Highlights from the ABA Exempt Organizations Committee Meeting 10/17/23 – Part Two

Here are more highlights from the American Bar Association Exempt Organizations Committee meeting held on October 17, 2023 as part of the ABA Virtual 2023 Fall Tax Meeting. Part One is available here.

Subcommittee on Audits, Appeals & Litigation; Private Foundations, International Philanthropy & UBIT

Mayo Clinic case. See DOJ Seeks to Overturn Mayo Clinic’s Win in UBIT Refund Case (Tax Notes)

This federal tax case involves a tax exception limited to “educational organization[s]” that maintain a regular faculty and curriculum for enrolled students. See 26 U.S.C. §§170(b)(1)(A)(ii), 514(c)(9)(C)(i). This Court previously held that to qualify for this exception, appellee Mayo Clinic must be organized and operated “exclusively” for “educational rather than other purposes.” Mayo Clinic v. United States, 997 F.3d 789, 802 (8th Cir. 2021). To satisfy that standard, education must be Mayo’s “primary purpose” and its other purposes cannot be “’substantial.’” Id. (quoting Better Bus. Bureau of Wash., D.C. v. United States, 326 U.S. 279, 283 (1945)). The District Court concluded that Mayo qualified for the limited exception, even though it found that Mayo was organized and operated to both educate students and care for patients and that its patient-care purpose was substantial.

For background on the District Court’s holding in the Mayo case, see District court holds Mayo Clinic is a qualified educational organization entitled to a $11.5m refund for UBIT paid (EY).

The district court’s favorable ruling for Mayo provides a basis for tax-exempt hospitals and health systems with educational activities to take a position that they qualify for the debt-financed real property UBIT exemption under IRC Section 514(c)(9)(C)(i) as “educational organizations.” In particular, under the court’s reasoning that “primary” means “substantial,” even if a majority of a health system’s activity involves patient care, it may qualify as an educational organization if its educational purposes are substantial. The court found it significant that “education is at the heart of what Mayo does every day” and that its educational purposes and activities are integral to and interrelated with its patient care and research activities. Tax-exempt hospitals and health system parents that have a similar integration of educational and patient care/research activities, such as those with teaching hospitals and academic medical centers, may also be able to qualify as educational organizations for purposes of IRC Section 514(c)(9)(C)(i) under the district court’s interpretation of that term.

Fearless Foundation and private foundations. More common to see private foundations make grants engaged in activities that might be scrutinized under anti-discrimination laws. Some private foundations have been concerned about risks, but the risks under IRC Section 4945 (taxable expenditures) may be more academic at this time. Section 1981 continues to be a concern, but one that may be drafted around. Whether a grant agreement can escape definition as a contract may not be a strong long-term solution. Section 1982 of the Civil Rights Act of 1866 might also be applied in a reverse discrimination claim. But it may be premature to anticipate such theoretical exposure until more case law has developed.

The Foreign Agents Registration Act (FARA) imposes registration, disclosure, and other legal on any individual or entity that is or becomes an “agent of a foreign principal.” FARA’s application to nonprofits has received increasing attention in recent years. See, e.g., DOJ Releases FARA Advisory Opinions that Scrutinize Nonprofit Activity (Alex Langton, Covington); New FARA Advisory Opinions Put Nonprofits on Notice (Meredith McCoy, Venable). Other countries (e.g., Canada) are developing similar laws.

More developments in Canadian nonprofit laws: Changes to Trust Reporting Rules will Seriously Affect Charities, Clarity Needed (Terrance S. Carter, Theresa L.M. Man, Jacqueline M. Demczur & Lynne M. Westerhof, Carters).

State Regulatory Update

Oversight happens at the state level, but various national associations are involved:

Regulatory priorities:

  • Closure of Institutions of Higher Education
  • Health Care Transactions
  • Criminal Prosecutions
  • Outreach and education
  • Fraudulent solicitation, false reporting, private benefit, etc.

Some examples of investigations:

Aid for Starving Children – see Attorney General Becerra Secures Cease and Desist Orders and Over One Million Dollars in Penalties Against Three Charities for Deceptive Solicitations

The Hope Box, Inc. – see Consent Order, which provide an anatomy of an investigation

Major Questions: What Counts as Binding Legal Authority for Tax Opinions?

It is important to differentiate between guidance applicable to all taxpayers (e.g., revenue rulings, revenue procedures, notices, announcements, publications, IRS forms and instructions) and guidance applicable to only a specific taxpayer (e.g., letter rulings, technical advice memoranda, chief counsel advice). There are also several pieces of published internal guidance (Internal Revenue Manual Provisions, Audit Technique Guides, Issue Snapshots).

Issue: To What Extent Can Taxpayers Rely on the “Published” or “Unpublished” Position of the IRS?

Rev. Proc. 89-14 (taxpayers may rely on Revenue Rulings and Revenue Procedures if “the facts and circumstances are substantially the same”).

Issue: What Exposure Does a Return Preparer Have?

Internal Revenue Code Section 6694 provides for a penalty on a return preparer for an understatement due to taking a position that the preparer knew or reasonably should have known was an “unreasonable position.” A position is unreasonable unless –

  • There is “substantial authority” for the position;
  • The position was disclosed and there is a “reasonable basis” for the position; and
  • For tax shelters and reportable transactions, it was reasonable to believe that it is “more likely than not” that the position would be sustained.

There is substantial authority for the tax treatment of an item only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment. The weight accorded an authority depends on its relevance and persuasiveness, and the type of document providing the authority. Only the authorities listed in Treas. Reg. § 1.6662-4(d)(3)(iii) may be considered. These include the Internal Revenue Code, temporary and final regulations, revenue rulings and procedures, treaties, cases, congressional intent as reflected in congressional history, private letter rulings, technical advice memos, action on decisions and general counsel memos, IRS notices, announcement and press releases.

Issue: What About Informal Guidance?

lt is important to recognize the value and importance of informal guidance from federal agencies, without which some programs may not be able to go forward. At the same time, all parties must recognize the limitations of such guidance, which may not always have or leave a public record of its development. Informal guidance may also call into question whether it is or should be subject to the Administrative Procedure Act, which governs the process by which federal agencies develop and issue regulations and includes public notice and comment requirements.

The Supreme Court has previously opined that whether or not an agency action is subject to Administrative Procedure Act notice and comment requirements depends upon whether it carries the “force of law.” The Supreme Court also stated that whether or not an agency action is eligible for Chevron deference (see below) turns on whether it carries the “force of law.”

There are two standards of review/type of deference given to agency actions:

  1. Skidmore deference applies when a federal court defers to a federal agency’s interpretation of a statute administered by the agency according to the agency’s ability to demonstrate persuasive reasoning.
  2. Chevron deference compels federal courts to defer to a federal agency’s interpretation of an ambiguous or unclear statute that Congress delegated to the agency to administer

The government for several years asked courts for Chevron deference on revenue rulings and maintained that, except for their lack of notice-and-comment rulemaking, revenue rulings carry the “force of law” and are indistinguishable from Treasury regulations for this purpose. But in light of the 2011 Mayo Supreme Court decision, the Department of Justice announced it would stop asking courts for Chevron deference for Internal Revenue Bulletin guidance, including regarding revenue rulings. However, the Ninth Circuit and Federal Circuits have suggested that IRB guidance may be entitled to Chevron deference perhaps in part because penalties associated with noncompliance of revenue rulings and certain other guidance suggest that they have the “force of law.”