Gap Between Tax and Sanctions Law Blocks Lifesaving Aid

• Publication year: 2017
• Author: By Kay Guinane & Cherie Evans

Gap Between Tax and Sanctions Law Blocks Lifesaving Aid1

By Kay Guinane² & Cherie Evans³

EXECUTIVE SUMMARY

This paper (which was originally published by Tax Analysts in Tax Notes, Oct. 10, 2016, pp. 289-298, and is reprinted here with permission) provides background and analysis to support a review of the gap between Treasury's redress procedures for individuals, charities, and other entities designated as specially designated global terrorists (SDGT) or specially designated terrorists (SDT) and Internal Revenue Code requirements that charitable assets be used solely for charitable purposes. This paper notes deficiencies in the current redress procedures, analyzes relevant court cases, and explains why regulatory review is needed to address the gap. It focuses only on charities that are entitled to protection under the U.S. Constitution, which is a small subset of the total universe of persons subject to designation.

The legal gap arises in part because of the limited redress procedures provided in current sanctions regulations⁴ governing the procedures used by individuals, charities, and entities to challenge designation and placement on Treasury and other sanctions lists. The process limits the applicant to making a written request to the agency to reconsider its decision. Although the petitioner can request a meeting with the Treasury Office of Foreign Assets Control (OFAC), the agency is not required to grant it. While OFAC must respond in writing, there is no deadline for when that must happen and no formal process for how it makes its determination. While the process is underway, the assets of the person or entity challenging designation are frozen (blocked).

Regarding two designated U.S. charities, the courts found the process used by Treasury violated both the Fourth and Fifth amendments by freezing the charities' assets without a warrant based on probable cause and by denying the charities meaningful notice and opportunity to respond to the accusations against them. In an earlier case, the U.S. District Court for the District of Columbia recognized that at some point a long-term asset freeze might ripen into "vesting of property in the United States."⁵ However, the court did not specify at what point that vesting occurs. The findings in those cases demonstrate the need for Treasury to align its rules with constitutional principles.

The OFAC designation due process problem particularly affects U.S. charities. Once a charity is listed, its section 501(c)(3) status is suspended under section 501(p) and the charity usually faces dissolution. But there is no mechanism in the law for the charity's assets to be distributed for charitable purposes as required by reg. section 1.501(c)(3)-1(b)(4). Thus, when a charity's funds are frozen upon an OFAC designation, the money intended by donors to help people in dire need becomes lost in a legal limbo.

The proposed regulatory review would create an opportunity to address this legal gap as well as provide greater transparency and fairness. It would improve public credibility of Treasury's sanctions lists and ensure that tax-deductible donations benefit those in need.

I. BACKGROUND A. IRS Requirements for Tax-Exempt Organizations

The IRC provides requirements for nonprofit organizations to achieve tax-exempt status. Although there are various types of exempt organizations, from labor unions to homeowners associations, the most common form is charities under section 501(c)(3). Because these organizations are organized exclusively for charitable purposes, as defined by the code, donations to them are tax deductible.

To be recognized as a section 501(c)(3) organization, a charity must satisfy both an organizational test and an operational test. To satisfy the organizational test, the organization's governing documents must limit the purposes of the organization to one or more exempt purposes.⁶ Also, the governing documents must dedicate the organization's assets to exempt purposes. An organization's assets will be considered dedicated to exempt purposes if, "upon dissolution, such assets would, by reason of a provision in the organization's articles or by operation of law, be distributed for one or more exempt purposes . . . or would be distributed by a court to another organization to be used in such manner as in the judgment of the court will best accomplish the general purposes for which the dissolved organization was organized."⁷ An organization is operated exclusively for exempt purposes only if it engages primarily in activities that accomplish those exempt purposes. Usually an organization must submit a lengthy application to the IRS, which includes its governing documents and a detailed description of its activities and finances. The IRS determines whether the organization qualifies as a charity based on that application.

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Section 501(p) was added to the IRC in 2003. It suspends the tax-exempt status of organizations designated as terrorist organizations under an executive order. The suspension and designation may not be challenged in any administrative or judicial proceeding concerning the federal tax liability of the organization. In most cases, the suspension and freezing of all assets forces the charity to dissolve. But there is no mechanism in the law for the charity's assets to be distributed for a charitable purpose, as required by Treasury regulations.

B. The Sanctions and Listing Regime

Passed in 1977, the International Emergency Economic Powers Act (IEEPA) authorizes the president to declare a state of emergency relating to "any unusual and extraordinary threat, which has its source in whole or in substantial part outside the United States, to the national security, foreign policy, or economy of the United States"⁸ The declaration of a national emergency, which is announced in the form of an executive order, establishes criteria for designating people and organizations to be a threat. Designated people and organizations are put on various lists, including the SDGT and SDT lists. Those are combined into the specially designated nationals (SDN) list, which includes all sanctions programs.

Once a national emergency is declared, IEEPA allows the president to "investigate, regulate, or prohibit" a host of financial transactions with "any foreign country or national thereof" through regulations, licenses, instructions, or other means. The president can block (freeze bank accounts and take control of files and equipment) any property in which the designee has an interest that is subject to U.S. jurisdiction. Although the designated entity retains legal title to the funds and property, it cannot access them. Also, IEEPA allows the government to investigate, "block during the pendency of an investigation, regulate, direct and compel, nullify, void, prevent or prohibit" any transactions relating to property held by the designated foreign country or national.¹⁰ Once on the list, the person or entity is subject to asset freezes, travel bans, and other sanctions.

IEEPA bars anyone, including charities, from engaging in transactions described in the relevant executive order with designated persons or entities, including designated terrorist organizations.¹¹ Violation of those prohibitions can result in criminal prosecution, civil sanctions, or placement on the terrorist list.¹²

IEEPA developed from economic sanctions laws that target specific foreign nations, originally passed as the Trading With the Enemy Act in 1917. IEEPA is implemented through executive orders giving Treasury or the State Department authority to impose sanctions on non-state groups or governments. For example, in 1995 President Bill Clinton issued Executive Order 12,947, which declared sanctions against SDTs that threaten to undermine the Middle East peace process, including individuals, nongovernmental entities, and nation states. That was the first time IEEPA was invoked to impose economic sanctions on specific organizations and individuals unrelated to country sanctions. Since then, executive orders have been expanded to include U.S. citizens and charities.¹³ In December 2001 the assets of three of the largest Muslim charities in the United States were blocked.¹⁴

Executive Order 13,224, issued by President George W. Bush on September 24, 2001, declared a national emergency based on the September 11 attacks and directed Treasury, in consultation with the attorney general and secretary of state, to designate SDGTs and to take action to freeze all of their assets subject to U.S. jurisdiction. Designation may be as a terrorist organization or as a supporter of one if Treasury finds that an individual or entity has provided material support to an SDGT or is "otherwise associated with" an SDGT ("to be otherwise associated with" is defined as "(a) to own or control; or (b) to attempt, or to conspire with one or more persons, to act for or on behalf of or to provide financial, material, or technological support, or financial or other services, to.")¹⁵ There is no knowledge or intent requirement.

IEEPA bars the president from blocking "donations . . . of food, clothing, and medicine, intended to be used to relieve human suffering, except to the extent that the President determines that such donations (A) would seriously impair his ability to deal with any national emergency."¹⁶ That exception was invoked in Executive Order 13,224, which placed humanitarian aid on the list of prohibited transactions with designated terrorist organizations. That executive order has been used as the basis for Treasury and State Department designations, covering geographic areas from central Africa to Sri Lanka to Northern Ireland.¹⁷ It has been routinely invoked in other executive orders where non-state armed groups have been designated as terrorists.¹⁸

To designate a person or entity for placement on a terrorist list, Treasury must find that there is a reasonable basis to believe that the person or entity meets the criteria...