Misuse of Tax-Exempt Entities by Donors and Investors
We are facing a number of other current issues where donors or others are using or attempting to use tax-exempt organizations for private purposes, including sheltering assets for deferred personal use or claiming accelerated or inflated deductions. I will briefly discuss certain classes of cases in which we have found abusive behavior. It is important to note that although certain types of organizations are being used inappropriately in particular instances, the abuses are not typical of these types of organizations, taken as a whole.
Section 509(a)(3) supporting organizations
A supporting organization is a public charity that in carrying out its charitable purpose supports another exempt organization, in almost all cases another public charity. The phrase can cover a wide variety of organizations: endowment funds for universities; subordinate entities that provide essential services for hospital systems; and many others. The classification as a supporting organization is important because it is one method by which a charity can avoid classification as a private foundation. Because of the required relationship between the supporting organization and its supported organization, the supporting organization is classified as a public charity, even though the supporting organization may be funded by a smaller number of persons. Private foundations are subject to many more restrictions and to the above-referenced regime of excise taxes on certain behaviors.
Let me emphasize here that we believe the vast majority of supporting organizations are entirely legitimate and upstanding charities. However, some tax planners see the supporting organization primarily as a means by which an organization’s creator can effectively operate what would ordinarily be a private foundation under the less restrictive rules applicable to public charities. Self-dealing and certain other transactions with substantial contributors to these organizations would be prohibited in the private foundation context.
However, some of the abuses and promotions we have seen clearly are not consistent with tax-exempt status. For example, in one promotion we have uncovered there is, almost immediately after a purported charitable donation to a supporting organization, an unsecured loan of all or a significant portion of the funds back to the donor and creator. A key part of this transaction is the effort by the promoter to ensure a lack of oversight of the supporting organization by the public charity it purports to support. While too technical to outline in this testimony, we are seeing several strategies that frustrate the ability of the supported public charity to oversee its supporting organization, clearing the way for abuses.
We have several promoters under investigation in this area and are examining dozens of organizations. More examinations are likely and we expect to be examining numerous individual returns shortly.
First, let me say that corporation sole statutes are a historical artifact intended to allow church officers, such as bishops or parsons of a church, to be incorporated for the purpose of insuring the continuation of ownership of property dedicated to the benefit of a legitimate religious organization.
However, we have become aware that some promoters are urging use of corporation sole statutes for tax evasion. Individuals incorporate under the pretext of being a “bishop” of a religious organization or society. The idea promoted is that this entitles the individual to exemption from federal income taxes as an organization described in section 501(c)(3). Individuals are told that their income will not be reportable or taxable, that their assets cannot be reached by current or future creditors.
These promotions have no legitimacy, and we are taking vigorous action to stop them. We are conducting dozens of promoter investigations of corporate sole promoters. To deter potential customers from being lured into the scheme, we published Rev. Rul. 2004-27, 2004-12 I.R.B. 625, which clearly explains that a taxpayer cannot avoid income tax by establishing a corporation sole.