A.        INTRODUCTION.

 

The year 2004 will be long remembered as the year in which major changes to the tax code in the United States pertaining to planned giving and tax exempt organizations were first proposed.  Although there were some significant tax code changes for charities and donors in 2004, last year also generated a number of indications that the exempt organization sector will be more heavily regulated in 2005 and beyond.  The following will provide details about what new regulations took effect in 2004 and provide a look into future regulation in 2005 and beyond.

 

B.        2004 TAX ISSUES REVIEW.

1.       New Restrictions on Donating Patents and Other Intellectual Property.

Historically, charitable contributions of patents and other intellectual property interests in the United States have been treated in the same manner that donations of any other type of property have been treated.  A deduction generally was available for the full fair market value of the patent right or other intellectual property donated.  The key issue was typically valuation, determined typically by means of an independent appraisal, the true fair market value of the donated patent or other intellectual property. As of June 2, 2004, the rules for deducting charitable contributions of patents and other intellectual property are changed.  As part of the American Jobs Creation Act of 2004 (the “JOBS Act”), Congress amended Section 170 of the Internal Revenue Code to place patents, trademarks, trade secrets, software, and other intellectual property into a separate category of charitable contribution.  For property in this category, no charitable contribution deduction is allowed for the amount of capital gain that would have been received had the taxpayer sold the property. Internal Revenue Code Section 170(e)(1)(B)(iii).  This limitation applies to both short term and long term capital gain.  Practically speaking, this means that the initial charitable contribution deduction available to any donor of such property is limited to the lessor of the tax payer’s basis in the patent or other intellectual property, or the actual fair market value of the property. 

 

2.         Vehicle Donations/Non-Cash Property Donations.

Leading up to 2004, there were indications that the United States Congress was displeased with the handling of car donations by tax exempt, charitable organizations.  The JOBS Act referenced above also created changes in how donations of vehicles and other non-cash property are to be treated from the standpoint of deductibility to the donor and substantiation of the contribution.

 

New Section 170(f)(12) was added to the Internal Revenue Code to apply to donations of “qualified vehicles.”  The definition of a “qualified vehicle” includes motor vehicles manufactured primarily for use on public roadways, boats and aircraft. The definition does not extend to inventory property as defined under Section 1221(a)(1).  This new section applies if the claimed value of a qualified vehicle donated to a charitable organization exceeds $500.00.

 

The requirements of the new section depend on the ultimate use (or non-use) of the donated vehicle by the recipient charitable organization.  Whether the organization sells the vehicle without significant use or material improvement, or whether it first uses or improves the vehicle, plays an important factor.  If the organization simply sells the donated vehicle, the donor’s deduction may not exceed the gross proceeds the organization actually receives from the sale of the vehicle.  If the charitable organization retains the qualified vehicle for its own use, then the donor may deduct the “fair market value” of the donated vehicle.  The “fair market value” may be substantially different than the gross proceeds received on a sale of a similar vehicle, and is usually determined by using a used car valuation guide with adjustments for condition, mileage and other related factors. 

 

The new law also requires the charitable organization give the donor a contemporaneous written acknowledgment of receipt of the donated vehicle.  The donor must utilize this written acknowledgment to substantiate their contribution of a qualified vehicle.  The acknowledgment must contain the name and tax payer identification number of the donor and the vehicle identification or other similar number.  The remaining content of the acknowledgment depends on whether the organization sells or uses the vehicle.  If sold, the acknowledgment must state the gross proceeds of the sale; indicate that the deductible amount may not exceed that figure; and certify that the sale was an arms-length transaction between unrelated parties.  Alternatively, if the organization retains the vehicle for its own use, the acknowledgment provided to donors must contain a certification stating either the organization’s intended use of the vehicle and the intended duration of such use or any intended material improvement of the vehicle.  There must also be a certification by the exempt organization that the vehicle will not be transferred in exchange for money, property, or services prior to completion of the intended use or improvement.  Both the tax payer and the charitable organization must submit the acknowledgment with their tax/information returns.

 

C.        NON-CASH PROPERTY DONATIONS.

New Internal Revenue Code Section 170(f)(11) creates reporting requirements for donations of property made after June 3, 2004.  The key change generated by the new Code section is in the reporting requirements relative to the establishment of the fair market value of any non-cash property donation.  The new Code section does not change the qualified appraisal requirements described in Section 1.170(A)(13)(c) of the Treasury regulations for property valued at over $5,000.00.  However, the new Code section extends the appraisal requirements to C corporations.  Prior to the new Code section’s enactment, C corporations were only required to attach Form 8283 (“Non-Cash Charitable Contributions”) to returns for such donations unless the donated property was a work of art valued at $20,000.00 or more.  Under the new Code section, C corporations and individual taxpayers generally will have to attach the qualified appraisals to their returns if the claimed value of the property is over $500,000.00.  This is important because all similar donated items of property, whether they are contributed to a single or to multiple qualified charitable organizations, must now be aggregated and treated as a single donation.  If cumulative donation amount for that year exceeds $500,000.00, a qualified appraisal must be obtained, and a copy filed with the taxpayer’s return.

 

D.        STATE LAW ENACTMENTS.

A number of states have been taking a closer look at new legislation directed towards nonprofit organizations that either hold assets in the given states or solicit contributions from consumers in those states.  The new legislation is designed to apply certain principles from Sarbanes-Oxley to tax exempt, nonprofit corporations.  Sarbanes-Oxley is a federal statute which primarily applies to for-profit corporations, focusing on ethics, internal controls, investments spending policy, and compensation standards as applied to the governing board.  Only two provisions of Sarbanes-Oxley presently apply to exempt organizations.  One provision is the whistleblower protections and the other is record retention.  While Sarbanes-Oxley is not completely relevant to the field of nonprofit corporations, there has been a continuing effort to generate legislation at the state level to apply certain potentially relevant aspects of Sarbanes-Oxley to nonprofit, charitable organizations.  The State of California is one of the more recent states to enact such legislation.  California Senate Bill 1262 created changes to certain aspects of the State’s laws governing charitable corporations and trustees.  Among other things, the new law in California requires all charitable organizations, whether incorporated or unincorporated, to have an annual financial statement prepared and audited by an independent certified public accountant when that organization’s gross revenue exceeds $2,000,000.00.  Such organizations are also required to appoint an independent audit committee and to make its annual audited financial statements available to the public.  These new requirements apply to any organization holding charitable assets in the State of California and to any charitable organization soliciting charitable contributions from California consumers.

 

It is likely that additional states will follow creating the same or similar kinds of Sarbanes-Oxley oriented laws.  These new laws are an indication of the general direction that both federal and state regulators are headed relative to tax exempt, charitable organizations operating in the United States. 

 

 

 

E.        PRACTICAL INDICATIONS OF EMINENT LEGISLATION IN 2005 AND BEYOND.

In addition to the above-described steps being taken at the state level, it is likely that the federal government in the United States will take further legislative action that will affect both tax exempt charitable organizations and those who make contributions to such organizations.  The focus is now coming from both the Internal Revenue Service and from Congress.

1.         The Internal Revenue Service.

The Internal Revenue Service is now focusing on abusive schemes, anti-terrorism, and excessive compensation in the exempt organization arena.  The Internal Revenue Service has specifically stated that these are the key areas for the Service as it moves forward. The IRS’s Fraud and Financial Transactions Unit will be fully staffed and ready to begin operations in April of 2005.  The IRS is also setting up a second exempt organization’s compliance unit through which it hopes to conduct more organization contacts and perhaps correspondence audits.  There are also plans to establish a second screening unit at the Determination Center in Cincinnati to decrease the backlog of applications. 

2.         New Form 1023.

One of the key areas of focus for the IRS beginning in 2004 and continuing into 2005 is the area of excessive compensation arrangements for charity officials and employees.  One of the significant methods of addressing the excessive compensation arrangement issue is through the implementation of a new Form 1023, Application for Recognition of Exemption.  The revised Form 1023 became available in October of 2004 and contains significant changes from the prior application form.  While the new exemption application form is designed to speed up the application process and to give the IRS more information about transactions that could be abusive, because of its immense detail, the form is likely to actually slow down the process.  Among a number of other things, the new form asks for information about payments to third parties who help create an exempt organization and requests information on compensation and other financial arrangements with officers, directors, trustees, employees, and independent contractors.  Information about family and business relationships and arrangements that could indicate impermissible private benefit is also requested in the new form.  The new application additionally addresses issues such as the adoption of a conflict of interest policy, continuous reporting of transactions with related parties, and seeking explanation as to how the organization determines whether compensation arrangements with officers, directors and employees are reasonable. 

3.         Joint Committee on Taxation.

An entire, separate article could be presented to address upcoming issues affecting the United States nonprofit community as a result of actions being sought by the Joint Committee of Taxation in Congress.  That Committee recently issued a lengthy report suggesting ways to close the federal budget gap by improving tax compliance, including a series of suggestions that would greatly affect tax exempt, charitable organizations in the United States.  In short, the Committee’s proposals include denying exempt status for organizations that fail a five-year review of its activities.  Organizations that fail the review would become taxable entities and deductibility for gifts to those organizations would be removed.  Additional proposals include imposing a termination tax on exempt organization conversions; extending the intermediate sanctions regulations more broadly; 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 information 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 seriously reviewing tax-exempt organizations that engage in credit counseling activities.  While many of the foregoing issues are important to exempt organizations, perhaps the greatest concern lies in a proposal that would seriously reduce the ability of taxpayers to deduct the full value for donations of property to charitable organizations.

 

F.         CONCLUSION.

While 2004 has been an interesting year for United States tax exempt organizations, the many proposals for changes in 2005 and beyond make 2004 pale in comparison.  The year 2004 will go down as an historic year not for what was changed in the year, but for what was proposed.  There is a certainty that change will take place in 2005, but an uncertainty as to when and how extensive the changes will be.  Tax exempt, charitable organizations and those who support charity will need to track these proposals fully and carefully as 2005 roles on.  

 

About Greg Lam:  Greg Lam, a Partner of Copilevitz & Canter, P.C., is an attorney specializing in non-profit corporation law, fundraising regulation and tax-exempt issues.

 

Mr. Lam has worked in the field of non-profit organizations, charitable trusts and foundations, and state fundraising laws and regulation since his entry into the legal profession.  Mr. Lam’s practice focuses on corporate issues facing nonprofit corporations, recognition of tax-exempt status, state registration and oversight of charities and fund-raisers, and constitutional litigation.  He is a frequent speaker on issues pertaining to tax exemption and state fundraising regulation.