Vol. VI, No. 3 • August 1998 Censorship of Nonprofit Issue Advocacy Passes U.S. House On August 3, 1998, the U.S. House passed Shays-Meehan (HR 3526), which would prohibit incorporated nonprofits from broadcasting issue advocacy which reports the stance of a clearly- identified federal candidate on any or every issue unless certain conditions were met. However, under the rule by which the campaign finance reform bills are being debated, the House still has to consider the Freshmen Bill (HR 2183), which would (1) impose new reporting requirements on broadcasted issue advocacy by nonprofits, and (2) prohibit nonprofits from mentioning the name of current and prospective Senators or Representatives in any communication unless certain conditions were met. Additionally, even though the House passed Shays-Meehan (237-186), if the Freshmen Bill passes by a larger margin, only the Freshmen Bill will be sent to the Senate for consideration. Only after the Freshmen Bill is voted on will one of these two bills go to the Senate. The House has rejected a proposed Constitutional amendment which would change the First Amendment freedoms guaranteed to issue advocacy (and upheld by the U.S. Supreme Court in the 1976 case Buckley v. Valeo). The House also rejected a proposal which would have created a temporary commission to propose federal campaign finance reforms, to be considered by Congress under fast-track procedures (i.e., they cannot be amended). FSC takes no position with regard to campaign reform legislation except where it restricts advocacy organizations' exercise of their Constitutional rights. IRS Issues Proposed Intermediate Sanctions Regulations On July 30, 1998, the Internal Revenue Service issued a notice of proposed rulemaking publishing the draft regulations which would implement intermediate sanctions &emdash; provisions of the 1996 Taxpayer Bill of Rights 2 which are found at section 4958 of the Internal Revenue Code. These intermediate sanctions involve the imposition of three forms of excise taxes: a 25 percent excise tax on "disqualified persons" who receive an "excess benefit" from a transaction with a tax-exempt organization; a 200 percent excise tax on such persons where the excess benefit is not corrected within the taxable period; and a 10 percent excise tax on "organization managers" who knowingly participated in the excess benefit transaction. These taxes are computed from the amount of the identified excess benefit. Where more than one person is subject to the excise tax, all persons on whom the tax is imposed are jointly and severally liable to pay the excise tax. The IRS states that independent contractors, such as attorneys, accountants, and investment managers, are not "organization managers." Furthermore, where the IRS is examining a possible excess benefit transaction, the status of being an independent contractor is described as a fact and circumstance tending to show that the individual is not a "disqualified person" (unless the individual acted as an attorney, accountant, or investment manager with respect to a transaction that resulted in an excess benefit to him or her). However, fundraisers beware. A revenue-sharing transaction may constitute an excess benefit transaction regardless of whether the economic benefit provided to the disqualified person exceeds the fair market value of the consideration provided in return &emdash; if "it permits a disqualified person to receive additional compensation without providing proportional benefits that contribute to the organization's accomplishment of its exempt purpose." (Emphasis added.) One factor the IRS will look at is the ability of the party receiving the compensation to control the activities generating the revenues on which the compensation is based. The IRS provides examples to illustrate the principles used in determining whether a revenue-sharing transaction constitutes an excess benefit transaction. Proposed §53.4958-5, example 2 addresses a contract between a nonprofit ("L") and a company that manages charitable gaming activities for public charities ("H"). Under the contract, H agrees to provide all of the staff and equipment necessary to carry out charitable gaming operations on behalf of L, and to pay L a certain percent of the net profits, which are calculated as the gross revenue less rental for the equipment, wages for the staff, prizes for the winners, and other specified operating expenses. The IRS concludes: All of the gross revenues generated by the charitable gaming operation belong to L. The arrangement between H and L allows a portion of those revenues to inure to H. Therefore, this arrangement results in the inurement of L's net earnings to the benefit of H, and the entire amount paid to H under this arrangement constitutes an excess benefit under the rules of this section. (Emphasis added). Evidently, the IRS is advancing the proposition that any contingency arrangement which provides for a portion of the nonprofit's gross revenues to be paid to the fundraiser results in the inurement of nonprofit's net earnings to the benefit of the fundraiser. Moreover, under this example, the only reasonable contingent compensation appears to be no compensation &emdash; as the entire amount paid to the fundraiser constitutes an excess benefit, not the portion calculated to be excessive. According to published reports, Treasury Associate Tax Legislative Counsel Catherine Livingston told the American Bar Association's Exempt Organizations Committee that the key in analyzing revenue-sharing arrangements under the proposed regulations is "whether the arrangements could cause the interests of the organization and disqualified person to diverge." The proposed regulations provide that a compensation arrangement between an applicable tax-exempt organization and a disqualified person is presumed to be reasonable, and a transfer of property or any other benefit or privilege between an organization and a disqualified person is presumed to be at fair market value, if three conditions are satisfied. The three conditions are as follows: (1) the compensation arrangement or terms of transfer are approved by the organization's governing body or a committee of the governing body composed entirely of individuals who do not have a conflict of interest with respect to the arrangement or transaction; (2) the governing body, or committee thereof, obtained and relied upon appropriate data as to comparability prior to making its determination; and (3) the governing body or committee adequately documented the basis for its determination concurrently with making that determination. The proposed regulations also provide a special safe harbor (i.e., the governing body's reliance on comparability data from 5 similar groups) for organizations with annual gross receipts of less than $1 million. The proposed regulations would apply to "transactions occurring on or after September 14, 1995." (Emphasis added.) However, these taxes are not applicable to transactions "pursuant to a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurred." (Emphasis added.) The IRS states that contracts which are materially modified, including term extensions, would be treated as a new contract. One immediate impact of the proposed regulations would be the additional recordkeeping imposed on nonprofits. The IRS estimates the annual recordkeeping burden will increase by between 3 and 308 hours per year. A prominent issue regarding intermediate sanctions has been the standards which will determine when such sanctions are imposed in addition to revocation of tax-exempt status. The IRS notice stated that imposition of section 4958 excise taxes would "be the sole sanction imposed in those cases in which the excess benefit does not rise to a level where it calls into question whether, on the whole, the organization functions as a charitable or other tax-exempt organization." (Emphasis added.) The IRS states that this analysis would examine factors such as: • whether the nonprofit has been involved in repeated excess benefit transactions • the size and scope of the excess benefit transaction; • whether the nonprofit implemented safeguards to prevent future recurrences; and • whether there has been compliance with other applicable laws. Comments and requests for a teleconference on these proposed regulations are due by November 2, 1998. Comments (a signed original and eight copies) may be mailed to CC:DOM:CORP:R (REG-246256-96) Room 5226, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044, hand delivered to CC:DOM:CORP:R (REG-246256- 96) Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, D.C. 20044, or submitted electronically at www.irs.ustreas.gov/prod/tax_regs/comments.html. Comments were sought concerning the relationship between revocation of tax-exempt status and the imposition of section 4958 excise taxes. Comments were also requested with respect ot the effect of the proposed regulations on different compensation arrangements, including revenue-based compensation, deferred compensation, and the use of options as compensation. We encourage readers of FREE SPEECH to submit comments regarding these proposed regulations to the IRS, and ask that you provide us with a copy of your comments. For a copy of FSC's comments to help you prepare your comments, please call (703) 356-6912. FSC members will be receiving a copy of these proposed regulations, with a more detailed analysis of their provisions. State Charitable Solicitation Speech Police Visit Nonprofits The Northern Virginia corporate offices of at least two nonprofits have been visited by Speech Police from the Commonwealths of Pennsylvania and Virginia. The Speech Police from both states &emdash; drawn from the state charitable solicitation enforcement agencies (the Charitable Organizations Section of the Pennsylvania Attorney General's office, and the Virginia Department of Agriculture and Consumer Affairs) &emdash; arrived together, and were evidently working in cooperation, notwithstanding the representation that the visits were separate and not coordinated. No credible reason was given for the visits &emdash; in one case the agents of both agencies expressed an interest in simply confirming the address of the nonprofit. If nothing else, this visit adds an interesting insight to the analysis of state charitable solicitation laws published by FSC entitled "Consumer Protection or Bureaucratic Racket." Not only do state and local governments impose $100 million of administrative fees and costs each year on U.S. nonprofits, but the income which they have derived from nonprofits provides state and local governments with money to burn (e.g., sending state employees out-of-state merely to confirm nonprofit addresses, and to hand-deliver packets of information). FSC Leadership Considers Litigation Against AICPA Over SOP 98-2 FSC is continuing to examine a possible legal challenge to the American Institute of Certified Public Accountants' ("AICPA") Statement of Position ("SOP") 98-2. Concerns were raised that the AICPA had drafted and approved SOP 98-2, despite vehement and nearly universal opposition from the nonprofit community, due to pressure from, among others, the National Association of Attorneys General ("NAAG"). The legality of such "indirect government regulation" is extremely questionable, especially when the organization acting indirectly as regulator (the AICPA) seems exclusively responsive to the dictates of large companies, government regulatory groups or quasi-regulatory organizations. Regulatory authorities such as state attorneys general cannot do indirectly (e.g., by applying pressure to the AICPA) what they lack the authority to do directly. SOP 98-2 provides new financial standards (for Fiscal or Calendar Years starting on or after December 15, 1998) for costs of joint activities &emdash; activities involving both fundraising and other functions, such as program activities or management and general activities. SOP 98-2 requires that unless certain standards regarding the (1) purpose, (2) audience, and (3) content of an activity (as defined in the SOP) are met, all the costs of these joint activities should be reported as fundraising costs, including costs that otherwise might be considered program or management and general costs if they had been incurred in a different activity. This is a change from the standard in SOP 87-2 (currently in effect) which called for all circumstances surrounding the activity to be considered together when determining allocations. The allocation of costs from joint activities solely to fundraising is important, because more and more regulatory and quasi-regulatory agencies use fundraising expenditures (as a percentage of total expenditures) as the basis for judging nonprofits. For example, the Attorney General of New York, Dennis Vacco, offers Internet access to a database (www.oag.state.ny.us/moneymatters/ charities/pennies98/intro98.html) which he claims provides data on the percentage of 1996 fundraising expenditures (out of total expenditures) for 4,200 charities. Further, federal and state agencies encourage donors to inquire regarding the percentage of expenditures allocated to fundraising before donating funds. By requiring nonprofits to exaggerate the resources actually spent on fundraising activities, the AICPA's SOP 98-2 has become part of NAAG's effort to squeeze nonprofits which do not receive large foundation or government support out of business. Oklahoma Attacks Nonprofit for Failure to Register Under Dormant State Charitable Solicitation Statute FREE SPEECH readers will recall that two years ago, due to staff cutbacks, the State of Oklahoma ignored applications for charitable solicitation licenses (except to deposit the fees). The applications were merely thrown into a box. Thereafter the state apparently has sought to enforce its law selectively. This law criminalizes charitable solicitation without a license (with penalties ranging from loss of tax-exempt status to a $1,000 fine and two years in prison, making it a felony). FSC has recently learned of the only known effort to enforce this statute &emdash; against a political adversary of the Oklahoma Attorney General. State officials brought a state representative, Charles Key, before a grand jury for failure to register a nonprofit (which he had formed) under the state charitable solicitation statute, even through the nonprofit had not yet received the threshold amount of donations ($10,000) required for registration under the statute. New Law Protects Charitable Donations from Bankruptcy Courts On June 19, the Religious Liberty and Charitable Donation Protection Act of 1998 was signed by President Clinton. This Act, Public Law 105-183, amended federal bankruptcy law by defining certain charitable contributions (to tax-exempt nonprofits as described in sections 170(c)(1) and 170(c)(2) of the Internal Revenue Act) as not fraudulent, and thereby not subject to recapture in bankruptcy proceedings. United Cancer Council Case Amicus Briefs Filed Two amicus briefs were filed on July 22, 1998 in support of the United Cancer Council's appeal of the tax court case to the Seventh Circuit. Hayden Codding, Esquire, of Codding & Codding, Fairfax, Virginia, filed an amicus brief in the case of United Cancer Council, Inc. v. Commissioner of Internal Revenue Service on behalf of Bruce W. Eberle & Associates, Inc., and other interested fundraising agencies. Another amicus brief in the above-referenced case was filed on behalf of the interests of nonprofit organizations. Supreme Court Refuses To Define Political Committee On June 1, the U.S. Supreme Court ruled in the case FEC v. Akins, which questioned both the definition of a "political committee" under the Federal Election Campaign Act of 1971 (as amended) ("FECA"), as well as the right of complainants to sue the FEC for unlawful dismissal of a complaint alleging violation of the FECA. Several individuals, including James Akins, filed a complaint with the FEC stating that the American Israel Public Affairs Committee ("AIPAC") had made more than $1,000 in political expenditures in a year, making it a "political committee" subject to the reporting requirements of the FECA. AIPAC responded that the expenditures identified in the complaint were not political expenditures, but rather its communications (as a membership organization) to its members. The FEC's General Counsel rejected AIPAC's description of its expenditures, and concluded that AIPAC had exceeded the $1,000 threshold on political expenditures. However, the Commission decided that AIPAC was not a political committee because the nomination or election of individuals was not a "major purpose" of the organization, and therefore dismissed the complaint. Akins and the other complainants sued in federal court, asking it to review the FEC's dismissal of their complaint. The trial judge gave summary judgment to the FEC, but the U.S. Court of Appeals for the District of Columbia Circuit, sitting en banc, reversed, stating that the FEC's dismissal of the complaint reflected a definition of "political committee" which was based upon a mistaken interpretation of the FECA. The FEC appealed the case to the U.S. Supreme Court, challenging whether the complainants had any right to sue the FEC, and asking whether AIPAC qualified as a political committee under the FECA. However, the U.S. Supreme Court did not decide whether AIPAC is a political committee, ruling that AIPAC's characterization of the expenditures cannot be assessed until after the FEC has completed its efforts to redefine "membership" &emdash; in response to the rejection of the FEC's rules in that area by the Court of Appeals for the District of Columbia Circuit in another case. The Supreme Court did affirm the right of Akins and the other complainants to file suit in 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.