Donations and Kickbacks

It was recently reported that the Internal Revenue Service is investigating whether a patient-assistance charity, Good Days, has been providing prohibited private benefits to its pharmaceutical company donors by using the donated monies to make purchases of drugs from these donors. According to Reuters:

In court papers, the IRS said that in 2011, about 95 percent of the $129.3 million in assistance the charity provided patients to cover co-pays was spent on drugs made by the companies that had made donations for specific diseases.

Under applicable federal law, a 501(c)(3) organization must be operated primarily for an exempt (e.g., charitable) purpose and not for the benefit of private interests, except incidentally in furtherance of its exempt purpose. This “operational test” requirement prohibits charities from providing benefits to other persons or entities unless they are incidental, qualitatively and quantitatively to furthering the charity’s mission. Thus, payment of a reasonable salary for services necessary to operate the charity would be fine. But payments for unnecessary services that do not advance the charity’s mission would not. And enforcement of this prohibition becomes particularly concerning where the payments are made to board members, major donors, and others with substantial influence over the organization’s affairs and activities. This concern arises because of the risk that those individuals could use their influence over the charity to line their own pockets.

When a company donating funds to a charity inappropriately arranges for substantial benefits from the charity to flow back to the company, it may be a form of “kickback” that raises several problems.

First, there is the question of whether the charity is violating the operational test by providing a benefit to one of its donors. Sometimes it’s clear that providing the benefit is not related to advancing the charity’s mission other than to keep the relationship with a significant donor, and is therefore prohibited. But other times, the benefit may be mission-related, like where the charity pays the donor for goods or services necessary in operating the charity.

Second, there is the issue of whether the donor is getting a return benefit of significant value from the charity for making its “contribution.” In such case, the donor’s payment, in part or in full, may not be a charitable donation at all. Instead, it may be a payment to get the planned return benefit, whether it be services provided to the donor or valuable contractual rights. For example, a donor might give a $100,000 to a charity but with the condition that the charity sell the donor’s goods on the charity’s website and at the charity’s events. In such case, a portion or perhaps all of the $100,000 was not a charitable contribution, it was a payment for the charity’s services. And in the example illustrated by the IRS investigation of Good Days, it appears that the issue is whether in exchange for the donations, the charity was required to use such funds to purchase drugs from the donor. This could appear to be a form of “kickback” in which the donor recoups its donated funds but still may have taken the benefit of a charitable contribution deduction.

It’s not uncommon for our firm to see a for-profit business propose creating an affiliated nonprofit in which the nonprofit would exist primarily to purchase services from the for-profit. The nonprofit would seek donations, for which donors could receive a tax-deduction, and use them to provide subsidized rates for certain disadvantaged populations of consumers of the for-profit’s business. For example, a nonprofit affiliated with a software company might raise funds to allow low-income consumers purchase the software company’s products at a discounted rate subsidized by the nonprofit (i.e., the nonprofit pays the for-profit the difference between the discounted and non-discounted rates). While this sounds like it could be charitable because it allows an economically disadvantaged community to access a useful product it might otherwise not be able to access, it also looks like a way to increase the software company’s sales. If the software company controls the nonprofit, and requires the nonprofit to principally work only with that particular company, this would likely be a violation of the operational test and private benefit doctrine. A key issue in determining whether a violation occurred is whether the software company actually controlled the nonprofit’s activity resulting in a significant benefit to the company. Control, of course, can be created and exercised in many ways, including through the explicit or implied promise of future funding.

With respect to the  the “patient-assistance” charity cases, The Nonprofit Quarterly published an article on the IRS investigation of Good Days and noted:

Many have talked about this practice [of using donated funds to purchase the donors’ goods] as merely a part of any modern pharmaceutical company’s attempt to play any angle available, including the faux charity gambit, to keep prices high for those who will pay full freight while not actually killing anyone (though that may be questionable in cases of emergency medications) for their lack of ability to pay.

This would be a problem regardless of whether the company took a charitable contribution deduction for the donation because it would enable the company to inflate its rates for its drugs, driving up the cost of healthcare, while preserving its goodwill by helping to ensure access to those who could not afford such drugs. If a pharmaceutical company gave direct co-pay help to patients on Medicare, this would be a violation of a federal anti-kickback statute. But the law does not prohibit the company from making contributions to charities that help those patients, “provided the charities are independent and there’s no coordination or detailed information shared on how the drugmakers’ donations are spent.”

We’ll look forward to see how the “patient-assistance” charity cases progress. Stay tuned.