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Abusive tax transactions involving exempt organizations.

The tax-exempt sector has faced increased scrutiny in recent years as it has grown in size and complexity. Exempt organizations are being watched closely by the IRS, Federal and state legislators, the press and the public. A key concern in the aftermath of high-profile tax-shelter controversies is the shift of abuse, which is now being curtailed in the for-profit sector, to the tax-exempt arena. Abusive tax transactions involving exempt organizations are especially troubling because nonprofits, particularly charities, are seen as doing social good and relieving the burden of government. Questionable transactions and third parties receiving benefits not only threaten tax fairness, but undermine the reputation of the tax-exempt sector. The issue of tax-exempt entities and tax shelters remains the focus of IRS compliance plans and is on the Senate Finance Committee's (SFC's) policy agenda.

Business Purpose

Many tax-avoidance or "listed transactions" may involve exempt parties as a way of accomplishing their goals. To effect these transactions, shelter promoters in the for-profit sector are moving over to tax-exempt organizations to serve as "accommodating parties." Tax shelters require both taxpayers looking for a benefit and, as a minimum, one accommodating party that will act along with the taxpayer to structure a transaction to meet certain criteria. Often, there is also an accommodating lawyer and/or CPA.

In addition to tax exemption, a benefit of using a nonprofit is perhaps the ability to play down traditional issues over whether a transaction has a business purpose, as the focus is generally on the generosity of the donation as the reason for the transaction. However, donative intent may be only part of a larger picture; the use of a tax-exempt organization with a good reputation alone does not make a questionable transaction any better.

Exempt organizations should exercise caution if approached about entering into a transaction, especially if there is a promoter or similar professional adviser involved. They need to ensure first whether the motive for the transaction is donative. Although a transaction is likely to produce third-party tax benefit (e.g., a charitable deduction), the benefit should not be excessive.


Abuses of tax-exempt entities generally fall into two categories--Sec. 170 charitable contribution deductions and the use of an exempt entity as an accommodation party in a transaction that will shift tax benefits. The IRS's Website provides comprehensive descriptions of (1) listed transactions involving exempt organizations, (2) other abusive transactions involving exempt organizations and (3) other abusive tax-avoidance transactions, as well as links to specific guidance; see,,id=128722,00.html.

Sec. 170: Abusive transactions based on Sec. 170 can include acts such as overvaluing tangible or intangible property contributed to a Sec. 501(c)(3) entity when the charity substantiates the value, or undervaluing the quid pro quo benefits a charity provides to a contributor in exchange for a contribution. Key tax-exempt activities that have received attention and regulation in this area include car donation programs, intangible property donations and conservation easements.

Tax-indifferent accommodation parties: Although many joint ventures with tax-exempt organizations are both beneficial and properly structured, exempt organizations can be used as tax-indifferent accommodation parties to disaggregate and reallocate tax benefits. A series of steps can pointedly separate and allocate tax benefits among taxpayers that can use them better. This could entail shifting deductions and risk of loss to the taxable entity, while shifting income (along with protection from loss) to the nonprofit. Often a tax-exempt organization will receive a modest return in exchange for participating in a transaction while knowingly or unknowingly enabling the other entity or the promoter to reap greater benefits. An appropriate joint venture with a tax-exempt entity would allow tax benefits and losses consistent with the entity's ownership interest. Key tax-exempt activities that have received attention and regulation in this area include S corporation tax-shelter strategy and credit counseling.

Consequences of Abuse

How an exempt organization might be affected by its participation in a tax-avoidance transaction is somewhat unclear, particularly how such behavior might affect its exempt status. Congress has enacted a range of penalties and sanctions that apply to tax-shelter participants (including managers and professionals who advise exempt entities), and an array of transactions classified as reportable to the IRS. Because both the IRS and the SFC are concerned about the use and abuse of nonprofits, it is conceivable that they will initiate further legislation. Almost certainly, there will be more investigation and scrutiny by the IRS, whose Tax-Exempt and Government Entities Division has already shifted significant resources to abusive tax transactions. Notably, in February 2006, two of the IRS's top "Dirty Dozen" tax scares involved credit-counseling and abuse of charitable organizations and deductions.

The tax-exempt sector in general has been responsive to the issues raised about abusive tax transaction and has assisted in developing guidance and educating the SFC. Although it has received acknowledgement from IRS Commissioner Mark Everson at recent conferences, Mr. Everson is less comfortable in his expectations of the accounting, legal and business communities based on their performance in the for-profit arena.

Exempt organizations should be aware of the increased scrutiny of their sector, and seek not only to understand the methods used to carry out tax-avoidance transactions in the sector, but also to consider the tax implications to all parties, especially when a promoter is involved. It is no longer enough to only consider the effect of a transaction on the exempt organization.

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Article Details
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Author:Underwood, Joyce M.
Publication:The Tax Adviser
Date:May 1, 2006
Previous Article:Statutory mergers.
Next Article:Corporate inversions and the affiliate-owned stock rule.

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