Tax-exempt organizations, by definition, are exempt from federal income tax under various provisions of the Internal Revenue Code. However, some are directly involved in abusive tax avoidance transactions (ATATs). In addition, because they are tax-indifferent, tax-exempt organizations are, at times, used by for-profit entities as accommodation parties in these transactions.

Abusive Tax Avoidance Transactions Involving S Corporations

The Treasury Department and the Internal Revenue Service has issued guidance on certain kinds of abusive tax avoidance transactions involving S corporations and tax-exempt entities, such as charities. These transactions are structured to improperly shift taxation away from taxable S corporation shareholders to an exempt party, for the purpose of deferring or avoiding taxes.

In Notice 2004-30, the IRS says it intends to challenge these transactions on a number of grounds. It further declares that these abusive transactions are considered "listed transactions." Participants in a listed transaction who are required to file tax returns must disclose their participation to the IRS. In addition, promoters of listed transactions must keep lists of investors and, in certain cases, register those transactions with the IRS. 

Additional Information:

S-Corporation Tax Shelter Strategy

Contributions of Successor Membership Interests in Limited Liability Companies Holding Real Property

The IRS has issued Notice 2007-72, designating certain transactions as having the potential for tax avoidance or evasion and alerting participants to required disclosures and potential penalties. In these transactions, a taxpayer transfers a membership interest in a limited liability company that directly or indirectly owns real property to a section 501(c)(3) charitable organization or government entity, claiming a charitable contribution deduction for an amount significantly higher than the original purchase price paid by the taxpayer to acquire the interest. Charitable organizations that receive property in these transactions after August 14, 2007, are participants in these transactions for the first year in which their tax returns reflect the acquired interest, which is generally the year of receipt of the interest. For that year, the charity must disclose certain information to the IRS required by the reportable transaction regulations or be subject to penalties as described in the notice.

The IRS has begun notifying organizations that have participated in these transactions that they have been selected for examination.

Conservation Easements

Background - Abusive Transactions Involving Charitable Contributions of Easements

In recognition of our need to preserve our heritage, Congress allowed an income tax deduction for owners of significant property who give up certain rights of ownership to preserve their land or buildings for future generations.

The IRS has seen abuses of this tax provision that compromise the policy Congress intended to promote. We have seen taxpayers, often encouraged by promoters and armed with questionable appraisals, take inappropriately large deductions for easements. In some cases, taxpayers claim deductions when they are not entitled to any deduction at all (for example, when taxpayers fail to comply with the law and regulations governing deductions for contributions of conservation easements). Also, taxpayers have sometimes used or developed these properties in manner inconsistent with section 501(c)(3). In other cases, the charity has allowed property owners to modify the easement or develop the land in a manner inconsistent with the easement’s restrictions.

Another problem arises in connection with historic easements, particularly façade easements. Here again, some taxpayers are taking improperly large deductions. They agree not to modify the façade of their historic house and they give an easement to this effect to a charity. However, if the façade was already subject to restrictions under local zoning ordinances, the taxpayers may, in fact, be giving up nothing, or very little. A taxpayer cannot give up a right that he or she does not have.

Additional Information:

• The Pension Protection Act of 2006 enacted several provisions to encourage conservation contributions while limiting abuses.

  • Notice 2007-50, Guidance on percentage limitations imposed by Code section 170(b)(1)(E) on qualified conservation contributions made by individuals.

• Remarks of Steven T. Miller, before the Spring Public Lands Conference, Washington, DC (Mar. 28, 2006)

• Remarks of Steven T. Miller, before the Land Trust Alliance, Madison, Wisconsin (Oct. 17, 2005)

• Testimony of Steven T. Miller on the Tax Code and Land Conservation, before the Senate Finance Committee (June 8, 2005)

• IR-2005-19, News release announcing "dirty dozen" tax scams, including contributions of historic facade easements (Feb. 28, 2005)

• Remarks of Steven T. Miller, before the American Society of Appraisers (Oct. 22, 2004)

• Notice 2004-41, Notice informing taxpayers of the potential adverse tax consequences of certain transactions involving conservation easements

• IR-2004-86, News release announcing issuance of Notice 2004-41 (June 30, 2004)

Corporation Sole Organizations

This revenue ruling Revenue Ruling 2004-27 held that a legitimate corporation sole is designed to ensure continuity of ownership of property dedicated to the benefit of a legitimate religious organization. A taxpayer cannot use a corporation sole created to avoid or evade income taxes as a means to exclude the taxpayer's personal income from tax.

Additional information:

• IRS Warns of "Corporation Sole" Tax Scam, IRS News Release, IR-2004-42, March 29, 2004
   

• IRS Publication 1828, Tax Guide for Churches and Religious Organizations

Credit Counseling Organizations

Three federal agencies are working together to promote integrity within the credit counseling industry and help individuals obtain reliable high quality services. In doing so, each agency pursues its individual enforcement responsibilities.

• IRS ensures that credit counseling organizations holding themselves out to the public as tax-exempt charitable and educational organizations comply with the requirements for tax-exempt status. The IRS website provides resources for persons needing to verify the tax-exempt status of a credit counseling organization, and information about its initiative to ensure that credit counseling organizations comply with federal tax laws. It also highlights provisions of a new law that establishes standards an organization must satisfy to qualify for exemption under Internal Revenue Code section 501(c)(3) or 501(c)(4).

• The Federal Trade Commission (FTC) brings law enforcement actions against credit counseling agencies for violations of federal consumer protection laws. To get tips on selecting a credit counseling organization or to file a complaint, visit the FTC website or call toll-free, 1-877-FTC-HELP (1-877-382-4357) (TTY 1-866-653-4261).

• The U.S. Trustee Program (USTP) at the Department of Justice approves credit counseling organizations to provide pre-bankruptcy counseling and pre-discharge debtor education as required under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.  The USTP's website provides information for consumers about the role of credit counseling organizations in personal bankruptcy proceedings, and offers links to assist consumers in selecting a credit counseling agency from the list of approved providers that fits the consumer's needs.
  
  These agencies provide educational resources about credit counseling that are helpful to both the public and credit counseling organizations. General reference materials about credit counseling are also available.

Currency Strategy

On December 4, 2003, the Service issued Notice 2003-81, 2003- 2 C.B. 1223 , announcing
that it will challenge transactions involving the assignment of offsetting foreign currency options to a charity in order to claim substantial artificial losses and identifying these transactions as listed transactions for purposes of Internal Revenue Code sections 6011, 6111, and 6112. The transaction purportedly creates permanent tax deductions (either ordinary or capital losses)
when a taxpayer donates two foreign currency contracts to a charity where only one such contract is subject to the mark to market recognition rules contained in Code section 1256.

The Notice describes a situation which a taxpayer claims a loss upon the assignment of a section 1256 contract to a charity but fails to report the recognition of gain when the taxpayer's obligation under an offsetting non-section 1256 contract terminates.  The notice identifies the described transaction and those that are substantially similar to that transaction as listed transactions.  As described in the Notice, the charity accepts the assignment of the purchased option that has a loss and assumes the taxpayer's obligation under the offsetting written option that has a gain.  The notice holds that the taxpayer must either recognize gain when the option is assumed by the charity or must recognize the premium at the time the taxpayer's obligations under the option contract terminate.

Additional information:

Notice 2007-71 modifies and supplements Notice 2003-81 by correcting a statement in the Facts section of the previous notice.  Pursuant to section 7805(b), certain taxpayers who reasonably relied on Notice 2003-81 in adopting methods of accounting are granted relief from retroactive application of the new ruling.

Down Payment Assistance

1. What is a down payment assistance program operated by a tax-exempt organization?

2. Why is the IRS focusing on down payment assistance programs of exempt organizations?

3. How does an exempt organization's seller-funded down payment assistance program generally work?

4. Doesn’t a seller-funded down payment assistance program facilitate the ability of low-income individuals and families to purchase affordable housing, and therefore further the exempt purposes of a tax-exempt organization that sponsors the program??

5. What is the IRS doing to stop abuses involving down payment assistance programs sponsored by exempt organizations?

6. Has the IRS issued any guidance on the criteria for exemption, under section 501(c)(3), of organizations that sponsor sponsor down payment assistance programs??

7. How does the revenue ruling affect seller-funded down payment assistance organizations?

8. Is down payment assistance includable in the homebuyer’s income?

 

Section 509(a)(3) Supporting Organizations

Trusts - An Abusive Scheme Toolkit for External Stakeholders

501(c)(15) Overcapitalization ("Stuffing") Transactions

This notice Notice 2003-35 states that an organization qualifies as a section 501(c)(15) organization only if its primary and predominant business activity during the taxable year is issuing insurance or annuity contracts or reinsuring risks underwritten by insurance companies. In addition, legislation enacted on April 10, 2004 substantially modifies section 501(c)(15) to address the stuffing concerns.

Notice 2006-42 - This notice provides guidance on how to calculate gross receipts for purposes of determining whether an insurance company is tax-exempt under section 501(c)(15).

Additional information:

• Increase in prohibited tax shelter penalties - Tax Increase Prevention and Reconciliation Act of 2005
   

• Abusive transactions

DISCLAIMER: This information is not intended to provide legal or accounting advice,
or to address specific situations. Please consult with your legal or tax advisor to supplement and verify what you learn here.