Legal Rulings

The real story behind the IRS tax-exempt org. scandal

When the media gets hold of a controversial issue, it is always a good idea to hear what insiders on the issue think is the real story because it is often diametrically different than what we are hearing.

In this case of the IRS targeting political enemies of the ruling administration, what do tax lawyers for tax-exempt orgs think of the scandal?

If you are interested, click here to check out a post from the TaxGirl blogger (now on


In short, the IRS does this kind of stuff all the time (with or without the Obama administration)!  Just bad timing for getting caught during a particularly strong scandal season for the President.

My own two cents: in my experience, the IRS has no problems with overstepping their jurisdiction.  Orgs I have advised were held hostage over their exemption status over non-federal tax issues or issues irrelevant to tax-exempt status.  One organization was forced to sign an agreement that they would never again participate in raffles schemes (clearly a state law issue) if they wanted their 501(c)(3) letter.  Another organization was held hostage over their use of parsonage for their clergy-teachers (probably incorrectly and certainly not relevant to the 501(c)(3) application).  Basically, they used their strong bargaining position to push around the nonprofit for any issue they didn’t feel comfortable with – regardless of whether it had anything to do with the application being submitted.

The message I took from my limited experience was that when you go to the IRS for tax-exempt recognition, go in with as clean an application as possible, plain vanilla, nothing out of ordinary.  Nothing to give them reason to think twice.

Don’t Forget Those Gift Receipts and Don’t Forget the “No Goods/Services” Stmt

The timing and content of gift receipts by nonprofits for charitable gifts over $250 can mean the difference between a generally happy situation and a very unhappy one (where your donor loses his deduction, with significant legal costs no less!).

The gift acknowledgement rules are simple:

  1. Donor must receive gift receipt (for gifts over $250) by the time he files his tax return covering the year of the gift (filing date or due date – whichever is earlier).
  2. The gift receipt must include language that clearly states that no goods or services were offered in return for the gift being acknowledged.

Miss either of these rules and you are looking for trouble.  And, that is exactly what the charity in a recent tax case must be going through right now.

What was the case?  Charity sent a thank you letter to the donor for $22,000+ in gifts soon enough after the gift but it didn’t include the “no good or services” statement. Then, a year later, the charity gave the donor a letter with the right language about goods or services.

Easy case: deduction denied by the tax court.

There are times a taxpayer can get away with “substantial compliance” but not here.  If you want to read the case, click here: Chartiable Contr Deduction Durden TC Memo 2012-140.  Otherwise, get the right language into your gift receipts!

Garth Brooks Beats Hospital for Return of $500,000 Gift and $500,000 Punitive Damages$1-million-in-hospital-lawsuit/

Not a great day for fundraisers – this case proves a few tough points for nonprofits that we should all be aware of:

  1. Never trust a jury to come up with a rational decision – How did the hospital let this go to a trial without settling?
  2. Courts will always favor a donor and the donor’s intent over the substance of an alleged agreement (or lack thereof).
  3. Get it all in writing – written donor agreements detailing the expectations of all parties is essential for naming opportunities.
  4. Be extra careful when dealing with celebrities!

Commercial annuity as investment option for a Charitable Remainder Trust?

I worked on the issue of a commerical annuity in a CRT last year – the aftermath of a CRT investing its principal in a commercial annuity and the disaster that followed.

Now, thanks to the planned giving design center and an IRS letter ruling, use of a commercial annuity in a CRT might become more prevalent.  Click through to see the short letter ruling:

The question though is why would a trustee want to do this?

Let’s start with why not.  The story I worked on was a classic example of why not.  Unwitting donors created a CRT with a few hundred thousand dollars of hard earned money, to create an income steam for themselves and a remainder for great charitable works.

Sadly for them, everyone involved with the process of creating this CRT were absolutely clueless – from the drafting attorney to the third party planned giving specialty company to the investment manager.  The investment adviser saw that this trust needed to produce an annuity for the donors for their lives.  So, the investment adviser suggested to put the entire principal in a commercial annuity paying exactly what they are supposed to receive yearly. 

Problem: the principal was not guaranteed.  Second problem: the annuity wasn’t guaranteed either.  Third problem: stock market crashes and eats up the value of the principal.

This was an incredibly poor piece of advice given to these CRT donors. 

I actually devised a bailout plan for this disaster which entailed the donors relinquishing their interest in the CRT in favor of a charity, and that charity issuing a CGA on their lives.  The new income stream would have been about half of what the CRAT was paying but it would have at least salvaged a remainder and guaranteed a fixed income for life.

What they really should have done is sue all of the offending advisers involved – they were all sitting ducks for their so-called professional advice.

In the end, they decided to let the CRT languish.  Having been burned very badly once, I don’t think they were up for any more complexities and just hoped for the best.  Maybe the annuity recovered.  Maybe not.

There was a serious legal issue in that case that is not addressed in the letter ruling that just came out.  The question is whether a trustee should make such an investment, especially if it is not in the best interests of the remainder charities.  Prior rulings, I recall, required an independent trustee to help make this risky decision.

Bottom line, and why I wrote this piece, is that regardless of this new letter ruling, CRT trustees should be very cautious before ever investing in a commercial annuity.  It has to make sense for both income and remainder beneficiaries or the trustee deserves to be sued.

I did promise a discussion of why it would make sense for a CRT to invest in a commercial annuity.  Well, if it can guarantee a remainder, then it might make sense.  Something like reinsurance within a CRT.  The key is guaranteed principal for the charities while guaranteeing the income stream.  In the end, you might be giving up half or more of the principal to accomplish this but that isn’t so bad considering the cases where there is nothing left for the charity.

I have discussed before that I actually believe that reinsurance in the CGA arena is very useful and sometimes a better long term option for a charity.  Could work similarly here for CRTs.

The main thing is to have advisors who knows CRTs and who know commercial annuities – real knowledge, not just faking it.