And on to Tax Matters. Or, as they say in Texas, “On to Tax Matters, Partner.”

Edges of Foundations

The Sixth Circuit decided “Lapham Foundation, Inc. v. C.I.R., No. 03-1229. In this case, the court upheld the decision of the Tax Court which held that the Lapham foundation is not a “supporting organization” of the American Endowment Foundation under 26 U.S.C. 509. AEF is one of these “donor advised funds” in which allow people to donate to them in one year, and yet maintain some control over the funds in later years. They don’t really control the funds, but they have a “say” in how the funds are later donated. Believe it or not, if you are filthy rich, these funds are a godsend.

Now, the problem is that Lapham Foundation only existed to contribute to the AEF, and Lapham Foundation only had one asset: a promissory note payable to the Laphams, that was – get this – written by a corporation that the Laphams owned, Estate Storage, Inc. When the Laphams asked to be recognized “tax-exempt organization under § 501(c)(3) and as a supporting organization under § 509(a)(3)” the IRS looked at what was really going on, and concluded that, yes, it was an exempt 501(c)(3), but it was a private foundation as it was really controlled by “disqualified person” under Treas. Reg. 1.509(a)-4(j)(1), and not a supporting organization. It isn’t that great to have a private foundation, because, as the court points out, “Private foundations are subject to various taxes, such as an excise tax based on investment income and taxes on self-dealing and failure to distribute income.” In other words, an organization can be a “supporting organization” if it meets the “attentiveness” test under Treas. Reg. 1.509(a)-4(j)(1) meaning that the organization must provide enough supposed to the “supported organization “sufficient to insure the attentiveness of such organization[ ] to the operations of the supporting organization." The AEF only received about $7,000 in the first two years, anyway. It can also be a “supporting organization” if it meets the “The But-For Test” in Treas. Reg. 1.509(a)- 4(i)(3)(ii) which allows an organization to qualify if “[t]he activities engaged in for or on behalf of the publicly supported organizations are activities to perform the functions of, or to carry out the purposes of, such organizations, and, but for the involvement of the supporting organization, would normally be engaged in by the publicly supported organizations themselves.” However, the court pointed out that merely donating money is not really an activity.

For a discussion of public charities, and how the IRS thinks about this stuff, see, the Internal Revenue Manual, An Article by the Greater Kansas City Community Foundation, and the Baton Rouge Area Foundation's Summary (and previous commentary disagreeing with the Tax Court)

Innocent rats are not Entitled to New Captain when Ship Going Down.

In Mekulsia v. Commissioner, No. 03-2304 the court held that the unwitting partners in an illegal tax shelter don’t have a right to be informed that the promoter (e.g. the “bad guy”) is under criminal investigation. They also don’t have a right to have the IRS stop treating the person under investigation as the “Tax Matters Partner” and therefore let someone who presumably isn’t an “almost-criminal” handle the audits with the IRS. 26 USC § 6231(c) allows the IRS to stop treating an investigated partner as a Tax Matters Partner, and 26 C.F.R. § 301.6231(c)(5), requires that the IRS do this if continuing to do that “interfere” with tax administration. The petitioner argued that “Secretary has already exercised the discretion granted him by statute and has determined that criminal investigation of a partner will always disrupt enforcement.” While a number of neat statutory interpretations were raised by both parties, the Sixth Circuit appears to have relied on the Ninth’s decision in Phillips v. Comm'r of Internal Revenue, 272 F.3d 1172 (9th Cir.2001), which involved the same partnership scam, and the Ninth Concluded that notification of the non-tax-matters partners was discretionary. Id. (“It is argued, a criminal investigation imposes a mandatory obligation to end the partnership treatment. The argument is ingenious but unconvincing. Read as a whole, the regulation [26 C.F.R. § 301.6231(c)-5T] vests discretion in the Commissioner to notify a partner that he or she is under criminal investigation. Until such notice is given, partnership items remain partnership items.”) Therefore, the court concluded that notifying the petitioners was not a “ministerial task” and therefore the petitioners were not entitled to not have the individual partner's items as partnership items.

The Sixth refers to the “District Court” once. I wish they would stop doing this. This was an appeal from the Tax Court.

For a biased opinion on the IRS's behavior in this case (including a description of the shelter) see here. For the Tax Court's opinion, see here.