of one percent of all federal income tax-exempt organizations. Yet
while small in number, credit unions play an important role in directly
serving their members, and ultimately in indirectly benefiting the
American public since studies have shown that the presence of credit
unions benefits not only credit union members but all Americans who use
federally-insured depository institutions.
NAFCU would like to take this opportunity to emphasize this point
to the members of the Committee: the credit union federal income tax
exemption benefits not just credit unions and their members, but all
who have savings in any regulated depository institution. Credit union
critics have erroneously claimed that some credit unions today are no
different than banks and thus should forfeit their federal income tax
exempt status. Such claims simply do not stand up to close scrutiny.
While credit unions--like all financial service providers--have evolved
and grown over the years to meet the changing financial services needs
of their members, the basic structure, philosophy and guiding
principles of credit unions remain the same today as when the federal
income tax exemption was granted to credit unions in 1937. Congress
reaffirmed this fact just seven years ago, when as part of Section 4 of
the ``Findings'' contained in the Credit Union Membership Access Act
(P.L. 105-219) Congress declared that:
``Credit unions, unlike many other participants in the financial
services market, are exempt from Federal and most State taxes because
they are member-owned, democratically operated, not-for-profit
organizations generally managed by volunteer boards of directors and
because they have the specific mission of meeting the credit and
savings needs of consumers, especially persons of modest means.''
As part of that legislation, the Treasury Department was asked to
examine credit unions and their role in the financial services
marketplace, including ``the potential effects of the application of
Federal laws, including Federal tax laws, on credit unions in the same
manner as those laws are applied to other federally insured financial
institutions.'' The Treasury Report (Comparing Credit Unions with Other
Depository Institutions, U.S. Department of Treasury, January 2001)
found that credit unions were, indeed, serving their purpose and that
there was no reason--or recommendation--to remove the federal income
tax exemption from credit unions. This position was supported by then
candidate and now President George W. Bush in 2000, when he stated ``.
. . as part of my overall commitment to lower taxes and provide more
opportunities for working Americans, I support continuing the tax-
exempt status of credit unions''. During the 2004 campaign, President
George W. Bush reiterated that position when he noted that ``I support
strongly the tax-exempt status of credit unions and will continue to
highlight the important contributions that credit unions make to our
financial system.'' Treasury Secretary John Snow recently told a credit
union audience ``We oppose this talk of taxation of you and your
industry--it's a truism I think in economics, you always get less of
anything you tax. Well, we don't want to get less of what you do.''
Reflecting the bipartisan nature of this issue, in also supporting the
credit union federal income tax exemption, 2004 Democratic presidential
nominee John Kerry wrote to NAFCU that ``. . . I want you to know that
I will continue to support America's credit unions and oppose any
efforts to change the existing tax-exempt status of credit unions.''
Bankers Myths vs. The Credit Union Reality
Some critics of credit unions would have you believe that credit
unions pay no taxes at all. That is false. Credit unions still pay many
taxes and fees, among them payroll and property taxes, but Congress has
determined that federal income taxation of member-owned shares in a
credit union would put a ``disproportionate and excessive'' burden on
credit unions due to their nature.
Other critics of credit unions would have you believe that credit
unions are growing bigger and bigger and really are no different than
banks, which pay corporate income taxes. Again, that is false. The
defining characteristics of a credit union, no matter what the size,
remain the same today as they did in 1937: credit unions are not-for-
profit cooperatives that serve defined fields of membership, generally
have volunteer boards of directors and cannot issue capital stock. They
are restricted in where they can invest their members' deposits and are
subject to stringent capital requirements. A credit union's
shareholders are its members (and each member has one vote, regardless
of the amount on deposit), while a bank has stockholders.
While credit unions have grown, like all financial institutions,
over the years, they are quite tiny when compared to banks. Federally
insured credit unions had $647 billion in assets as of December 31,
2004, while FDIC-insured institutions held over $10.1 trillion in
assets, and last year Federal Deposit Insurance Corporation (FDIC)-
insured institutions grew by an amount exceeding the total assets of
all credit unions combined. The world's largest credit union, with just
over $22.9 billion in assets, is dwarfed by the nation's largest bank
with over $967 billion in assets. Although banks claim there is
``competition'' from credit unions, banks continue to see record
profits quarter after quarter. According to Federal Reserve Board
statistics, the credit union share of total household assets is
extremely small, just 1.4 percent as of December 31, 2004 (the same
percentage of household assets that credit unions had in December of
1980). Banks, on the other hand, accounted for 18.7 percent of
household assets as of December 31, 2004.
Furthermore, while banks continue to attack the credit union
federal income tax exemption, the number of banks that pay no corporate
federal income tax at the corporate level continues to rise through
increases in the number of banks organized as Subchapter S corporations
and through the utilization of other tax avoidance measures. According
to NAFCU's analysis of FDIC call report data, as of December 31, 2004,
nearly 20% of all FDIC-insured institutions paid no federal corporate
income tax. These 1,771 FDIC-insured institutions not only account for
nearly 20% of all FDIC-insured institutions; they collectively hold
over $286 billion in total assets, or more than 44% of the total assets
of all federally-insured credit unions combined. Of these 1,771 FDIC-
insured institutions that paid no corporate federal income tax, 693 of
them (ranging in size up to $18.4 billion) were not Subchapter S
corporations.
The Credit Union Income Tax Exemption Benefits Everyone
Consumer advocates have also recognized and supported the federal
income tax exemption of credit unions. In the fall of 2003 the Consumer
Federation of American (CFA) examined the federal income tax status of
credit unions and reaffirmed these points in a study entitled ``Credit
Unions in a 21st Century Financial Marketplace''. In the study CFA
concluded, among other things, that:
The benefits that credit unions deliver to the public far
exceed the costs, as measured by the tax exemption, through lower cost
services and paying higher interest rates; and,
The value of tax breaks enjoyed by banks is ``far
greater, in absolute and relative terms, than the value of the credit
union tax exemption.''
Furthermore, even bankers have admitted that credit unions'
influence in the market has led them to better serve their customers.
An article in the January 31, 2005 issue of the American Banker
newspaper entitled ``Feeling Heat from Deposit Competition'' reported
that ``Zions Bancorp [of Salt Lake City, Utah] was one of the many
large regional banks that while making record profits for the 4th
quarter of 2004 and for the calendar year, gave in to deposit pricing
pressure in the fourth quarter [of 2004].'' The article continued:
``Zions said pressure from other banks and specifically credit unions
in Utah prompted it to raise rates on money market accounts by 20 basis
points late in the fourth quarter.''
A September 2004 report and analysis by Robert M. Feinberg,
Professor of Economics at American University, entitled ``An Analysis
of the Benefits of Credit Unions to Bank Loan Customers'' found that
``the presence of a substantial credit union presence in local consumer
lending markets has a significant impact on U.S. bank loan customers,
saving them at least $1.73 billion per year in interest payments.'' A
January 2005 study by Robert J. Tokle, Professor of Economics at
IdahoStateUniversity, entitled ``An Estimate of the Influence of Credit
Unions on Bank CD and Money Market Deposits in the U.S.'' estimated
that bank customers benefit to the tune of $2.0 to $2.5 billion
annually in just interest on deposits due to the presence of credit
unions. The credit union federal income tax exemption, therefore, does
not just benefit credit unions and their members, but each and every
American who uses a federally-insured depository institution.
The loss of the federal tax exemption would seriously threaten the
fundamental nature of not-for-profit credit unions and significantly
change the role that they play in the consumer financial services
marketplace. Almost all federally insured credit unions must build
their capital reserves through retained earnings, and all are
prohibited from accessing the open capital markets by law. As noted by
former NCUA Chairman Dennis Dollar in a letter to The Honorable Sheryl
Allen (a member of the Utah State House of Representatives) regarding
potential safety and soundness implications from the taxation of credit
unions in that state: ``. . . it is certain that any resulting net
worth considerations that might arise (from taxation) could indeed
become a significant issue . . . [as a result of] credit unions having
their retained earnings negatively impacted [by taxation].''
Furthermore, because of their structure, any taxes imposed on credit
unions would be passed directly to their members in the form of lower
savings rates, higher borrowing rates and/or higher fees--in essence a
tax increase on America's 85 million credit union members. Finally,
credit unions boards and management would be driven to make decisions
in a manner similar to banks, with the end result being a decision-
making process driven by tax considerations or other issues rather than
what is in the best interest of members. As a result, a very
unfortunate consequence could be a shift in orientation to profit-
motivated interests, instead of providing low-cost financial services
to member-owners.
Conclusion
In summary, the basic structure, philosophy and guiding principles
for credit unions, large and small, remains the same today as it was in
1937; i.e., they continue to be member-owned, democratically-
controlled, not-for-profit organizations generally managed by volunteer
boards of directors with the mission of meeting the credit and savings
needs of consumers, especially persons of modest means. Thus, we
believe there is more than ample justification for continuing the
federal income tax exemption for all credit unions, regardless of size,
charter type, field of membership or services offered.
Statement of Mary Martha Fortney, National Association of State Credit
Union Supervisors
The National Association of State Credit Union Supervisors (NASCUS)
is a professional association representing the forty-eight (48) state
and territorial regulatory agencies that supervise the nation's more
than 4,000 state-chartered credit unions. NASCUS has been committed to
enhancing state credit union supervision and advocating for a safe and
sound state credit union system since its inception in 1965. NASCUS is
the sole organization dedicated exclusively to the promotion of the
dual chartering system and advancing the autonomy and expertise of
state credit union regulatory agencies. NASCUS appreciates the
opportunity to provide a submission for the record to the House
Committee on Ways and Means Hearing on An Overview of the Tax-Exempt
Sector.
NASCUS understands and respects that it is not the position of
state regulators to set tax policy. Tax policy is rightfully a concern
for our elected officials, both state and federal. NASCUS does believe,
however, that our elected officials must have access to accurate
information to develop sound public policy.
State and Federally Chartered Credit Union Taxation Explained
NASCUS wants to clarify the tax treatment of state-chartered and
federally chartered credit unions. Under our current tax system, state-
chartered credit unions are taxed differently than federal credit
unions. Section 501(c)(1) of the Internal Revenue Code grants federal
credit unions their tax exemption, while state credit unions are
exempted under Section 501(c)(14).
In his written testimony, the Honorable Sheldon Cohen, Partner,
Morgan, Lewis and Bockius, and Commissioner, Internal Revenue Services
from 1965--1969, distinguishes the difference between Section 501(c)(1)
and Section 501(c)(14) of the Internal Revenue Code, noting that credit
unions receive their tax exemption under one of these sections. He
explains that a Section 501(c)(1) designation exempts federal
instrumentalities from federal taxes and notes that a Section 501(c)(1)
designation is preferable for credit unions because the IRS has taken
an audit position that Section 501(c)(1) entities are tax exempt.
State-chartered credit unions are taxed according to state law and do
not enjoy the totally exempt status as their likewise non-profit
federally chartered credit unions.
Current tax policy threatens the credit union dual chartering system
As the association representing state credit union regulators, our
concern with federal tax policy is that state and federal charters are
treated fairly, so an unintended tax advantage is not provided for
either state or federally chartered credit unions in our nation's tax
policy.
Together, the Federal Credit Union Act, the Internal Revenue Code
and case law grant federal credit unions a broad tax exemption as
instrumentalities of the federal government. State credit unions are
provided a federal exemption under Section 501 (c)(14) of the Internal
Revenue Code andvarious state statutes mandate when and whether state-
chartered credit unions are taxed.
As Mr. Cohen references in his testimony, for tax purposes, it is
preferable for credit unions to be designated as Section 501 (c)(1)
organizations. NASCUS does not want the tax burden on any credit unions
increased. But treating credit unions differently for tax purposes
solely based on their charter is simply wrong, and continues to
threaten the dual chartering system we so highly value in America.
NASCUS Advocates Fairness in the Tax System
NASCUS does not advocate any new taxes for credit unions--whether
they are state or federally chartered. However, they should receive the
same tax treatment; both state and federally chartered credit unions
should be tax-exempt.
NASCUS does not believe that it was ever the intent of Congress to
benefit, via preferential tax treatment, one charter over another
charter for like institutions. Congress recognized the cooperative
nature of credit unions and approved their tax-exempt status in 1934
when it voted to approve the Federal Credit Union Act. President
Roosevelt signed the Act and it became law. Congress has never wavered
in its position that credit unions should be tax exempt. Further,
President Bush's Administration has publicly acknowledged its support
of credit unions' tax-exempt status.
NASCUS supports equal treatment of the state and federal credit
union charter regarding federal tax policy. State credit unions should
be granted the same tax exemptions as their federal counterparts. State
and federal credit unions provide the
same not-for-profit financial services and should not be accorded
disparate tax treatment due solely to their choice of charter.
NASCUS is pleased to have the opportunity to submit written
testimony to the House Ways and Means Committee regarding the Overview
of the Tax-Exempt Sector Hearing. We appreciate your time studying our
concerns; we are available for dialogue or to answer questions.
Statement of Rick Cohen and Jeff Krehely, National Committee for
Responsive Philanthropy
``Reforming the United States Philanthropic Sector''
The National Committee for Responsive Philanthropy (NCRP) has long
advocated for significantly improving philanthropic accountability and
responsiveness and the means for providing necessary government
oversight and enforcement. It is insufficient to call for stronger
oversight and enforcement of the standards of philanthropic
accountability if the standards are inadequate or completely missing.
This statement outlines the elements of philanthropic accountability
that should be the basis for both public policy and foundation self-
regulation to create a truly responsive and accountable philanthropic
sector.
For several years, the media have regularly uncovered and reported
on egregious instances of abuse and mismanagement in the nation's
private foundations and other tax-exempt institutions. Leaders of the
nonprofit and philanthropic sectors' leaders have responded to these
scandals and the resulting increased public scrutiny in a very
defensive and self-interested fashion. Often, self-regulation is the
suggested remedy to these ethical and illegal ills. In other cases, the
suggested solutions to these problems involve minor mechanical changes
to current oversight efforts. Based on NCRP's perspective--as well as
the sheer size and diverse scope of the nonprofit and philanthropic
sectors--such a response is wholly inadequate and would do little to
clean up current abuses, prevent future abuses, or restore public faith
in the sectors.
It is time to recommend comprehensive reforms to bring new
standards of public and private accountability to the approximately
70,000 private foundations that control $500 billion in philanthropic
assets in the United States today.\1\ Independent research estimates
that at least 45 percent of those $500 billion belong to the American
public, having been accumulated thanks to various tax breaks that
foundations receive at their inception and throughout their
institutional lives.\2\
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\1\ Significantly more organizations, perhaps as many as 100,000,
are counted as private foundations with the IRS, but we estimate that a
third or so are actually public charities that failed to meet their
public support test.
\2\ Mark Dowie. American Foundations: An Investigative History.
Cambridge: MIT Press, 2002.
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Speaking of the American people, public trust in the nation's
charities and foundations is at historically low levels. They have read
the news stories about scandals in philanthropy, and they have
concluded what most of the media and many lawmakers--but only a few
leaders of philanthropy--have as well: It's time for change. The
current laws and regulations pertaining to foundations were established
more than 30 years ago, when the philanthropic sector was much smaller,
both in numbers and dollars. In the last ten years alone, the number of
foundations has doubled and their assets have more than tripled.
The U.S. Congress has a responsibility and obligation to pass new,
better laws to regulate private philanthropy. Because foundations wield
so much financial power and influence over their grantee
organizations--which know foundations the best--calls for reform will
not be coming from the nonprofit sector. And the public has no say in
who sits on foundation boards of directors, so there are no outside
share--or stakeholders to bring foundations into line. The government,
therefore, must step in and take action. No other entity has the
authority, integrity, or courage to do so.
This statement will provide concrete suggestions for reform of the
nation's philanthropic sector. Foundation leaders will be unhappy with
many of them, but this statement was crafted not to please the
philanthropic elite, but to bring a sense of democratic and fair
governance and oversight to billions of dollars that are not living up
to their legal mandates or ethical obligations.
The suggestions are organized into three broad areas:
Maximizing foundation accountability and transparency
Maximizing foundation support for nonprofits
Maximizing foundation support for justice and democracy
These suggestions were drafted based on NCRP's observation of and
research on current deficiencies among the nation's foundations, as
well as comments from our organizational members and board of
directors.
It is an honor and privilege to offer this statement to the United
States House of Representatives Ways and Means Committee. They are
offered in the hopes of aiding the Committee's efforts to bring about a
new era of reform and transparency for the United States philanthropic
sector.
Maximizing Foundation Accountability and Transparency
Use the foundation excise tax: Reduce and consolidate the
private foundation investment excise tax to 1% of investment income and
devote the bulk of the tax payment to IRS and state government
oversight of nonprofits and foundations--as the foundation excise tax
was originally intended to be used when first enacted. The remainder
can and should be used to supplement government oversight through
grants for nonprofit activities such as research and data collection on
the nonprofit sector, nonprofit accountability standard setting, and
special investigations.
NCRP's legislative proposal for making the foundation excise tax a
tool for a more accountable philanthropic sector includes the
following:
1. Reduce the foundation tax to a simplified, consolidated 1
percent of private foundation investment income, but require that the
money that foundations ``save'' from the tax reduction go to nonprofit
organizations in the form of grants--as opposed to being used by
foundations to increase foundation executives' salaries, foundation
trustees' compensation, and other expenses.
2. Dedicate 20 percent of the remaining excise tax to more than
double the budget of the Tax Exempt/Government Entities division of the
Internal Revenue Service from its current budget of less than $60
million to approximately $130 million, enabling it to more effectively
oversee and audit private foundations, public grantmaking foundations,
donor advised funds, and other philanthropic grantmaking mechanisms, as
well as nonprofits in general, to weed out the more than a few bad
apples currently undermining the accountability of philanthropy and
charity.
3. Dedicate 40 percent of the remaining excise tax to create a
fund of $140 million, which the Commissioner of the Internal Revenue
Service (IRS) can use to supplement the charity investigative and
oversight arms of state attorneys-general offices.
4. Allocate 15 percent (or approximately $50 million) of the
remaining excise tax for the IRS Commissioner to grant to nonprofit
organizations whose research, ratings, and evaluation efforts
complement and augment the oversight functions of federal and state
agencies.
5. Use another 15 percent of the excise tax for the generation of
IRS statistics on the finances of foundations and charities comparable
with the research IRS generates on other sectors of the economy.
6. Reserve the remainder of the excise tax revenues to support
special initiatives of the Tax Exempt/Governmental Enterprises division
of IRS and for additional research and data collection and
dissemination.
The private foundation excise tax, originally set at 4 percent of
foundation investment income when enacted in 1969, was intended to pay
for IRS costs of overseeing tax-exempt organizations. Had the reduction
of the foundation excise tax been enacted to start in 2004, $144
million would have been potentially freed up for grantmaking in the
first year and nearly $200 million in the second year.
Oversight and enforcement of the nonprofit sector has changed since
1969, when Congress last implemented broad changes to rules pertaining
to nonprofits and foundations. The responsibility is no longer just
that of the Internal Revenue Service's Tax Exempt Division, but also
the charity oversight offices of states attorneys-general, few of which
were on the radar screen 35 years ago; their on-the-ground roles in
monitoring foundations and nonprofits overall should be supported by
the excise tax whose primary purpose was meant to bolster foundation
and nonprofit accountability.
Bolstering philanthropic oversight is crucial, given the explosive
growth in the number of private foundations, plus other kinds of
grantmaking charities, while IRS audits of foundations plunged from
1,200 in 1990 to less than 200 in 1999 and considerably less today.
Improve IRS forms 990PF and 990: The 990 needs to be
radically overhauled to reveal important information about foundations
(and public charities) for necessary review and oversight; foundations
and nonprofits should be able to e-file; and there should be
significant penalties for foundations that do not file their 990PFs on
a timely basis. All publicly disclosed data should be available in a
free, publicly accessible and searchable format.
Some of the recommendations below--such as disclosure of insider
relationships between foundations and outside vendors providing
services for hire--can be implemented through changes to the IRS Forms
990PF and 990. Institutions filing these forms should also be regularly
required to state in specific terms how their grantmaking and/or
programmatic activities further their tax-exempt purposes.
Increase disclosure of corporate philanthropy: The bulk
of corporate giving to nonprofits is not disclosed to the public due to
the privacy of corporate tax returns and the unwillingness of the SEC
to demand disclosure. The recent trajectory of corporate abuses
including philanthropic misbehavior makes the need for enhanced
disclosure clear.
Corporations undoubtedly have a variety of motives for giving to
charity. Tax breaks, positive publicity, and a genuine concern for the
public good could all encourage a company to donate its money, time,
products, or services to charity. In more sinister cases, corporate
charitable gifts could also be used as bribes to encourage corporate
directors to overlook financial improprieties, as in the case of Enron.
Corporations receive significant tax breaks for their giving--the
money that they donate is in a sense ``public,'' since it is actually
lost tax revenue for the government and the general public. Further,
whether or not it is a motivation for giving, being seen as a good
corporate citizen undoubtedly helps a company's bottom-line. For
example, in 1999 Philip Morris spent $75 million on charitable
contributions, and $100 million to publicize these donations.\3\
Corporate philanthropy, then, can be viewed in many cases as government
subsidized advertising for for-profit corporations. Further, there is
evidence that corporate philanthropy is being used to perpetrate and
perpetuate scandals in corporate America--to the eventual detriment of
shareholders, nonprofits, and citizens alike.
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\3\ Michael E. Porter and Mark R. Kramer. ``The Competitive
Advantage of Corporate Philanthropy.'' Harvard Business Review, 2002.
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For these reasons, NCRP recommends that the SEC adopt disclosure
requirements for all corporate philanthropic donations--in-kind or
cash, through a foundation or directly from the corporation. The amount
donated, as well as the recipient of the funds, needs to be made public
through paper and electronic means on an annual basis. Such a policy
would help restore some faith in corporate America, as well as the
recipients of its charity.It would also allow researchers and advocates
to understand a significant piece of US private giving and work to make
it more fair and responsive to the country's neediest and most
disadvantaged citizens.
Disclose grantmaking by public charities: Private
foundations are not the only charitable grantmakers. While some public
charities such as community foundations routinely and completely
disclose their grantmaking, the grantmaking disclosure performance of
public charities overall is spotty. The public deserves to know who
receives how much of charitable grantmaking whether from public or
private charities.
Current IRS regulations for both public charities and private
foundations require the public disclosure--on IRS Form 990 or 990-PF--
of grantees (including the organization's name and full contact
information), specific purposes of grants made, and potential conflicts
of interest. Based on our use of literally thousands of these documents
for various research projects, only one foundation comes to mind that
follows these requirements. More often than not, the only information
offered is the name of the grantee organization and the grant amount.
Contact information, a specific (or even general) description of how
the money will be used, and conflict of interest information are
rarely, if ever, provided.
Disclose the grantmaking from donor-advised funds: Donor-
advised funds (DAFs) are increasing rapidly, but there is virtually no
disclosure of their grantmaking, much less oversight of their
philanthropic probity. At a minimum, a comprehensive regime of DAF
disclosure should be established.
In 2003 alone, nearly 70,000 new DAFs were established, according
to the Chronicle of Philanthropy.\4\ A private financial adviser has
set up a website (www.donoradvisedfunds.com) to educate potential
clients why they should set up DAFs instead of private foundations.
According to this website: ``Starting a private foundation can involve
substantial start up costs and administrative expanses, such as the
yearly filing of a Form 990-PF. But one of the most important
differences is that Donor Advised Funds receive more favorable tax
treatment than a private foundation. Donor Advised Funds allow donors
to take a federal income tax deduction up to 50% of adjusted gross
income (AGI) for cash contributions and up to 30% of adjusted gross
income (AGI) for appreciated securities; versus 30% of AGI for cash
contributions and 20% of AGI for appreciated securities for a private
foundation. Donor Advised Funds also offer the ability to recommend
grants anonymously, if desired.''
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\4\ Leah Kerkman and Nicole Lewis. ``Donor Funds Are on the Rise
Again.'' The Chronicle of Philanthropy, May 27, 2004.
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Another perk, this site points out, is that donors get all of these
tax breaks, but do not have to make grants to any charitable
organizations anytime soon--while the funds continue to grow. But it is
recommended, however, that a DAF make a minimum grant contribution of
$250 annually.
If donors want to continue to receive significant tax breaks for
``giving'' through DAFs, then they must be held accountable in
radically new ways. At a minimum, DAFs should have the same disclosure
requirements that public charities and private foundations have, and
they should be required to pay out at least 6 percent of their
financial holdings annually to charities.
Disclose all insider relationships with foundation
vendors: Foundations only list a small number of their outside vendors
providing accounting, investment, consulting, and other services,
without any obligation to identify which are related to foundation
trustees or officers. Disclosure of vendors should include all firms
with business relationships with foundation insiders, piercing the
``doing business as'' shield some insider vendors currently hide
behind.
Stronger definitions of and restrictions against foundation trustee
self-dealing also should be implemented, especially a standard that
eliminates the practice of investing foundation assets through
foundation trustees' firms or funds. The Bielfeldt Foundation, in
Peoria, Illinois, paid nearly millions of dollars to three members of
the Bielfeldt family for investment services. The foundation's assets
were invested in risky commodities futures trading, resulting in a 64
percent loss in value in just two years. These types of services should
be outsourced on a competitive basis to companies that are qualified to
invest what are largely public dollars.
Don't count foundation CEO and staff salaries in
foundation payout: NCRP continues to advocate that foundation salaries
and other foundation administrative expenses should be removed from
calculations of qualifying distributions (payout). Removing
administrative costs from foundation payout--while maintaining or
increasing the required foundation payout rate--will result in more
grant dollars going to nonprofits and provide funders with incentive to
be more efficient when spending money on themselves as opposed to their
grantees. NCRP does not advocate that there should be specific limits
or caps on the salaries of foundation executive directors or staff, but
that foundation trustees should review executives' salaries very
carefully and include in their calculations pensions, stock options,
and other perks. In addition, foundations should disclose the total
compensation paid--including benefits, severance packages, and other
payments--to senior staff members.
According to NCRP analyses of IRS data on private foundations, in
2000 $2.5 billion in foundation administrative expenses were included
in their payout calculations. On average, throughout the 1990s, each
year nearly half of these payout-related administrative expenses--44
percent--was used for foundation executive, board of trustee, and staff
salaries and related benefits. As a matter of principle, foundations
should not be allowed to count a $1 million severance package to an
outgoing CEO as the legal and financial equivalent of a $1 million
grant to a nonprofit organization. Foundations receive tax breaks in
exchange for their charitable purpose, which is to get their assets
into the hands of nonprofit organizations. The constitution of
foundation payout should reflect this legal reality.
Limit foundation trustees' compensation: In nearly all
cases, foundation trustees should not be compensated for their board
service. If trustee compensation is deemed necessary, NCRP calls for
limiting compensation or fees for foundation trustees (not including
reimbursement for reasonable travel and incidental expenses) to no more
than $8,000 per year from all sources (i.e., not only fees, but also
compensation through contracts for services such as legal, accounting,
and investment functions). Like salaries and other administrative
costs, foundation trustee fees should be removed from foundations'
qualifying distributions.
If a public charity paid its board members, most foundations would
probably not even consider it for a grant. Ideally, all board service
in the nonprofit sector should be thought of as volunteer work, not as
a highly paid part-time job. And many board positions are highly paid.
A study from the Center for Effective Philanthropy, for example, found
that the median hourly compensation rate of foundation board trustees
in its research sample was $324.\5\
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\5\ The Center for Effective Philanthropy. Effective Governance:
The CEO Viewpoint. 2004.
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Ideally these rates should be reduced to a maximum of $8,000 per
trustee per year, and such payments should not count toward a
foundation's annual grants payout.
Promote foundation diversity: Despite some progress, the
diversity of the philanthropic sector still needs improvement. Racial,
ethnic, gender, and class diversity should be addressed and increased,
particularly among private foundation board members who are still
overwhelmingly white, male, and upper class. Information on the
diversity of foundation board members, senior staff members,
professional staff, and other staff should be publicly disclosed.
A semi-regular survey from the Council on Foundations tracks the
racial and gender diversity of foundation board members. In 1982, 77
percent of all foundation board members in the survey were men. By
2002, some erosion of the gender divide occurred, but not much, with
men representing 65 percent of all foundation board members. Similarly,
in 1982, 96 percent of all board members in the survey were white,
which fell to 89 percent in 2002.
Because foundations are using largely public dollars and many claim
to serve minority and other disenfranchised populations, it makes sense
that foundation staff and board members should reflect the citizens of
the United States--or, at the very least, the communities the
foundations strive to serve--in racial, gender, ethnic, and class
terms.
Maximizing Foundation Support for Nonprofits
Emphasize core operating support grantmaking: NCRP
maintains that at least half of foundation grant dollars should be in
the form of core operating support or flexible grants as opposed to
restrictive, program--or project-specific grants. NCRP's research
indicates that giving nonprofits flexible, unrestricted grant support
leads to stronger organizations, better support for the communities
they serve, and improved relationships between grantors and grantees.
Unlike foundations, nonprofits cannot simply give themselves grants to
cover their core administrative costs. Additionally, in program or
project support, the full cost of nonprofits' reasonable related
administrative or ``indirect'' expenditures should be included in the
foundations' grants.
Increase foundation grants payout: NCRP reaffirms its
longstanding position that private foundation spending, or payout,
should be a minimum of 6 percent annually, with all administrative and
operating expenses excluded from the payout and qualifying
distributions calculations.
Right now, private foundations are required to pay out 5 percent of
their assets each year. Again, this 5 percent currently includes
foundation overhead expenses, as well as grants to nonprofit
organizations and program related investments. Many foundations pay out
exactly 5 percent each year, effectively turning the 5 percent floor
into a 5 percent ceiling. IRS data show that smaller foundations tend
to exceed the 5 percent minimum much more frequently than larger
foundations; smaller foundations also tend to have little--and in some
cases, no--overhead costs.
Interestingly, the foundations with the most overhead costs tend to
also have the lowest payout rates, even when taking overhead costs into
consideration. For example, the IRS analyzed the payout rates of the 50
largest foundations from 1985-1997, and found that only thirteen
actually met or exceeded 5 percent. The other 37 foundations fall short
of this legal requirement, sometimes by more than one full percentage
point. Looking at the ratio of grants to assets, only four of these top
50 foundations met or exceeded 5 percent in 1997.
Many foundation leaders oppose increasing the foundation payout
rate because they claim that any rate about the current 5 percent
increases their minimum spending requirement to a level that is not
sustainable, effectively drawing down foundation assets to nothing.
Most research on payout and returns on investments do not, however,
substantiate the claims that these individuals have made. For example:
Research that the Council on Foundations commissioned
shows that foundations could have maintained a 6.5 percent payout rate
from 1950 to 1998 and would have still increased their assets by 24
percent.
A study conducted at Harvard University on the investment
returns of 200 of the nation's largest foundations found that they
earned an average return of 7.62 percent, while paying out an average
of only 4.97 percent.
US Bancorp's Piper Jaffrey who presented at a recent
meeting of Northern California Grantmakers found that an investment
portfolio made up of 70 percent equity stocks and 30 percent government
bonds earned nearly an inflation-adjusted 8 percent return from January
1980 through December 2002.
Lincoln Investment Planning, Inc. reports that the S&P
500 earned an average annual return of 10.2 percent from 1926 through
December 2002. Investments in small stock companies yielded an average
return of 12.2 percent for the same period.
Further, IRS data show that many foundations annually receive new
infusions of money beyond returns on investments, including new
contributions from individuals and profits from real estate holdings.
Assuming that the only source of revenue for foundations is returns on
investments simply does not reflect the reality of the philanthropic
sector. And considering that the foundation sector has more than
quadrupled in size over the past 25 to 30 years, it is mathematically
impossible that a one or two percent increase in foundation payout
would drain foundation assets and bankrupt the sector.
Establish foundation-comparable donor-advised fund payout
requirements: There is currently no payout minimum for donor-advised
funds. There should be a minimum grants payout from donor-advised
funds, established at a 6% level comparable to the payout rate that
should be required of foundations. Considering the substantial tax
breaks that DAFs receive--and their recent proliferation--they must be
required to provide some minimal return to society, as everyone is
impacted by the lost tax revenue from these charitable vehicles.
Promote philanthropic support for social equity:
Foundations need to better address the needs of disadvantaged and
disenfranchised populations--and the nonprofits that serve them. Toward
that end, there should be more foundation grantmaking devoted to social
justice organizing and advocacy, significantly higher proportions of
grantmaking devoted to racial/ethnic minorities, low-income
populations, immigrant populations, the disabled, gay/lesbian/bisexual/
transgender communities, and a willingness to make grants to smaller
organizations as opposed to the current propensity of many foundations
to make only a few large grants to a small number of large nonprofit
recipients.
In 2002, civil rights and social action nonprofit organizations
received only 1.7 percent of all foundation grant dollars. Minority
populations in general are underserved by foundations. Grants
designated for African Americans/Blacks amounted to only 1.9 percent of
all grant dollars in 2002; for Hispanics/Latinos the figure was 1.1
percent; for the disabled, 2.9 percent; the homeless, 1 percent; single
parents 0.1 percent; and gays and lesbians, 0.1 percent. These are the
groups of people who have been hardest hit by discrimination in
society, and they are entitled to receiving a greater share of
philanthropic dollars.\6\
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\6\ The Foundation Center. Foundation Giving Trends, 2004.
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Despite the fact that the overwhelming majority of nonprofit
organizations in the United States are financially small institutions,
nearly half of all foundation grant dollars was given out in grants
that were larger than $1 million in 2002. Only 18 percent of all grant
dollars were given through grants that were smaller than $100,000.
These data suggest that foundations are not supporting the countless
small, community-based organizations that the nation's most
disadvantaged communities and populations depend on for critical human
services and political representation.
Maintain and support small foundations: While some very
small foundations may very well be economically impractical, NCRP does
not believe that small foundations are any less accountable or
probative than large foundations, and in many cases, because of their
smallness and localism, they are more responsive to disadvantaged
constituencies than others. Therefore, NCRP calls for maintaining and
working with small foundations--and resisting calls for establishing
and raising arbitrary minimum capitalization levels for foundations.
The scandals and abuses in foundations that have been reported in
the press are not exclusive to small foundations. Foundations in all
parts of the country and of all sizes have been engaged in illegal and/
or unethical behaviors, according to these press accounts and the
foundations' IRS filings. It is irresponsible to pass blame for the
recent foundation scandals from the entire foundation sector to just
one segment of the sector, as some nonprofit and foundation leaders are
attempting to do. Doing so is inaccurate, irresponsible, and unethical.
Maximizing Foundation Support for Justice and Democracy
Encourage democratic participation: Foundations should be
encouraged to support nonprofit public policy advocacy, community
organizing, nonpartisan voter registration drives, and civic
engagement. It is perfectly legal for them to do so, and these
activities do more to advance a broad public interest agenda than most
service organizations and programs that foundations currently support.
Foundation investment activism: Foundations invest
hundreds of billions in corporate shares, giving them the opportunity
of voting their proxies on critical matters of corporate governance,
corporate accountability, and other corporate policies. The failure of
foundations to take these affirmative steps with proxy actions results
in missed opportunities for social change. NCRP encourages foundations
to use their powers as shareholders to promote social change.
Unfortunately, the majority of foundations do not take advantage of
this position of power that they currently hold.
Promote mission-based investing: It makes social and
economic sense for foundations to devote part of their investments to
mission-based investment options such as community loan funds, equity
funds, and other charitable instruments. Mission-based investing should
be a standard component of a foundation accountability regime.
Prevent portfolio concentrations: Foundations should not
invest more than a very small proportion of their investments in any
one particular corporation, as the law currently calls for, they should
desist in asking for exceptions to that standard, and those foundations
that have received approval to circumvent this standard should return
to the philanthropic norm of preventing such investment concentrations.
The experience of the David and Lucille Packard Foundation is a
great example why foundations should avoid such concentrations. The
majority of the foundation's investments was held in Hewlett-Packard
company stock. The economic boom of the 1990s--fueled in large part by
the technology sector--boosted the foundation's assets to around $10
billion. Following the economic downturn in 2001--which hit the
technological sector especially hard--the foundation's assets shrank by
$8.3 billion, forcing Packard to eliminate entire grantmaking program
areas and lay off staff members.
Conclusion
Current regulations, laws, and oversight are clearly not working.
The drumbeat of scandalous stories in the nation's newspapers will not
stop anytime soon. But it is not the responsibility of the media to
police the philanthropic sector. Responsibility rests with the
government, at both the state and federal level. Not only do the
current laws and regulations need to be actually enforced, but stronger
and more relevant laws and regulations are needed to reflect the
current realities that both foundations and the charities that they
support face.
NCRP was created nearly 30 years ago, which was the last time the
U.S. Congress took an active interest in holding foundations more
accountable to their grantees and the general public. We are encouraged
that the House Ways and Means Committee is returning to these very
important issues, and look forward to an ongoing dialogue that we hope
will strengthen philanthropy so that it can better serve the people and
communities who need it the most, as well as remain true to the U.S.
citizens who bear the brunt of tax breaks that support the
philanthropic sector.
Statement of Paul Hazen, National Cooperative Business Association
The National Cooperative Business Association appreciates the
opportunity to submit testimony about cooperatives and their tax
treatment. This is a critical issue for cooperatives, their members and
the communities in which they operate. NCBA is the nation's only
national organization representing cooperatives across all sectors of
our economy--including agriculture, childcare, electricity, finance,
food retailing and distribution, healthcare, housing, insurance,
purchasing and shared services, telecommunications and many others.
Cooperative taxation principles and specific provisions of the
Internal Revenue Code reflect the member-owned and governed structure
of cooperatives. Generally, cooperatives themselves do not have taxable
income because they pass through that income to their members in the
form of patronage refunds. Members pay tax on the patronage refunds
they receive. Though cooperatives may not be taxed on income and
business derived from their patrons, they typically do pay taxes on
non-patron income.
Co-ops operate as not-for-profit businesses in that they return any
profits they earn to their members based on the amount of business the
members do with the co-op. Some cooperatives are organized under
section 501(c) of the Internal Revenue Code and are entitled to a tax-
exemption if they meet certain criteria, e.g., operate on an at-cost
basis. While these exemptions address different types of cooperatives,
they are based on the same tax principles applied to other types of
cooperatives. Cooperatives that file under section 501(c), however, are
subject to restrictions not applied to other cooperatives.
How successful a cooperative is either in terms of size or meeting
the needs of its members should not be a measure of whether and how it
is taxed. Cooperatives may be Fortune 500 companies or they may be
small, community-based businesses. But regardless of the size or the
success of the cooperative, the structure remains the same. They are
member-owned and member-controlled. And the tax principles and
provisions that apply to them appropriately reflect that structure.
Cooperatives--A Business Structure that Promotes Ownership and
Accountability
Cooperatives are a vital part of the economy. An estimated more
than 40,000 co-ops in this country are, by definition, businesses that
are owned and democratically controlled by their members. These are the
people who buy the goods or services the cooperative provides, rather
than outside investors. Cooperatives serve some 120 million members by
providing them with agricultural processing and marketing services,
childcare, education, healthcare, affordable housing, financial
services, group purchasing, food and other consumer goods, electricity
and telecommunications services, among many others. Cooperatives and
their members generate millions of dollars in economic activity,
creating jobs, wealth, and opportunity.
Cooperatives return surplus revenues--that is, income over expenses
and investment--to members proportionate to their use of the
cooperative, not proportionate to their ``investment'' or ownership
share. Co-ops are motivated, not by profit, but by service to their
members. Their goal is to meet their members' needs for affordable and
high-quality goods or services. For this reason, outside capital
investment is often hard to attract. Co-op equity consists largely or
solely of member equity.
Cooperatives' member-owned and member-governed structure also
promotes accountability and trust among consumers. A national survey
commissioned by cooperative organizations together with the Consumer
Federation of America found that consumers trust the cooperative
structure more than the investor-owned structure.
Cooperatives fall into four categories:
Producer-owned cooperative--These cooperatives are owned
by farmers or craftsmen who form a co-op to jointly market, process or
produce a similar product. There are 1,600 farmer--or rancher-owned
marketing or processing cooperatives in the United States. New
generation cooperatives--small co-ops that specialize in value-added
agricultural processing--are becoming more popular.
Consumer-owned cooperatives--The largest co-op category,
these cooperatives are owned by the consumers who buy the businesses'
goods or services. They include food co-ops, rural electric and
telecommunications cooperatives, credit unions, housing co-ops, parent-
owned childcare co-ops, and consumer-owned HMOs.
Purchasing and shared services--These cooperatives are
owned by individuals or small businesses that buy goods or services as
a group to lower costs. As more and more small businesses see
purchasing co-ops as the key to their survival, this segment of the co-
op community is growing. NCBA estimates that, nationwide, more than
50,000 independent businesses are members of purchasing co-ops. The
nation's 1,600 farm supply and service co-ops fall into this category,
since they are effectively purchasing co-ops for farmers and ranchers.
Worker-owned cooperatives--These cooperatives are owned
and controlled by their employees. They are similar to companies with
Employee Stock Ownership Plans, known as ESOPs. However, in a worker
cooperative, the employees benefit from the profitability of the
company earlier than ESOP employees. Members of worker-owned co-ops
receive annual taxable dividends on the company's earnings, rather than
waiting for retirement to cash in their stock.
The cooperative structure lends itself to addressing economic
challenges facing America today, especially in rural areas.
Municipalities are using cooperatives to provide needed services at
lower costs. Communities are using the cooperative model to provide
affordable housing that allows seniors to age in place. Cooperatives
are also addressing soaring health care costs and other services for
seniors. Cooperatives also help retain the wealth and purchasing power
of communities. Instead of being drained away from communities by
outside interests, money is put back into local economies by co-op
member-owners. Studies show that the patronage refunds play a
significant role in the economy of the communities in which they
operate. These refunds can be critical to maintaining the vitality or
revitalizing communities, particularly in rural America.
Cooperative Taxation Reflects Unique Structure of Co-ops
Cooperative taxation, though addressed under different provisions
of the Internal Revenue Code, generally follows the same basic tax
principles regardless of the type of cooperative. The principles
reflect the common member-owned and member-governed cooperative
structure.
Unlike investors, members join a cooperative to benefit from the
goods and services it offers, not to make a substantial return on their
investment. Farmers join an agricultural co-op to benefit from the
leverage the group has in negotiating a price for their crop or the
premium enjoyed through the co-op's product branding. Small businesses
join a purchasing co-op to reduce their costs or to reach otherwise
inaccessible markets, such as international markets.
Following is a general description of the tax principles common to
all types of cooperatives.
Single Tax Principle: Surplus Member Revenues Not Taxable:
Cooperatives do not pay income tax for surplus revenues generated by
member business and distributed to or used in the service of members.
For some cooperatives, surplus revenues from member business are
returned to members as patronage refunds at the end of the year.
Refunds can be either cash or equity held by the co-op and allocated to
individual members. The co-op deducts these refunds from its tax
liability, creating a single tax treatment of those revenues at the
patron level. Patronage refunds effectively constitute patron
``overcharges'' or ``underpayments'' returned to members at the end of
the year.
Treatment of Non-Member Revenues: Cooperatives pay corporate income
tax on non-member surplus revenues. This is the same tax treatment as
any other type of corporation. Some co-ops, such as credit unions,
serve only members. As a result, they have insignificant or no non-
member income. IRS rulings and case law have upheld interpretations of
``member business'' that allow some non-member revenue to be treated as
member revenue and therefore not taxable at the cooperative level.
Generally, any income derived from activities for which the principle
purpose is serving members is not taxable.
Some cooperatives have no surplus revenues from member business to
return to their members. Essentially these cooperatives attempt to
operate as close to cost as possible. That is, they offer ``refunds''
in advance, discounts at the point of purchase, discounts negotiated in
advance from suppliers, lower fees, better interest rates on savings,
or lower interest rates on loans.
Tax Treatment of Patronage Refunds: Co-ops with surplus member
revenue may return those surpluses to patrons in the form of cash or
retained equity in the cooperative, or both. In some cases, patrons pay
tax on the refund they receive. Patronage refunds arising from personal
expenses, such as electricity for the home, groceries and other
consumer goods, and interest refunds, are not taxable at the individual
level.
Tax Code Provisions Embody Cooperative Taxation Principles
Cooperatives are covered under several sections of the Internal
Revenue Code. Subchapter T, section 1381-1388, provides single tax
treatment of surplus member revenue, or pass-through treatment, for
businesses that operate on a ``cooperative basis.'' Members are taxed
on any surplus returned in the form of patronage refunds. Cooperatives
filing under Subchapter T include agricultural and other producer
cooperatives, purchasing cooperatives, some banks within the Farm
Credit System, worker cooperatives, and some types of consumer
cooperatives, such as housing and food co-ops.
Under section 521, certain types of farmer cooperatives are allowed
to pass through earnings from non-patron income sources to their
patrons. Refunds are taxable at the patron level. To qualify for filing
under this section, these co-ops must meet thresholds for member versus
non-member business and other criteria.
Some cooperatives file under Section 501(c), which provides six
different types of exemptions. These include service cooperatives
serving non-profit hospitals, credit unions and educational service
cooperatives. While each exemption has its own history, all are based
on member ownership and a purpose of serving their members. For
example, public law states that ``credit unions . . . are exempt from
federal and most state taxes because they are member-owned,
democratically operated, not-for-profit organizations . . .'' PL 105-
219, August 7, 1998.
Under section 501, member revenue is generally exempt
from taxation if the conditions of the exemption are met. These
requirements are in addition to those imposed on other cooperative
businesses.
Section (501)(c)(1) provides tax exemption for ``federal
instrumentalities'' that are cooperative organizations, such as banks
for cooperatives. Some Farm Credit Associations receive tax treatment
under this section.
Section 501(c)(3) provides tax exemption for co-ops, such
as student housing cooperatives, that operate for charitable or
educational purposes.
Section 501(c)(12) provides tax exemption for rural
utility cooperatives--providing electricity, telecommunications, or
water--so long as 85 percent of the income comes from members and is
for the sole purpose of meeting losses and expenses (i.e., operation
at-cost). This is a requirement Subchapter T cooperatives do not face.
Section 501(c)(14) provides tax exemption for credit
unions. It requires them to operate ``without profit'' and ``without
capital stock,'' requirements Subchapter T cooperatives do not face.
Credit unions generally cannot serve non-members, a restriction not
imposed on Subchapter T co-ops.
Section 501(e) provides tax exemption for service
cooperatives serving non-profit hospitals. Like other tax-exempt
cooperatives, these cooperatives face additional operational
restrictions.
Section 501(f) provides tax exemption for educational
service cooperatives.
Some cooperatives covered by 501(c) are exempt from federal income
tax on non-member revenue under certain thresholds, generally related
to whether most of the co-op's income is for its exempt purpose. This
results from the additional statutory or regulatory requirements
specific to these cooperatives and does not constitute preferential
treatment. Generally, this is consistent with the concept of a
``purpose'' test applied to non-member revenue for non-501(c)
cooperatives--that is, the non-member income that is not taxable meets
the primary member service purpose of the cooperative.
Conclusion
Co-ops are member-owned and member-run businesses that return any
profits they earn to their members based on their patronage with the
co-op. This model of business is more accountable and instills more
confidence than companies owned by shareholders in search of
unrealistic returns. At a time of rising deficits, cooperatives are
poised to meet economic challenges such as high health care costs, a
growing aging population and senior housing in rural America.
From large agricultural co-ops to the local food co-op, all
cooperatives are owned and governed by their members. The tax treatment
cooperatives receive reflects their member-owned and member-controlled
structure. NCBA urges the committee to retain that treatment.
Thank you for opportunity to provide testimony. We would be pleased
to discuss the tax treatment of cooperatives further with the
committee.
Ohio Hospital Association
Columbus, OH
May 2, 2005
The Honorable Bill Thomas
Chair, U.S. House Ways and Means Committee
Washington, DC 20515
Dear Chairman Thomas:
On behalf of the Ohio Hospital Association (OHA), we thank you for
the opportunity to submit comments for the record regarding the hearing
held April 20, 2005, on the Tax-Exempt Sector.
OHA is the oldest state hospital association in the nation,
representing more than 170 acute-care hospitals and 40health systems
across Ohio. Our governing Board of Trustees is comprised of
representatives from the whole gamut of providers in Ohio--from large,
urban teaching facilities to small, rural hospitals, and from every
corner of the state. Each of our members is dedicated to providing its
community with the highest quality health care service all day, every
day. The majority of these hospitals are not-for-profit, 501(c) (3)
organizations.
Our members earn their tax-exempt status through a wide range of
services that benefit the community. Ohio hospitals annually provide
more than half a billion dollars in charitable services to the elderly,
uninsured, and indigent for which they receive no reimbursement. They
help educate patients on whether they qualify for discounts and public
health coverage. Hospitals care for everyone who comes through their
doors, regardless of ability to pay.
However, the immense amount of charity care hospitals provide is
only part of the story. Our hospitals provide hands-on training for the
next generation of nurses, technicians, pharmacists, and physicians.
They conduct blood drives, wellness and health diagnosis fairs,
vaccination events, and mobile screening services for cancer and other
life-threatening diseases, saving thousands of lives and health care
dollars each year. They help local and state government prepare for
natural and man-made disasters. Hospitals provide everything from
community education about health risks, diet, and exercise, to basic
items like bandages, thermometers and pedometers. In short, hospitals'
vital contributions to society cannot be measured in dollars alone.
Just like churches, universities, and other organizations,
hospitals receive considerable financial relief by way of their tax-
exempt status. And like churches, universities, and other
organizations, hospitals provide such a diverse and high-level of
service to their community that they more than earn their keep.
Moreover, the savings achieved by tax-exempt status are re-invested in
the community, stretching the value of the government's dollar. While
short-term government revenues might increase if hospitals did not
receive 501(c) (3) status, the long-term loss of access to health care
and of economic development would outweigh the small gains.
Like all of our nation's laws and regulations, those regarding the
tax-exempt sector deserve periodic review and occasional improvement.
As the Congress continues its evaluation of this sector, we look
forward to working with you to ensure the government's resources are
being used wisely and that our fellow citizens continue to receive the
high-quality health care they deserve.
Sincerely,
James R. Castle
President and CEO
Phoenix Children's Hospital Foundation
Phoenix, AZ 85006
April 26, 2005
The Honorable Bill Thomas
U.S. House of Representatives
2208 Rayburn House Office Building
Washington, DC 20515
Dear Congressman Thomas:
I am writing to urge you to protect the charitable sector from
unnecessary and overly burdensome regulations such as those presented
by the Senate Finance Committee, particularly those proposals that
would modify the tax rules regarding non-cash charitable contributions
(known as ``in-kind'' contributions).
The new proposals include recommendations to completely eliminate
or substantially modify deductions for in-kind contributions. Many
charities heavily rely upon non-cash donations, and there is no
legitimate reason to attack this lifeline. In particular, gifts of real
estate have been tremendously beneficial to Phoenix Children's
Hospital. In the past two years, gifts of real estate have generated
over $800,000 in revenue for Phoenix Children's Hospital. These dollars
were used to provide charitable healthcare to children whose families
had no means to pay. Our donors were motivated to donate real estate by
the resulting charitable tax deduction. Their property was fairly
appraised at the time it was donated resulting in their desired and
fair tax deduction.
Changing the in-kind contribution rules would unfairly compel
charities to divert valuable time and resources to new valuation
compliance schemes. The inability of the Internal Revenue Service to
address improper donor behavior should not result in penalties for
charities and the communities and populations which they serve.
Significant revision of the in-kind contribution rules would greatly
diminish my organization's ability to provide altruistic services.
Furthermore, these proposals are not based on any credible evidence
of wide-spread abuse. In fact, empirical data indicates that there is
NOT widespread abuse among the charitable sector and that proposals are
unnecessary. Reports collected by the FBI, the Federal Trade
Commission, State Attorneys General and even watchdog groups like the
Better Business Bureau show that reports of charity fraud are less than
1 percent of all complaints of fraud. This is consistent with every
single year's annual findings in the annual report on Fraud in the
United States published by the FTC.
It appears that many of the suggestions are driven by a desire to
raise federal revenues from the charitable sector. Such an effort is
completely inconsistent with the notion of tax-exempt status, and I
hope you will strongly oppose such proposals. The tax-exempt sector
provides an array of services to the public and advocates for under
served populations, including children, minorities, women and the
elderly. We fight disease, domestic violence, pollution and crime while
promoting education, literacy and family values. Without the tax-exempt
sector, there would be an enormous burden on the federal government to
provide these services. Please ensure the stability of this sector by
opposing these new, unnecessary regulations.
The Senate Finance Committee's proposals to alter the non-cash
charitable gift incentives come at a precarious time for charities.
Americans are a generous people, but many charities are still
recovering from the past several years when charitable giving has been
flat and even decreased for many organizations.
At the same time, we understand that your committee seeks to gather
information on the size, scope and impact on the economy of the
nonprofit sector; the need for congressional oversight; IRS oversight
of the sector; and what the IRS is doing to improve compliance by the
sector with the law. These are laudable objectives. We are interested
in assisting the committee in identifying appropriate areas for further
study as well as criteria and standards to better define and outline
the sector and its players.
Again, I urge you to oppose changes to the in-kind contribution
rules as well as any unreasonable and burdensome legislation that would
harm the charitable sector. I very much appreciate your support.
Thank you for your consideration.
Sincerely,
Heidi A. Droegemueller
Director of Major Gifts
Read ``Write'' Adult Literacy Program
Moriarty, NM 87035
May 4, 2005
The Honorable Bill Thomas
U.S. House of Representatives
2208 Rayburn House Office Building
Washington, DC 20515
Dear Congressman Thomas:
I am writing to urge you to protect the charitable sector from
unnecessary and overly burdensome regulations such as those presented
by the Senate Finance Committee, particularly those proposals that
would modify the tax rules regarding non-cash charitable contributions
(known as ``in-kind'' contributions).
The new proposals include recommendations to completely eliminate
or substantially modify deductions for in-kind contributions. Many
charities heavily rely upon non-cash donations, and there is no
legitimate reason to attack this lifeline. Twenty-three (23%) of
Torrance County reads below a first grade level. The need for our
literacy program is apparent. At least 45% of our annual budget is in-
kind contributions. This consists largely of donated space and
volunteer hours. Our volunteer tutors donate over 2,500 hours per year
to help adults learn to read, write, and comprehend English. In-kind
space for our office is donated by the Moriarty Community Library which
values up to $10,000. Neither the tutors nor the Library receive any
benefit other than the success of the students and our program. Without
our in-kind donations the program would not exist.
Changing the in-kind contribution rules would unfairly compel
charities to divert valuable time and resources to new valuation
compliance schemes. The inability of the Internal Revenue Service to
address improper donor behavior should not result in penalties for
charities and the communities and populations which they serve.
Significant revision of the in-kind contribution rules would greatly
diminish my organization's ability to provide altruistic services.
Furthermore, these proposals are not based on any credible evidence
of wide-spread abuse. In fact, empirical data indicates that there is
NOT widespread abuse among the charitable sector and that proposals are
unnecessary. Reports collected by the FBI, the Federal Trade
Commission, State Attorneys General and even watchdog groups like the
Better Business Bureau show that reports of charity fraud are less than
1 % of all complaints of fraud. This is consistent with every single
year's annual finding in the annual report on Fraud in the United
States published by the FTC.
It appears that many of the suggestions are driven by a desire to
raise federal revenues from the charitable sector. Such an effort is
completely inconsistent with the notion of tax-exempt status, and I
hope you will strongly oppose such proposals.
The Senate Finance Committee's proposals to alter the non-cash
charitable gift incentive comes at a precarious time for charities.
Americans are a generous people, but many charitable giving has been
flat and even decreased for many organizations.
At the same, we understand that your committee seeks to gather
information on the size, scope and impact on the economy of the
nonprofit sector; the need for congressional oversight; IRS oversight
of the sector; and what the IRS is doing to improve compliance by the
sector with the law. These are laudable objectives. We are interested
in assisting the committee in identifying appropriate areas for further
study as well as criteria and standards to better define and outline
the sector and its players.
Again, I urge you to oppose changes to the in-kind contributions
rules as well as any unreasonable and burdensome legislation that would
harm the charitable sector. I very much appreciate your support.
Thank you for your consideration.
Sincerely,
Tina J. Cates-Ortega,
President
Betty Miller,
Program Director
Statement of Steven M. Rose, Walpole, Massachusetts
The public charity reforms proposed by the JCT do not go far enough.
The problems need to be solved for decades to come. Please
consider the following 6 proposals:
1. Compensation Speed Limits: Please enact firm numerical ``speed
limits'' on public charity insider compensation. Legally require only
``government sector compensation comparisons'' for public charity
compensation. The JCT proposals for compensation limits are not
quantitative enough and will just further burden our limited Government
resources to interpret and police. Firm numerical speed limits on
insider compensation (along with fines for breaking and/or evading the
speed limits) will be much more efficient and will maximize the amount
of money applied to each charities' exempt purpose, as opposed to
enriching well connected insiders and their advisors. Public charity
insiders have developed schemes to evade and defeat the current
intermediate sanctions regime and they will do the same under a new
regime if speed limits are not clearly posted. Just like Government
public service, one should not be working at a public charity in order
to ``get rich,'' this only sullies and conflicts with the charitable
purpose. This is all about finding the most efficient way to limit
greed and increase accountability.
2. Report ALL Compensation and Fee Arrangements and Amounts Paid:
Public charity compensation and fee reporting should be greatly
expanded to report to the public ALL compensation and fees directly and
indirectly paid by public charities. Public charities are ``taxpayer
subsidized organizations'' and like the Government all compensation and
fee information and arrangements should be disclosed for the public to
see. This encourages public charity integrity and transparency. Hiding
most of the compensation and fee picture from public view does not
serve the public interest, it serves special insider interests and
allows for undisclosed ``special'' or ``patronage'' like arrangements
to run rampant among insiders, outside of Public and Government view.
More comprehensive Public disclosure of compensation and fee
arrangements and amounts paid is very important to help determine
whether individuals connected to public charities are overpaid at ALL
LEVELS of the public charity.
3. Directly Connect Each Donor's Charitable Contribution to Public
Charity Information: Most donors are unaware of and/or don't know where
to find information on the public charity they are contributing their
hard earned money to, and many public charity insiders would like it to
stay that way. That's unfair and should definitely change. When
soliciting money and after receiving any charitable contribution, the
public charity should be required to inform each donor of a web site
where the donor may review the public charity's detailed and fully
disclosed returns, related entity returns and audited financial
statements. This would be like giving the investor (contributor) an
opportunity to look at the financial prospectus and other fully
disclosed financial information filed with the SEC before they invest
(contribute). A simple and decent provision that would connect the
contributor to the charity's financial information will help
immeasurably toward making sure that public charity insiders and their
advisors are continually reminded that they are accountable to the
Public for the money they receive.
4. U.S. Government Posting of Public Charity Filings on the
Internet: The U.S. Government should establish and maintain a web site,
much like the SEC, for promptly posting all public charity filings and
disclosures so the Public can readily review them in order to make
important evaluations about how a particular charity is using its
money. The U.S. Government should charge each public charity a small
fee according to the size of the charity for this very important public
service.
5. A Visible and Welcome Place to Report Public Charity Abuse:
Public charity reform should include a formal mechanism and place for
the public to confidently report complaints and concerns about charity
abuse. The current avenue for raising concerns about possible terrorist
involvement, financial corruption and other abuse of public charities,
is an uncertain and difficult route to take. Congress needs to enact
laws that clear all roadblocks and welcome concerns about the conduct
of public charities. Please consider the establishment of an ``Exempt
Organization Commission,'' modeled after the SEC. Please also review
Massachusetts Attorney General Reilly's ``Act to Promote the Financial
Integrity of Public Charities, Section 3, Audit Committees; Procedures
for Submission of Complaints and Concerns'' (see www.bostonbar.org/sc/
bl/docmat0304.htm for a copy). The U.S. Government should enact similar
procedures to promote integrity.
6. Conflict of Interest Provisions: Please consider enacting strict
conflict of interest provisions modeled after state ``conflict of
interest'' laws, especially for large public charities. Conflict of
interest laws help to insure the integrity of state and local
government. They can be applied as well to insure the integrity of
public charities, which exist, like the government, to serve the public
interest. Firm and clear conflict of interest provisions that prohibit
self-dealing among insiders are crucial to public charity reform. The
Massachusetts conflict of interest laws can be viewed at: www.mass.gov/
ethics/. Conflict of interest ``red flags'' were raised last summer and
this prompted Massachusetts Governor Romney to veto a provision that
would have increased secrecy with public pensions funds and he said
(July 4, 2004 Boston Globe): ``Given our history in Massachusetts of
abuse and potential self-dealings, we're very concerned about
confidentiality provisions as they relate to investments of billions of
dollars of public pension funds.'' No question about it, these very
same concerns apply to the significant amounts of public charity money
being ``secretly'' managed by public charity insiders with ``No Public
Accountability or Transparency.'' We need more public charity openness
as opposed to secrecy (confidentiality); secrecy serves the self-
indulgent monetary interests of insiders, and is a recipe for
corruption.
The more quantitative and exact the rules are, the less likely they
will be subject to ``evasive interpretation'' by money hungry insiders
and their public charity paid advisors. Clear rules that require
minimal time and money to understand and comply with and will greatly
lessen the burden on the Government and public charities. This
objective will help public charities spend much more of their time and
money on fulfilling the charitable purpose. I hope members of Congress
will listen to the often under-represented concerns of people who are
Not public charity insiders when writing new rules needed to safeguard
our nation's charitable assets, for decades to come.
I've tried to limit my comments to 2 pages. However, since November
of 2002, I've submitted a great deal of information about charity abuse
to Senators Grassley and Baucus. Unfortunately, I know, first hand, how
really bad the abuse is. It's disheartening. So much depends on the
integrity of our country. Like you, I want to do all that I can to help
fix what I know is broken. Please feel free to contact me, if you would
like more information. Thank you for your public service.
San Diego County Veterinary Medical Association
San Diego CA 92120
April 18, 2005
The Honorable Bill Thomas
Chairman, Committee on Ways and Means
United States House of Representatives
1100 Longworth House Office Building
Washington, DC 20515
Dear Representative Thomas:
Concerns surrounding unfair business competition by tax-exempt
organizations continues among the tax paying small business community
nationally. Although currently not a direct problem for the veterinary
industry in San DiegoCounty, we have concerns that this activity may
soon be attempted here as it is done in other communities nationwide.
Our perspective is proactive rather than reactive at this time.
In some communities throughout the U.S., societies for the
prevention of cruelty to animals and like organizations have begun to
expand their services beyond their charitable mission. In an attempt to
generate revenue for their organization they are providing inherently
commercial, veterinary medical services to the general public without
regard for their charitable need or financial ability to pay.
Hearing testimony transcripts from a California legislative panel,
as well as a recent Internal Revenue Service Panel would indicate that
most of these business activities by tax-exempt organizations go
unreported to the IRS pursuant to the Unrelated Business Income Tax
(UBIT) reporting requirement. Criteria that provide examples of what
``unrelated business income'' activities are, are absent with the
exception of ``animal boarding'' referenced as ``unrelated'' to a
charitable mission. A solitary example in itself may encourage an
absence of income activity reporting.
The many other veterinary medical services that are provided by
these charities to the general public without regard to charitable need
apparently go unreported by most. In contrast, veterinarians operating
small business hospitals and clinics are taxed fully and at several
levels.
I am the President of this local veterinary association
representing 650 members and I appreciate the opportunity to make you
aware of our concerns, which we feel are representative of the almost
100,000 veterinarians nationally. In the March 1, 2005 Panel on the
Nonprofit Sector Interim Report presented to the Senate Finance
Committee we could not find UBIT reporting on their current agenda for
providing recommendations for ``strengthening the accountability of
charities and foundations'' but assume this issue will be addressed in
their final report. We hope that you will direct and support efforts to
define and enforce appropriate regulations, enhanced example
guidelines, and oversight. Doing so will show fair support for a
substantial small business sector as well as increase the taxable
revenue paid to the governmental coffers.
We commend philanthropic and charitable organizations for the
distinctive role they play in our society. Animal assistance
organizations have a significant and vital charitable role in serving
the plight of abandoned and abused animals. Some also provide subsidies
for medical services to a needs-based population. Veterinarians commend
and support that compassionate mission and many lend their own services
to these organizations and provide pro bono contributions to the
community on many levels on a regular basis. The practice of veterinary
medicine, both clinically and from its operational perspective, fairly
belongs in the established and well-regulated small business arena.
Taxation exemption should not be allowed when provided to the general
public by a ``charity''.
Keith Hilinski
President
Statement of Peter V. Berns, Standards for Excellence Institute
On behalf of the Standards of Excellence Institute we appreciate
the opportunity to submit comments as the Ways and Means Committee
undertakes a broad review of issues concerning the tax-exempt,
nonprofit sector in the United States.
The Standards for Excellence Institute is a national initiative
that promotes a comprehensive system of nonprofit sector self-
regulation. Originated in Maryland, it now includes active programs in
six other states with outreach to groups anywhere in the nation. The
Institute couples a strong ethics and accountability code--Standards
for Excellence--with the resources needed to achieve the highest
standards in governance, management and operations. The program
provides educational resource packets, clinics and person to person
technical help to assist groups interested in understanding and
implementing the individual standards. There is also a voluntary system
of certification, based on an extensive peer review process, leading to
the award of a ``Seal of Excellence'', which is subject to periodic re-
certification. The program was cited as a model in the Finance
Committee's discussion paper last year.
A careful review of the tax-exempt nonprofit community will clearly
find some examples of abusive practices, excessive compensation, and
areas such as tax shelters and credit counseling that demand
examination and corrective action by the Congress and regulators at the
federal and state level. What is less clear is how many of these
problems require new laws or regulations rather than more effective
enforcement of existing rules. It appears that many of these practices
are already illegal, and there is uniform support from the nonprofit
sector for more rigorous enforcement by the Internal Revenue Service,
and a need for more resources for that purpose. We strongly support the
work and recommendations of the Panel on the Nonprofit Sector convened
by Independent Sector on these issues.
A careful review will also find that the nonprofit sector is
extremely diverse, and that ``one size fits all'' reforms could be a
terrible mistake. Simply put, the level of regulation and reporting
appropriate and necessary for large national organizations may present
an impossible burden for groups that have small staffs, limited
resources, and may rely completely on volunteers in serving the
community. These make up the vast majority of tax-exempt organizations
across the country.
From years of providing assistance to hundreds of organizations,
and from our experience implementing the Standards for Excellence
program, we have come to understand that better management and
accountability cannot be assured simply by new laws and law
enforcement.
Adoption of new stringent regulations, new reporting requirements,
and new accreditation programs for nonprofits will not change two
essential facts. First, tens of millions of well-intended individuals
are involved in the management and operation of the nations' charities,
and many already know they should be doing more in terms of management,
but simply lack the time and resources. Second, for the most part,
nonprofits' compliance with legal requirements or with voluntary
standards of `best practice' is essentially self-enforced.
Our research and experience have shown that nonprofit board and
staff leaders have high expectations for themselves and their
organizations, that unfortunately often exceed the level of performance
they are able to achieve with the time and resources available to them.
Any effective program to broadly improve the governance, management
and accountability of nonprofit organizations must address the
obstacles that prevent them from improving these areas within their
organizations.
First, there must be an accessible, user friendly and clear
statement of standards that provides guidance and sets high
expectations for how nonprofits are governed, managed and operated.
A second significant problem is that we have under-invested in the
infrastructure of nonprofit organizations and the nonprofit sector.
Facing increasing demands for services they provide, with limited staff
and resources to perform core mission activities, few can afford the
time, effort and expense that is required to improve their governance
and management practices. In fact, most of the incentives at present
encourage nonprofits to spend as little as possible on their management
and administration.
We need to make clear that it's OK, in fact that it is expected,
for board and staff leaders to pay attention to internal organizational
health and to invest in building well run, responsibly governed,
sustainable nonprofits. And we need to make resources available to
support them as they endeavor to do so.
A further major obstacle is that there are limited financial
resources available to support those of us who are trying to help the
helpers. The assistance that is currently available from state
associations of nonprofits, local management support organizations, as
well as national groups, is limited by our reliance on members' dues,
fees, and already stretched thin philanthropic support.
Improvement and expansion of programs such as the Standards for
Excellence, and of training and information to promote basic legal
compliance, will require more than is foreseeable from these sources.
This is a logical area for partnership between government and the
nonprofit sector. Nonprofit organizations deliver many vital government
funded programs and services, and provide programs and services to
citizens where government efforts are limited or non-existent.
Just as it made sense years ago to develop federal and state
programs to support the development and growth of small businesses, it
makes sense now for both federal and state governments to invest in
strengthening the capacity of nonprofits to serve the community.
The national version of the Standards for Excellence is available
on the web at http://www.standardsforexcellenceinstitute.org/public/
html/explore_b.html.
Appended to these comments is additional information on the
Standards for Excellence Institute and its national programs.
______
The Standards for Excellence Institute is a national initiative to
promote the highest standards of ethics and accountability in nonprofit
governance, management and operations, and to facilitate adherence to
those standards by all nonprofit organizations. The Institute uses as a
vehicle the Standards for Excellence program, a system of nonprofit
sector self-regulation originated by the Maryland Association of
Nonprofit Organizations and now replicated by nonprofit associations in
Ohio, Pennsylvania, Georgia, Louisiana, North Carolina and Illinois.
The Standards for Excellence program has been developed to
strengthen nonprofit organizations' ability to act ethically and
accountably in their management and governance, therefore enhancing the
public's trust in the nonprofit sector. The program promotes widespread
application of a comprehensive system of self-regulation in the
nonprofit sector--the first of its kind in the United States.
The Standards for Excellence: An Ethics and Accountability Code for
the Nonprofit Sector (Standards, Standards for Excellence) is the
centerpiece of the program. The Standards are based on the fundamental
values of honesty, integrity, fairness, respect, trust, compassion,
responsibility and accountability, and provide a guideline for how
nonprofit organizations should act to be ethical and accountable in
their program operations, governance, human resources, financial
management and fundraising.
Standards for Excellence set a high benchmark,exceeding the minimum
legal requirements by establishing a new standard to quantify how well
managed and responsibly governed nonprofit should operate.
The Standards cover eight areas of nonprofit governance and
operations:
Mission and Program
Governing Board
Conflict of Interest
Human Resources
Financial and Legal Accountability
Openness
Fundraising
Public Affairs and Public Policy
The Standards cover a broad range of topics such as: how many times
each year an organization's board of directors should meet, what
subjects should be covered in an organization's personnel policies, and
when audited financial statements should be prepared. The Standards
also encourage organizations to have procedures in place to evaluate
their programs and require board member, staff and volunteers to
disclose any conflicts of interest.
Standards
The Standards for Excellence Institute works with its affiliates to
implement the Standards in their organizations in a number of ways. The
Institute provides affiliates with extensive written educational
materials detailing best practices, outlining model policies, and
providing user-friendly samples. Specialized training seminars are
available on a range of topics that are pertinent to implementing the
Standards in your organization. Ongoing one-on-one technical assistance
is also accessible, allowing your organization to personally contact
the Institute to address any questions that might emerge during the
implementation process.
Putting The Standards for Excellence Program to Work
If you are a nonprofit organization you can . . .
Set a new benchmark for your organization by implementing
the Standards for Excellence: An Ethics and Accountability Code for the
Nonprofit Sector, with the support of your Board of Directors and
Staff;
Show a copy of the Standards for Excellence Introductory
Video to your Board of Directors and Staff; or
Apply for the Seal of Excellence through the Standards
for Excellence voluntary certification program (Now available in
Maryland, Ohio, Pennsylvania, and Louisiana).
If you are a foundation or a grantmaker you can . . .
Distribute copies of the Standards for Excellence: An
Ethics and Accountability Code for the Nonprofit Sector to the
nonprofits in your area as a blueprint for well managed, responsible
governed organizations.
Encourage and/or underwrite the organizations you support
to use the Standards for Excellence as a tool for strengthening
operations.
License the Standards for Excellence Program and launch a
full-scale Standards program in your region.
Support the Standards for Excellence programs operating
in your region.
Sponsor a Standards for Excellence Institute training for
nonprofits or grantees in your region.
If you are an association you can . . .
Purchase copies of the Standards for Excellence: An
Ethics and Accountability Code for the Nonprofit Sector to distribute
to nonprofits in your area as a blueprint for well managed, responsible
governed organizations.
Contract with the Standards for Excellence Institute to
provide training for nonprofits or grantees in your region.
Apply for the Seal of Excellence through the Standards
for Excellence voluntary certification program (Now available in
Maryland, Ohio, and Pennsylvania). Soon to be available in additional
states and jurisdictions.
Become a supporter of the Standards for Excellence
program by partnering with current or potential Standards replication
partners.
Affiliation to the Standards for Excellence Institute provides your
organization and/or you, as an individual, access to a wealth of
knowledge and support that will enable you to abide by the highest
level of standards set forth by the nonprofit sector.
Affiliate packages are available for:
Nonprofit Organization--501(c)(3), 501(c)(4), or 501(c)(6)
Individual Associates--not employed by a nonprofit
Foundations/Federated Funding Agencies/Grantmaking Organizations
Full Time Students
Affiliate Benefits include:
Discounts on purchases of Standards booklets
Access to the Standards Educational Resource packages and
permission to make additional copies of the materials
Contacting Standards For Excellence Institute's expert
staff through telephone technical assistance
Access to information from our comprehensive nonprofit
management library
Participation in online forums with other members
Discounts on customized Standards training programs
Fees are determined by the type of membership and are based on a
sliding scale. To receive more information about membership please
refer to www.standardsforexcellenceinstitute.org