Article Archives >> Lead Stories >> February 1-15, 2005

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Congress Looks to New Taxes on Charities
and Limitation on Deductions to Help Cure Deficit
Biggest hit would be limitation on deductions for clothes,
household goods, and other property given to charities

The Joint Committee of Taxation in Congress has issued a 435-page report suggesting ways to close the federal budget gap by improving tax compliance, including a series of suggestions, some more realistic than others, for picking up some of the revenue from tax-exempt entities. (JCS-02-05, 1/27/05.)

Although most of the proposals affect individual and business tax issues, a section on exempt organizations could pick up nearly $7 billion over the next ten years, the Committee says.

The proposals include denying exempt status for organizations that fail a five-year review for renewal, imposing a termination tax on exempt organization conversions, taxing participation in abusive tax shelter deals, extending intermediate sanctions, increasing excise taxes on private foundations, limiting deductions for conservation easements and gifts of clothing, household goods and other property, increasing penalties for failing to disclose tax returns, expanding the base of the excise tax on private foundation investment income, limiting the exempt status of fraternal beneficiary societies that provide commercial-type insurance, and cracking down on credit counseling organizations.

Sen. Chuck Grassley (R-IA), chairman of the Senate Finance Committee, which is already seeking to reform charitable organizations (See Ready Reference Page “Senate Committee’s White Paper Proposes Vast Expansion of Federal Power Over Charities”), says the recommendations “should help to remove the rose-colored glasses that a lot of people use to view tax-exempt organizations.”

Limiting Deductions for Gifts of Personal Property

The biggest chunk of money would come from limitations on deductions for charitable gifts of clothing, household items and other property. The proposal would limit a taxpayer’s deduction for clothing or other household property to $500 a year for all donations, no matter what the value of the goods or the number of contributions, and prohibit any carry-over to other years. Paintings, antiques and other art objects are excluded from the proposal. The Committee said the valuation of household goods has presented “a similar problem” to that involved with gifts of automobiles, which Congress addressed by limiting deductions in last year’s American Jobs Creation Act. (See Nonprofit Issues, October 16-31, 2004.)

The Committee noted that “some might argue that the deduction for clothing and household items should be eliminated entirely, in part on the grounds that such property is difficult to value and such contribution deductions are difficult for the IRS to enforce, but also for the reason that taxpayers that contribute such property do not need a tax incentive to make the contribution.” But the Report concluded that it was sufficient merely to limit the deduction. The proposal would save an estimated $1.9 billion over ten years.

The Committee would also eliminate the fair market value deduction for appreciated property contributed to charity for use in its charitable program and would limit the deduction to the donor’s tax basis in the property. The stated rationale is because the determination of fair market value “creates a significant opportunity for error or abuse.” The Committee offers two variants on the proposal, but estimates that permitting the deduction limited to the tax basis or fair market value, whichever is lower, would generate $2.5 billion over ten years.

In addition to the problems with valuation, the Committee says that the fair market value deduction generally places gifts of cash and gifts of property “on an equal footing,” but “a primary goal of the charitable deduction … should be to encourage gifts that are most useful to a charitable organization, and should not be to encourage gifts that entail significant diversion of resources from the charitable mission or that require a charity to incur substantial transaction costs. Cash, publicly traded securities, and arguably property that can be used directly in substantial furtherance of exempt purposes meet this standard. Other gifts of property generally do not and so need not be as favored.”

The proposed change would not affect gifts of publicly traded securities, but would apparently apply to privately traded securities, real estate, and S corp stock.

Five-Year Review Proposal

The proposal for a five-year review of charitable exempt status parallels a proposal already floated in the Senate Finance Committee report. It would cause some organizations to become taxable and remove deductibility for gifts to those organizations, but would return less than $50 million in new revenue over ten years.

The Joint Committee would impose a tax equaling the value of any assets of a charity that are not continued in a charitable use after a “conversion” through sale, merger or joint venture or other transaction. Since many “conversions” result in creation of a grantmaking foundation (See Ready Reference Page “Conversion Foundations Face Key Issues Early”) or continuation of the charitable program in a different form, the loss of charitable dollars has not seemed to be a great problem. The Committee proposes an elaborate mechanism to determine how to impose the tax, but estimates that it, too, would raise less than $50 million over 10 years.

The proposal to extend intermediate sanctions would eliminate the rebutable presumption rules (See Ready Reference Page “Charities Must Avoid Excess Benefit Transactions”) and impose a tax on organizations that do not follow the safe harbor procedures as minimum due diligence for reviewing transactions with insiders of the charity. The key change, however, would be to eliminate the “initial contract” exception which provides that a person is not a “disqualified person” subject to the tax as the result of the first transaction with the charity. Approval of this proposal could result in imposition of excess benefits taxes on contractors who charge too much for major contracts or purchasers who pay too little for buying assets of a charity. The Committee estimates this change would pick up $200 million over ten years.

Private Foundations Not Exempt from Proposals

The Committee proposes to increase private foundation excise taxes for self-dealing, failure to distribute sufficient income, excess business holdings, jeopardizing investments, and taxable expenditures (See Ready Reference Pages for Private Foundations), even though it estimates the changes would raise less than $50 million over ten years.

In increasing the tax on private foundation investment income, the Committee would expand the definition of gross investment income to include certain items not now in the Tax Code but identified by Treasury Regulations, including income from notional principal contracts, annuities and other substantially similar income. The Committee would also impose a new tax on the gain from the sale of capital assets, such as a foundation’s office building, used to further an exempt purpose. This would pick up $200 million over ten years.

Modifying deductions for façade and conservation easements and eliminating them altogether for personal residence properties would raise $1 billion.

The Committee would add a requirement for a charity to publicly disclose its Form 990-T tax return for unrelated business income tax and would require an organization with gross revenues of more than $10 million (including contributions and investment income) to file a certification by an independent auditor or counsel stating that the regular Form 990 return and Form 990-T, if any, accurately reflect the unrelated business income tax liability of the organization. (See Ready Reference Page “Nonprofits Often Worry About UBIT”.) This proposal would also pick up less than $50 million over ten years.

The Committee would remove the Section 501(c)(8) exemption of a fraternal beneficiary society if a substantial part of its activities involves providing commercial-type insurance in order to remove an “unfair competitive advantage” of such groups. This would save $500 million over 10 years.

The proposal to add additional exemption standards on consumer counseling agencies would reduce the number of exemptions and add $100 million over ten years.

YOU NEED TO KNOW

Charities cannot take these suggestions lightly. These proposals would raise a pittance of the funds necessary to cure our deficit — less than $7 billion in an additional deficit estimated to be about $2.3 trillion in the next ten years, which could expand to $4.1 trillion if the Bush Administration makes its tax cuts permanent and by another $1 or $2 trillion if we borrow for social security personal accounts. But they are relatively easy to impose because there is not a well organized and well financed constituency to oppose them. It is time for charities to redouble their efforts to show their local members of Congress what the charities do for our society and how they would be adversely impacted by some of these rules.

Article Archives >> Lead Stories >> February 1-15, 2005