Vol. VI, No. 2May 1998

FSDEF Supports Appeal of Tax Court Decision in United Cancer Council
The U.S. Tax Court upheld the IRS' retroactive revocation of United Cancer Council, Inc.'s ("UCC") tax-exempt status. (UCC v. Commissioner, 109 T.C. No. 17). UCC is in bankruptcy as a result of the IRS' actions, but nevertheless has noticed an appeal of the Tax Court's unprecedented decision to the U.S. Court of Appeals for the Seventh Circuit. The Free Speech Defense & Education Fund, Inc. (FSDEF) has agreed to take the lead in raising support for UCC's appeal to pursue the vital legal principles at stake for the benefit of the entire nonprofit community.

The Tax Court decision approved the IRS' retroactive revocation of a 501(c)(3)'s tax-exempt status &emdash; even though the charity's board of directors had negotiated the contract at arm's length with the fundraiser, and the charity received substantial benefit from the contract &emdash; simply because the IRS concludes a contract worked out too favorably for the fundraiser. Lead IRS counsel in this case later stated that: "It was not that UCC did not get enough of the revenue; it was that the fundraiser got too much." (Emphasis added.) Many charities now believe they will need experts to certify the fairness of their fundraising contracts, or risk their tax-exempt status. An IRS official asserted that application of this precedent is not limited to fundraising, and predicted increased IRS scrutiny of contracts with limited numbers of bidders.

United Cancer Council, Inc. was organized as a non-profit corporation in 1963. Its tax- exempt status under section 501(c)(3) of the Internal Revenue Code was recognized by the IRS in 1969. Until 1984, UCC was supported primarily by affiliate member agencies, but also engaged in some direct solicitation of individuals. Its annual budget never exceeded $50,000.

When a budget crisis developed in 1983, UCC's board sought a professional fundraiser who could assist it in conducting fundraising without requiring any initial capital expenditure by UCC. UCC's board of directors (30 members, including two judges) negotiated with the Watson & Hughey firm ("W&H") for six months, then formally reviewed and approved the contract. W&H agreed both to provide the initial capital to conduct the fundraising campaign and to furnish funds to permit UCC to continue to operate. Additionally, if the funds raised were not sufficient to cover the fundraising expenses, W&H agreed to pay the excess. The contract was similar to contracts which have been signed by many other tax-exempt organizations in the past.

In 1985, the first full year of the contract, UCC received $168,000. (The Tax Court stated that more than a year passed before the net revenue from the direct mailings "began to somewhat approach" the amount disbursed by W&H to UCC.) By January 1987, UCC received $50,000 a month, its maximum annual income before the contract had been signed. The contract lasted for five years, and expired by its terms in June 1989. UCC netted $2.25 million from the contract, and had $500,000 in the bank and no fundraising debts when the contract ended.

However, the Tax Court found W&H received unreasonable compensation. Also, W&H as a vendor was deemed an "insider" of UCC because "the fundraising arrangement with W&H accounted for substantially all of [UCC's] funds" giving W&H "substantial control over [UCC's] finances." (Emphasis added.) Neither W&H nor its principals were directors or officers of UCC, nor did they have a formal voice in the selection of any director or officer. But the court concluded that W&H had "effectively exclusive control over [UCC's] fundraising activities." (Emphasis added.) This conclusion appears inconsistent with the court's findings of fact:

Before each direct mail package was mailed, [UCC] received from W&H all materials to be included in the package, as well as the names of all mailing lists to which W&H proposed to send the package and the estimated numbers of names from each mailing list to be used in the mailing. [UCC], though its staff and a committee of its board, reviewed and revised the package and the mailing list and gave instructions as to the mailing list numbers, the copy, the dates of mailing, and the total number of letters to be sent....

A January 1985 major prospect mailing was planned… However, although the package had been approved by [UCC], [UCC's] board of directors then urged that the… package be replaced by a different package. That different package… lost $110,000. [Emphasis added.]

The Tax Court concluded:
The instant case does not involve an insider's embezzlement or any other kind of theft or use of assets unbeknownst to the other insiders. What we conclude to be excessive compensation resulted from what [UCC] and W&H apparently believed the Contract permitted or required. The fact that the Contract was bargained for is a significant factor pointing toward reasonableness.... However, even under the standards of § 162(a)(1) the bargaining factor does not by itself conclusively protect an arrangement from a determination that the compensation was unreasonable; we are required to consider all the circumstances. [Emphasis added.]

According to the court, these circumstances convinced it that W&H's risk "did not justify so high a level of compensation." The court asserted that it was "not holding that an arm's-length arrangement that produces a poor result for an organization necessarily would cause the organization to lose its tax-exempt status." IRS officials identified the case as precedent for application of intermediate sanctions, including personal liability for board members of nonprofits.

The IRS revoked UCC's tax-exempt status &emdash; retroactive to the date when UCC contracted with W&H &emdash; in November 1990, more than one year after the contract with W&H had expired.

Contributions to FSDEF to help fund the UCC appeal are tax-deductible. In light of the IRS' attempt to see how far they can expand this precedent, a donation to FSDEF today may save your organization (and your board members) substantial litigation fees tomorrow.

Legislative Efforts to Censor Issue Advocacy Before U.S. House
FSC members recently received a fax alert regarding H.R. 2183, the "Bipartisan Campaign Integrity Act of 1997" (the "Freshmen Bill" or the "Hutchinson-Allen Bill"), expected to come to the floor under an open rule in late May. Among the features of the Freshmen bill which would affect nonprofits are:
• imposing new expenditure reporting requirements on nonprofits which engage in express advocacy or issue advocacy and which (i) use radio or television, (ii) mention or includes the name, likeness, or other representation of a federal candidate in their advertisements, and (iii) exceed certain dollar thresholds; and
• prohibiting holders of, or candidates for, federal office (or their agents) from soliciting, receiving, or directing any funds for nonprofits unless the nonprofits never mention the name of (or otherwise identify) any candidate for the House or Senate in all communications (not just radio and television advertisements) produced with such funds. In effect, nonprofits could not, in any context, mention any Senator or Representative who had not announced retirement in such communications. This would appear to apply to funds raised where Senators or Representatives (or candidates for these offices) sign fundraising letters, serve on the boards of nonprofits, appear at nonprofit fundraisers, or even appear on the letterhead of the nonprofit's stationery bearing solicitations.

Another bill expected to be debated on the House floor is H.R. 3526, the "Bipartisan Campaign Reform Act of 1998" ("Shays-Meehan"). This bill would also affect nonprofits by:
• prohibiting incorporated nonprofits from broadcasting issue advocacy which neutrally report the stance of a clearly-identified federal candidate on any or every issue within 60 days of an election; and
• prohibiting incorporated nonprofits from broadcasting issue advocacy which reports and comments upon the stance of a clearly-identified federal candidate on any or every issue more than 60 days before an election.

According to the May 14, 1998 Roll Call, House Majority Whip Tom DeLay "has organized an action team of Republican Members" to oppose "campaign reform" legislation. Rep. DeLay calls this action team the Free Speech Coalition. We are happy to see that others like our name. We urge all nonprofits to defend against this legislative assault on the First Amendment-protected activities of nonprofits and individuals.

FSC takes no position with regard to election law except where it restricts advocacy organizations' exercise of their Constitutional rights.

Update on Challenge to Utah Charitable Solicitations Statute
FREE SPEECH readers will remember American Target Advertising, Inc.'s ("ATA") suit against the state of Utah: ATA v. Giani is a Constitutional challenge to the Utah Charitable Solicitations Statute, which was filed in U.S. District Court (District of Utah). This suit arose after a nonprofit, located in Washington, D.C., retained ATA, a Virginia corporation, to assist them in preparing nationwide mailings. When the nonprofit attempted to register with the State of Utah, Francine A. Giani, who directs the office enforcing the Utah Charitable Solicitations Act, demanded that ATA also register with the State before the nonprofit could mail into Utah. In response, ATA filed suit.

The Free Speech Defense & Education Fund, Inc. (FSDEF) and 26 other nonprofits and companies filed an Amicus Curiae brief which argued that the Utah Act is unconstitutional &emdash; violating the First Amendment, due process of law guaranteed by the 14th Amendment, and the Commerce Clause. After FSDEF filed its amicus brief, 16 state attorneys general, two secretaries of state, and one county attorney sent an Amici Curiae Memorandum in defense of the statute.

The case is awaiting a ruling on cross-motions for summary judgment. Such motions allow the Court to decide the case without a trial if no material facts are in dispute.

A hearing was held on April 15 on the cross-motions for summary judgment by ATA and the state of Utah. Following the hearing, according to ATA's attorney, Mark Fitzgibbons, Esquire, the judge requested additional briefing by both parties on two key First Amendment issues:
1) Whether core political speech is at issue in the case; and
2) Whether there is evidence in the record that there was a compelling state interest requiring registration.

These briefs were due May 18. The parties expect a decision in the near future. The judge's request suggests that his deliberations are focused on the First Amendment rights burdened by the Utah statute. Thus, there is reason to hope that nonprofits' First Amendment rights may be vindicated by this federal court.

The Free Speech Coalition, Inc. is a nonpartisan, nonprofit 501(c)(4) organization which educates, lobbies, and litigates to defend the rights of advocacy organizations and their members. FSC needs your support to continue its fight to protect the rights of citizens to associate together and exercise their First Amendment right to petition their government for redress of their grievances. Contributions to the Free Speech Coalition, Inc. are not tax-deductible. However, contributions to the Free Speech Defense & Education Fund, Inc., a 501(c)(3) public charity, are tax-deductible.