State Schedule B Disclosure Requirement Held Unconstitutional in As‐Applied Challenge

• Date: 01 February 2017
• Published date: 01 February 2017
• DOI: http://doi.org/10.1002/npc.30286

IRS ISSUES FINAL

REGULATIONS

CONCERNING RECEIPT

OF UBTI BY

REMAINDER TRUSTS

The IRS, on June 19, issued final regulations that provide guidance on the

tax effect of receipt of unrelated business taxable income (UBTI) by charitable

remainder trusts (T.D. 9403). The regulations, which affect remainder trusts that

have UBTI in tax years beginning after December 31, 2006, accompany the

change in the statutory law made by enactment of the Tax Relief and Health Care

Act of 2006 (see the February 2007 issue). A summary of the regulations in pro-

posed form is in the May 2008 issue.

Background

Prior to this law change, a charitable remainder trust could not be tax-exempt for

any year in which the trust had any UBTI. A trust in this circumstance was taxed on its

income, for each such year, under subchapter J as though it were a nonexempt, com-

plex trust. Today, however, charitable remainder trusts that have UBTI remain exempt

from federal income tax but are subject to a 100-percent excise tax on their UBTI.

Technicalities

This excise tax is imposed by IRC ß 664(c)(2)(A). The amount of UBTI is deter-

mined pursuant to IRC § 512; the modifications in IRC § 512(b) apply, including the

$1,000 specific deduction created by IRC § 512(b)(12). This excise tax is treated as

imposed under the excise tax rules that apply to private foundations and other tax-

exempt organizations (IRC chapter 42). Currently, the appropriate form to report

and pay the excise tax on charitable remainder trusts with UBTI is Form 4720.

Examples

For 2007, a charitable remainder annuity trust on the calendar year has

$60,000 of ordinary income, including $10,000 of gross income from a partnership

that constitutes unrelated business income to the trust. The trust does not have any

deductions that are directly connected with that incme. The trust has, for 2007,

administration expenses (deductible in computing taxable income) of $16,000,

resulting in net ordinary income of $44,000. The amount of UBTI is computed by

THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Analysis of current developments in tax

and related law for nonprofit organiza-

tions and their professional advisors.

Volume 25 Number 8

August 2008

ALSO IN THIS ISSUE…

NYT Takes Measure

of Charitable Sector 2

IRS Rules Restructuring Plan

Will Eliminate Excess Business

Holdings 3

Churches and Politics:

New Developments 5

TIGTA Lightly Rebukes

TE/GE Division on PACI 5

Millionaires’ Amendment

Ruled Unconstitutional 7

Other Developments 7

Bruce R. Hopkins’

NONPROFITCOUNSEL

© 2008 Wiley Periodicals, Inc.

Published online in Wiley InterScience

(www.interscience.wiley.com).

DOI:10.1002/npc.20055

THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

STATE SCHEDULE

B DISCLOSURE

REQUIREMENT HELD

UNCONSTITUTIONAL

IN AS-APPLIED

CHALLENGE

The US District Court for the Central District of California held, on November

16, that the California attorney general’s requirement that the fully prepared Form

990, Schedule B, be disclosed to that office is unconstitutional as applied to the

plaintiff in the case (Thomas More Law Center v. Harris). In so holding, the court

used an exacting scrutiny standard, which requires a “substantial relation” between

the disclosure requirement and a “sufficiently important” governmental interest.

The attorney general argued that the Schedule B disclosure rule is substantially

related to that office’s compelling interest in protecting the public and ensuring

that charitable organizations are not engaging in abusive practices. The court

found to the contrary, on two grounds. The court concluded that the attorney

general only recently (since 2012) determined a need for the information and

has access to the information from other sources. Also, the court held that the

disclosure requirement is more “burdensome than necessary.”

The court relied heavily on testimony of employees in the attorney general’s

office. A supervising investigative auditor testified that auditors and lawyers “sel-

dom” use Schedule B when investigating charitable organizations. A deputy attor-

ney general said it was “very likely” he could complete investigations of charities

without the schedule because the same information is available elsewhere, such

as on Form 990, Schedule L. The auditor testified that he successfully audited

charities without use of Schedules B and did so for years before the schedule

existed. All of this led to the court’s conclusion that the attorney general’s office

can achieve its ends by “more narrowly tailored” means.

© 2017 Wiley Periodicals, Inc.

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DOI:10.1002/npc

Analysis of current developments in tax

and related law for nonprofit organiza-

tions and their professional advisors.

Volume 34 Number 2

February 2017

Also in This issue...

Proposed Fractions Rule

Regulations Issued 2

Historic Preservation Can Be

Exempt Function; However… 4

Report: Minimize Distinction

Between Hospital Community

Benefit and -Building 5

Other Recent IRS Private Letter

Rulings 7

Other Developments 7