Abusive tax transactions involving exempt organizations.

• Author: Underwood, Joyce M.

The tax-exempt sector has faced increased scrutiny in recent years as it has grown in size and complexity. Exempt organizations are being watched closely by the IRS, Federal and state legislators, the press and the public. A key concern in the aftermath of high-profile tax-shelter controversies is the shift of abuse, which is now being curtailed in the for-profit sector, to the tax-exempt arena. Abusive tax transactions involving exempt organizations are especially troubling because nonprofits, particularly charities, are seen as doing social good and relieving the burden of government. Questionable transactions and third parties receiving benefits not only threaten tax fairness, but undermine the reputation of the tax-exempt sector. The issue of tax-exempt entities and tax shelters remains the focus of IRS compliance plans and is on the Senate Finance Committee's (SFC's) policy agenda.

Business Purpose

Many tax-avoidance or "listed transactions" may involve exempt parties as a way of accomplishing their goals. To effect these transactions, shelter promoters in the for-profit sector are moving over to tax-exempt organizations to serve as "accommodating parties." Tax shelters require both taxpayers looking for a benefit and, as a minimum, one accommodating party that will act along with the taxpayer to structure a transaction to meet certain criteria. Often, there is also an accommodating lawyer and/or CPA.

In addition to tax exemption, a benefit of using a nonprofit is perhaps the ability to play down traditional issues over whether a transaction has a business purpose, as the focus is generally on the generosity of the donation as the reason for the transaction. However, donative intent may be only part of a larger picture; the use of a tax-exempt organization with a good reputation alone does not make a questionable transaction any better.

Exempt organizations should exercise caution if approached about entering into a transaction, especially if there is a promoter or similar professional adviser involved. They need to ensure first whether the motive for the transaction is donative. Although a transaction is likely to produce third-party tax benefit (e.g., a charitable deduction), the benefit should not be excessive.

Abuses

Abuses of tax-exempt entities generally fall into two categories--Sec. 170 charitable contribution deductions and the use of an exempt entity as an accommodation party in a transaction that will shift tax benefits. The...