(a) Introduction

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In 2019 there were some major news stories involving tax-exempt organizations. One involved the National Rifle Association, an IRC section 501(c)(4) organization, and its related foundation, an IRC section 501(c)(3) organization. Reported allegations include claims that the NRA's CEO, Wayne LaPierre, spent approximately $274,000 over a 13-year period on clothing purchased from designer boutiques through an arrangement with the NRA's advertising agency, Ackerman McQueen, and that he also charged alleged lavish vacations through a credit card from the agency, which he then submitted for reimbursement from the NRA. In addition, there are claims that the NRA made $185,000 in undisclosed donations to a charity run by Mr. LaPierre's wife, whose exempt purposes are unrelated to the NRA's mission.

In addition, accusations of impropriety were made in regard to the relationship between the NRA Foundation, which is controlled by the NRA board, and the NRA. Even though a charity may be controlled by an IRC section 501(c)(4) organization, as is the case here, there are strict rules governing transfers of money or other assets from a charity to a related IRC section 501(c)(4) organization, as charities must devote their assets and revenue toward charitable purposes. Published stories allege that the NRA Foundation made millions of dollars of purchases from a shooting supply company that is controlled by a former NRA director and president, which could be deemed improper inurement or private benefit to an insider. (See subsection 5.1(b).) In 2017, the NRA Foundation purchased $3.1 million of ammunition and other supplies from this entity, which it later donated to local shooting groups.^8.1 In addition, since 2012, the NRA Foundation has reportedly transferred more than $100 million to the NRA and allegedly lent the NRA $5 million in 2017.^8.2

News stories regarding the so-called “Healthy Holly” matter resulted in an audit of UMMS, which, in turn, led to numerous board resignations following disclosure of self-dealing among board members and officers whose businesses benefited from contracts with UMMS. The hospital network has reportedly adopted a new conflict of interest policy that bars it from granting sole-source contracts to board members or their businesses, and precludes it from having any business with certain board leaders. Under new legislation, all board members must submit their resignations by year-end; the Governor has said he does not expect to reappoint “many—if any.”^8.3

(b) Private Inurement and “Insiders”

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(c) Distinction between Private Benefit and Private Inurement

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Private inurement is a subset of private benefit. See PLR 201044025.

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Kentucky Bar Foundation, 78 T.C. at 923.

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(a) Compensation for Services

(c) Joint Ventures with Commercial Entities

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(e) Asset Sales to Insiders

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(f) Valuation of New-Economy and Internet Companies

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(g) § 501(c)(3) Bonds

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(a) Operations for Profit

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(c) Compensation

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^223.1 In specific reference to this issue, the 2017 Tax Law added § 4960, an excise tax on tax-exempt organization excess compensation. See subsection 2.1(1)(F) for a discussion of this new tax.

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Statistical information garnered from Forms 990 reveal that executive pay at nonprofits is rising, paralleling the trend at for-profits. According to analysis of IRS data of 100,000 tax-exempts from 2014, approximately 2,700 employees of organizations classified as charities earned at least $1 million or more in that year.^237.1 The analysis also revealed an increase in bonus and deferred compensation arrangements similar to those in the for-profit sector and that approximately three-quarters of the charities that provided compensation packages in the million-dollar range were “involved in health care.”^237.2 What is not known is the impact of the rebuttable presumption safe harbor on the rise—that is, is the safe harbor of Treas. Reg. § 4958-6 facilitating the ability of nonprofits to pay higher compensation?

1. 2019 Interim Guidance^237.3

   Under section 4960, in tax years beginning after 2017, an employer^237.4 is liable for an excise tax equal to the product of the rate of tax under section 11 [currently 21 percent], and the sum of (1) so much of the remuneration paid (other than any excess parachute payments) by an applicable tax-exempt organization (ATEO) for the taxable year^237.5 with respect to employment of any covered employee in excess of $1,000,000, plus (2) any excess parachute payment paid by such an organization to any covered employee.^237.6

   Section 4960(c)(1) defines an ATEO as any organization that is exempt from taxation under § 501(a)^237.7 or has income excluded from taxation under § 115(1).^237.8 Moreover, § 4960(c)(4)(A) provides that remuneration paid to a covered employee by an ATEO includes any “remuneration paid with respect to employment of the employee by any related person or governmental entity.”^237.9

   Further, under § 4960, a covered employee is “any employee (including any former employee) of an [ATEO] if the employee: (A) is one of the five highest compensated employees of the organization for the taxable year, or (B) was a covered employee of the organization (or any predecessor) for any preceding taxable year beginning after December 31, 2016.”^237.10

   Inherent within the covered employee definition is also the notion that an individual cannot be an ATEO's covered employee unless the individual is first established to be an ATEO's employee. However, § 4960 does not provide a definition for “employee.” The Interim Guidance states that “only an ATEO's common law employees (including officers) can be one of an ATEO's five highest-compensated employees.”^237.13 In determining the existence of a common-law employer-employee relationship, “the crucial test lies in the right of control, or lack of it, which the employer may exercise respecting the manner in which the service is to be performed and the means to be employed in its accomplishment, as well as the result to be obtained.”^237.14

   1. Amount of Remuneration Paid. Section 4960's excise tax is based on the remuneration paid by an ATEO for the taxable year in respect of any remuneration paid to a covered employee in excess of $1 million.^237.16 Section 4960(c)(3)(A) defines “remuneration” as wages (as defined in section 3401(a)).^237.17 Further, a remuneration is treated as paid when there is no substantial risk of forfeiture of the rights associated with the remuneration.^237.18 For the purposes of § 4960(a), a “substantial risk of forfeiture” is defined by cross-reference to § 457(f)(3)(B), which itself cross-references Proposed Treasury Regulation § 1.457-12(e)(1).^237.19 Under § 1.457-12(e)(1), compensation is subject to a substantial risk of forfeiture “only if entitlement to the amount is conditioned on the future performance of substantial services, or upon the occurrence of a condition that is related to a purpose of the compensation if the possibility of forfeiture is substantial.”^237.20
   2. Excess Parachute Payment. Under § 4960, an “excess parachute payment means an amount equal to the excess of any parachute payment over the portion of the base amount^237.21 allocated to such payment.”^237.22 Section 4960's excess parachute payments rules are modeled after § 280G.^237.23

      Under Section 4960, a payment is contingent on an employee's separation from employment when a payment is subject to a substantial risk of forfeiture as defined under § 457(f). The Interim Guidance limited payments contingent on a separation from employment to “payments contingent on an involuntary separation from employment” as opposed to payments contingent on a voluntary separation from employment.^237.24

   3. Reporting on Form 4720. Lastly, on November 7, 2018, the Treasury Department and the IRS issued proposed regulations under § 6011 and § 6071 that state § 4960's reporting requirements and due date for paying the excise tax.^237.25 The proposed regulations state that § 4960's excise tax must be reported on Form 4720, which is the common form used to report Chapter 42 taxes.^237.26 Each employer that is liable for § 4960's excise tax, regardless of whether the employer is an ATEO or a related organization, must separately report and pay its share of the excise tax.^237.27 Finally, the payment under § 4960 is due when Chapter 42 taxes are ordinarily due—“the 15th day of the 5th month after the end of the taxpayer's taxable year.”^237.28
2. Bona Fide Volunteer Exception

   Currently, many practitioners are concerned that the IRS's future guidance regarding § 4960 will stipulate that an ATEO's volunteer officer, who is compensated by a for-profit entity and does not receive additional compensation from the for-profit entity for serving as a volunteer officer in an ATEO, will be nevertheless treated as an employee of the ATEO.^237.29 Because of the practitioners' concern as to § 4960's potential daunting consequences on ATEOs, they suggested that “the most straightforward approach … for purposes of avoiding severe harm to ATEOs with volunteer officers is for Treasury to clarify that individuals who serve as officers of an ATEO and do not receive any compensation, directly or indirectly, for their volunteer services are not considered employees of the ATEO for purposes of Section 4960.”^237.30

   Further, the Interim Guidance attempted to alleviate the problem by stating that “only an ATEO's common law employees (including officers) can be one of an ATEO's five highest-compensated employees.”^237.31 In determining the existence of a common-law employer-employee relationship, “the crucial test lies in the right of control, or lack of it, which the employer may exercise respecting the manner in which the service is to be performed and the means to be employed in its accomplishment, as well as the result to be obtained.”^237.32

   The initial IRS guidance raised a concern that an individual with limited involvement in an EO, such as volunteers who worked for corporations but provide services that are related to charity or individuals who do limited work at a nonprofit, could end up triggering the tax. The proposed rules (REG-122345-18) offered a number of important exceptions to limit the 21 percent tax so long as the nonprofit doesn't compensate the person for such services; the proposed rules provide a “limited hours” exception so that the tax will only be triggered if the individual spends more than 10 percent of his or her time or more than 100 hours per year at the nonprofit, whichever is greater. This should cover the typical volunteer at a charitable organization who receives no compensation and works for a limited number of hours.

   The proposed regulations also provide a “nonexempt funds” exception for employees who spend more than 10 percent, but less than 50 percent, of their time providing services to a nonprofit organization. The measurement is by hours or days.

   Nonprofit organizations affiliated with for-profit entities need to carefully examine their shared services agreements to confirm that the arrangement qualifies as an exception to the application of the section 4960 21 percent excise tax.

   To determine whether an employee is a “bona fide volunteer,” the Supreme Court has defined a volunteer as one who “without promise or expectation of compensation, but solely for his personal purpose or pleasure, worked in activities carried on by other persons either for their pleasure or for profit.”^237.33 The crux of this “bona fide volunteer” definition centers around whether an employee possesses a “promise, expectation or receipt of compensation for services rendered.”^237.34

3. Final Regulations: Section 4960

   In January, 2021, Treasury and the IRS released final regulations under section 4960. The final regulations retain the basic approach and structure of the proposed regulations, with certain revisions.^237.36

   Commentators expressed concern that highly paid employees of a non-ATEO performing services for a related ATEO without receiving compensation from the ATEO may be subject to the excise tax. To avoid the excise tax, individuals could cease performing such services, or ATEOs might dissolve their relationships with related non-ATEOs, reducing donations from related non-ATEOs. As a result, the final regulations include exceptions to the definitions of “employee” and “covered employees” (specifically to the rules for determining the five highest-compensated employees for purposes of identifying covered employees) to address such situations. With respect to the first exception, the regulations define “employee” consistent with section 3401(c), in particular adopting the rule that a director is not an employee in the capacity as a director and an officer performing minor or no services and not receiving any remuneration for those services is not an employee.

   The general rule provides that employees of a related non-ATEO are not considered for purposes of determining the five highest-compensated employees if they were never employees of the ATEO. In addition, individuals who receive no remuneration from the ATEO or a related organization cannot be among the ATEO's five highest-compensated employees.

   Changes to the proposed regulations include:

   • “Volunteer” exceptions. Under the exceptions, an ATEO's five highest-compensated employees also exclude an employee of the ATEO who receives no remuneration from the ATEO and performs only limited hours of services for the ATEO.
   • A modification to the nonexempt funds exception to covered employee status that expands the measurement period from one applicable year to two applicable years (that is, the current applicable year and the preceding applicable year are treated as a single measurement period). This allows organizations more flexibility for determining whether an employee provided services to the ATEO and all related ATEOs for not more than 50 percent of the employee's total hours worked as an employee of the ATEO and all related organizations. Therefore, in situations where an employee “rotates” to an ATEO for a period that extends longer than six months, or when an employee unexpectedly provides services beyond six months in an applicable year, that employee could still be excluded as a covered employee.
   • Taxpayers may use a reasonable, good faith method to allocate remuneration between medical services that are excluded from section 4960 and other services.

     The final regulations reserve the question as to whether a federal instrumentality for which an enabling act provides for exemption from all current and future federal taxes is subject to tax under section 4960. Until further guidance is issued, such an instrumentality may treat itself as not subject to tax under section 4960 as an ATEO or related organization. However, if that federal instrumentality is a related organization of an ATEO, remuneration paid by the instrumentality must be taken into account by that ATEO.

     The final regulations also reserve the coordination of sections 4960 and 162(m) in circumstances where there is a difference in timing between vesting and payment of remuneration. Until future guidance is issued, taxpayers generally may use a reasonable, good faith approach with respect to the coordination of sections 4960 and 162(m) in circumstances in which it is not known whether a deduction for the remuneration will be disallowed under section 162(m) by the due date (including any extension) of the relevant Form 4720.^237.37

(a) State Activity

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In May 2015 the Federal Trade Commission (“FTC”) and the attorneys general of all 50 states and Washington, D.C., charged the Cancer Fund of America, Inc. (“CFA”), Children's Cancer Fund of America, Inc. (“CCFOA”), The Breast Cancer Society, Inc. (“BCS”), and Cancer Support Services, Inc. (“CSS”), all of which were run by James T. Reynolds, his family and friends (collectively the “sham charities”), and their managers, with fraud.^284.1 Between 2008 and 2012, the sham charities raised more than $187 million under the auspices that they would fund research or pay for cancer treatment. However, the vast majority of the money raised went to professional fundraisers, the foundation managers, and their families, including paying for cars, college tuition, gym memberships, concert tickets, and trips to Las Vegas and the Caribbean.^284.2 To mask this from the authorities and watchdog groups, the sham charities utilized an accounting scheme involving the shipment of pharmaceuticals and other goods to developing countries to report over $223 million in revenue and program spending that did not exist. In reality, the people that the sham charities purported to aid received “boxes of sample-size soap, seasonal greeting cards and Little Debbie Snack Cakes.”^284.3

CFA, CSS, and their founder agreed to settle the charges. The founder is banned from profiting from any charity fundraising in the future, and both charities have been permanently dissolved and their assets liquidated. Additionally, CCFOA and BCS will be dissolved, and their managers are banned from fundraising, charity management, and oversight of charitable assets.

This represented one of the largest and most comprehensive investigations into fraudulent charities to date and was the first time that the FTC and the attorneys general of all 50 states and Washington, D.C., filed a joint enforcement action against a fraudulent charity.