Tax Court Again Uses Merger Clause to Find Adequate Substantiation

• Date: 01 November 2017
• DOI: http://doi.org/10.1002/npc.30391
• Published date: 01 November 2017

Bruce R. Hopkins’ NONPROFIT COUNSEL

5

November 2017

THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc

“evidence of a substantial nonexempt purpose.” The IRS

intoned: “Sharp business practices, including deceptive

contracts and untrue statements about the law or an

organization’s business methods, are incompatible with

the purpose of an organization claiming to be chari-

table.” [4.4, 6.3(i), 20.1, 25.2(c), 28.3(w)]

Commentary: This ruling, long on conclusions and short

on analysis, is hard to take seriously. But charitable orga-

nizations that engage in this type of fundraising, such as

solicitation of gifts of automobiles, airplanes, and boats,

should take note. Consider the allegation that the orga-

nization’s primary purpose is to attract customers who

would otherwise go elsewhere to sell their timeshares.

That could be said of any charity soliciting noncash gifts,

including real estate. The owners of property almost

always have the option to sell it (or contribute it to any

charity). Of course, this statement, which turns the trans-

action upside down, is irresponsible nonsense.

Without explanation, this charitable entity was faulted

for ostensibly principally operating to serve the business

needs of the companies. (There are two principal pur-

poses of this organization identified in the ruling.) So,

anytime a charity retains the services of a management

company, fundraising company, law firm, accounting firm,

or any other business enterprise for necessary services, is

the IRS going to revoke exemption because the charity is

functioning to serve businesses’ needs and is therefore

conducting itself in a commercial manner? Of course not.

Admittedly, this multiple-entity structure is clumsy. But

it is not illegal. The IRS complained about the “extensive

financial connections” between the founder and the com-

panies. So what? That’s no basis for revoking the exempt

status of a charity hiring one or more of the companies for

necessary services. Were the fees charged to the charity

by any of the companies unreasonable? The ruling does

not say. Yet “excessive private benefit” was said to have

been conferred by the charity to the founder. The ruling,

however, is silent as to the form of this private benefit.

In any event, the private inurement doctrine should have

been applied, not the private benefit doctrine.

These are related-party transactions that are permit-

ted under the law and are annually disclosed by the filing

of an annual information return, including Schedule R.

Deceptive business practices, if illegal, are grounds

for loss of exemption of the charity engaging in the

practices. The ruling does not reference the existence

of any illegality. How about “sharp business practices”?

This may be the first ruling using that type of behavior

as a basis for revocation. Are these practices contrary to

public policy? Again, the ruling is silent. I read what the

charity stated about the law and did not find anything

inaccurate. Perhaps the IRS saw an insinuation that the

gifts are deductible.

Speaking of the law, our agent here failed to consider

two, quite relevant, provisions of the Internal Revenue

Code. The law states that the “selling of merchandise,

substantially all of which has been received by the orga-

nization as gifts or contributions,” is not an unrelated

business (IRC § 513(a)(3)). This rule enables charities

to operate thrift stores and maintain car donation and

similar programs without adverse tax consequences. It

would seem to also shelter the solicitation and disposi-

tion of timeshares by charities.

Then there is the question of the deductibility of gifts

of timeshares. Gifts of this nature are presumably of non-

deductible partial interests in property (IRC § 170(f)(2)(B)).

The IRS did not raise this point. One of the companies

maintained a website that stated that the timeshare gifts

are deductible, which probably was misleading. But the

charity in this case does not control that website, so its

content should not be attributable to the charity.

The IRS’s quality control mechanisms failed it here. ◆

TAX COURT AGAIN USES

MERGER CLAUSE TO FIND

ADEQUATE SUBSTANTIATION

The US Tax Court, on August 28, ruled that a charita-

ble deduction for a gift of a conservation easement was

available to the donor, which did not receive a substan-

tiation letter from the donee, because of the existence

of a suitable merger clause in the deed of easement (Big

River Development, LLC v. Commissioner).

Facts

The donor in this case executed a deed of historic

preservation and conservation easement granting a quali-

fied public charity an easement over the façade of a build-

ing. This deed of easement’s granting provision recites

$10 of consideration, as well as “other good and valuable

consideration.” The deed states that in “further consider-

ation” for the benefits to be received by the donor, the

donor agreed to pay the donee a one-time “donation

fee” to be used to endow periodic easement monitoring

and related costs and support a preservation easement

defense fund. This easement is said by the deed to be “in

perpetuity over and across” the easement area.

Aside from the charity’s monitoring activities and the

donor’s fee payment, the deed of easement does not

contain any reference to any valuable goods or services

being furnished to the donor and does not recite any

receipt by the charity of any consideration for providing

goods or services. The parties stated their understand-

ing that the deed reflects the entire agreement of the

parties. The charity did not provide the donor with a

contemporaneous written acknowledgment in connec-

tion with the gift; it provided an acknowledgment to

the donor more than two years after the gift was made.

Neither party contended that the donee furnished the

donor with any valuable goods or services.