Grassley Solicits IRS Comment, Urges Enforcement on Series of Problems in the Tax-exempt Arena
WASHINGTON – Sen. Chuck Grassley, chairman of the Committee on Finance, is seeking
Internal Revenue Service (IRS) comment and in some cases stepped-up enforcement on a series of
problems in the tax-exempt arena, including non-profit hospitals, non-profits that may be used for
political purposes such as those tied to then-lobbyist Jack Abramoff, generous non-profit board
member compensation and trustee fees, and non-profits that appear to function like for-profit
businesses and undercut their business competitors.
“I’m seeing dozens of separate problems united by a theme,” Grassley said. “The theme is
some individuals are exploiting vagueness or silence in or a lack of enforcement of the laws
governing tax-exempt groups to enrich themselves rather than serve the public. It’s unseemly for
tax-exempt groups to function this way. It’s also unfair to the taxpayers who subsidize that behavior.
That’s why I continue to try to tighten the laws governing tax-exempt groups and encourage the IRS
to step up enforcement of the existing laws and go after bad actors.”
Grassley has developed a package of charitable giving incentives and improvements to
nonprofit practices to help protect charities from individuals who abuse them for personal gain. He
is working to get the package enacted as soon as possible, with the strong support of charities
The text of Grassley’s letters today to the IRS’ chief counsel and the commissioner of the
IRS’ Tax-Exempt and Government Entities Division follow here.
June 1, 2006
The Honorable Donald L. Korb
Internal Revenue Service
Dear Mr. Korb:
As you are aware, the Congress continues to consider several legislative proposals affecting taxexempt
organizations. However, as you are also aware, legislation is not always the easiest or
quickest way to correct abuse by and within tax-exempt organizations.
The Internal Revenue Service (“IRS”) is granted broad authority under Internal Revenue Code
(“IRC”) section 7805 to issue regulations and specifically under IRC section 7805(b)(3) to apply
regulations retroactively to prevent abuse. It appears that IRS has used this provision as recently as
2005 to prevent abuses in taxable entities. I encourage you to use this tool more frequently and
expeditiously, particularly with respect to tax-exempt organizations and in those situations when it
is an IRS regulation that may be frustrating congressional intent by permitting an abuse to continue.
I support the positions IRS stated in recent guidance regarding credit counseling organizations and
seller-funded down payment assistance programs. The recently enacted Tax Increase Prevention and
Reconciliation Act of 2005 includes a measure to discourage tax-exempt organizations from serving
as accommodation parties in tax-shelter transactions. I encourage the IRS to use the full weight of
its authority to ensure that this provision of the Act is effectively administered.
Following are some of the questions and concerns I have as a result of several Senate Finance
Committee (“Committee”) investigations. The investigations, for example, highlighted the difficulty
in determining when an activity of an exempt organization qualifies as “educational.” The
investigations also demonstrated the challenges that arise in determining when a “business” activity
is unrelated to an organization’s exempt purposes or perhaps even confers an impermissible benefit
on private persons. As a result, I would appreciate your comments and thoughts regarding the
following cases and answers to the questions that follow.
Tax-Exempt Organizations Used for Political Purposes
The staff of the Committee has reviewed numerous documents relating to the charities and social
welfare/advocacy organizations with which Jack Abramoff was directly or indirectly associated. In
addition, the Committee has reviewed documents of other tax-exempt organizations across the
political spectrum with fact patterns akin to those associated with Mr. Abramoff.
A primary concern is that these organizations may be disguising impermissible lobbying and political
activities, or activities intended primarily to benefit private parties, by classifying them as
“educational” activities purportedly related to the organizations’ exempt purposes. Consider, for
example, an organization that is tax-exempt under Internal Revenue Code (“IRC”) section 501(c)(3)
or 501(c)(4) and accepts a payment (designated as a contribution) in exchange for which the
organization provides a position paper or holds a conference extolling the contributor’s position on
a particular issue.
While not part of the Abramoff facts, I am particularly concerned about the circumvention of the
requirements of IRC section 527 by the use of 501(c)(4) organizations. Further, I have questions
about the use of 501(c)(4) organizations for activities primarily intended to benefit private parties
or which appear to have little or no connection to furthering a valid social welfare purpose. I am also
concerned that some such activities generate unrelated business taxable income to the organization.
Please inform me as to whether and how frequently you receive cases or ruling requests involving
these issue and whether you have plans to issue guidance in this area. In addition, I appreciate any
general comments or suggestions you may have for the Committee.
National Association of Investors Corporation (“NAIC”)
Enclosed is a copy of a letter recently sent to the NAIC. I understand that IRC section 4958 does not
cover many of NAIC’s transactions because the parties to these transactions were not disqualified
persons, but rather were just friends of NAIC’s trustees. Please inform me as to whether and how
frequently you receive cases or ruling requests that involve private benefits to “outsiders” (i.e.,
persons who are not disqualified persons under section 4958) and explain how these are currently
resolved. Please also provide information concerning the number of cases with IRC 4958 issues that
are currently open, the length of time they have been open, what the expected timeframe may be for
resolution, and what the resolution might be. Please also discuss what IRC section 4958 challenges
arise when board members are compensated for their dual roles as a board member and as an
executive or employee.
The Edward Orton Jr. Ceramic Foundation (“Orton”)
Enclosed are materials obtained in the course of the Committee’s investigation of Orton. The
Committee initiated this investigation based on information received from a small business in Iowa
that believes it is significantly disadvantaged because Orton is not subject to tax from income earned
from the same activities.
You will note that Orton’s primary purpose when it was founded was to further research in the field
of industrial ceramics. After reviewing Orton’s Forms 990 for the most recent years, it is difficult
to disagree with the concern of the Iowa small business “about the direction this non-profit
foundation has taken, which appears to be more about profit, accumulating surplus capital and
marketing their products, rather than about education and research to advance the ceramic arts”. It
appears that Orton’s resources are disproportionately dedicated to the manufacture and sale of
ceramic products rather than research.
You will also note that Orton’s tax exemption was challenged in court in 1971. At that time, four
judges issued a dissenting opinion challenging the majority’s ruling that income from the sale of
ceramic products was related to Orton’s exempt purpose and therefore exempt from tax. In the thirty
plus years since that ruling, Orton’s activities with respect to the sale of ceramics products appears
to have increased while its educational activities appear to have decreased.
Please inform me as to the challenges that exist in classifying an activity as unrelated to exempt
purposes such that income from that activity then is subject to the unrelated business income tax
(“UBIT”) or in determining whether such activity is so extensive that exemption may no longer be
warranted. What test does the IRS use to assess the level of commercial activity conducted by a
501(c)(3) exempt organization? Please also provide information concerning the number of cases
involving UBIT issues that are currently open, the length of time they have been open, what the
expected timeframe may be for resolution, and what the resolution might be. Please inform me as
to what guidance you may be planning to issue in this area.
Musculoskeletal Transplant Foundation (“MTF”)
Enclosed are copies of the Committee’s letter to MTF and MTF’s narrative response (without
attachments) to this letter. The Committee initiated this investigation due to information that MTF
was engaged in a “hostile takeover” of a public company. The facts appeared similar to the Orton
case in that a 501(c)(3) entity was in direct competition with a for-profit entity. In MTF’s case,
however, MTF provides products that generate low or zero margin that for-profit entities generally
will not provide.
This case is also interesting as it appears that MTF and other non-profit entities dominate this market
which may suggest the activity is appropriately conducted by charitable organizations. In some cases,
IRS rulings state that providing goods or services at or below cost might be an exempt purpose.
Nevertheless, the same questions with respect to UBIT that apply to Orton apply to MTF as well. I
would appreciate understanding to what extent you utilize industry analysis and statistics when
determining whether an activity results in UBIT.
Officer/Director Compensation & Trustee Fees
The staff of the Committee continues to study compensation issues related to private foundations and
public charities, including charitable trusts. In your confirmation hearing on March 8, 2004, you
pledged to work with me on this issue. In written communication subsequent to the hearing, you
indicated that you wanted to wait for the IRS Office of Exempt Organizations to make progress in
its study of executive compensation. I would appreciate an update on the work you are doing in this
area in light of this study.
The letter to the NAIC raises some compensation issues that are not unique to NAIC, particularly
the issue of board members being compensated for both board service and for their duties as an
executive or an employee. A similar issue with respect to certain charitable trusts arose during the
development of legislation regarding supporting organizations. Representatives of several trusts have
informed us that trustee compensation is often dictated by trust documents, which fall under the
jurisdiction of state and local governments. More importantly, these trusts argue that trustee
compensation is reasonable and meets the requirements of IRC section 4958 because the trust
document limits compensation. However, my staff found that the governing bodies of such trusts
often perform no analysis to determine whether compensation is reasonable, that is, whether a
trustee’s fees are justified in light of the services performed by the trustee.
For example, a trust may claim that trustee fees are reasonable, because the fees are only a ¼
percentage point of total trust assets. Thus, a trust with $500 million of assets might pay a trustee
$1.25 million for trustee fees. Yet, there may be few or no records or other forms of accountability
to substantiate what services the trustee is providing for these fees. Presumably, a trustee of a
supporting organization with named beneficiaries is simply transferring money to the supported
organizations, which raises the question of whether compensation calculated as a percentage of total
assets is reasonable. This question arises even more so when someone other than the trustee is
compensated for investment advisory, money management and bookkeeping services (in other
words, when the trustee is not required to pay such amounts out of the trustee’s fee).
If, in fact, a trustee incurs expenses with respect to administering the grants or running the trust, it
would seem that such expenses should be separately reported on the Form 990. Categorizing such
expenses simply as trustee fees provides no accounting or transparency with respect to how trustee
fees are spent. A question also arises as to whether a trustee should be compensated for serving on
the board of a supported organization since such service may be as a result of the trust’s supporting
organization status. A further problem arises when there are so few trustees that there is no
independent review of trustee compensation.
Although trusts may be governed by state and local authorities, particularly the courts, it is not clear
that such authorities are providing significant oversight regarding the reasonableness of
compensation or, more specifically, considering reasonableness under IRC section 4958 when
reviewing trustee compensation. There is no guarantee that such compensation is regularly reviewed
by relevant state or local authorities, particularly when a trust document may limit trustee
compensation to a certain percentage of assets. It is troubling that a trustee’s fees may increase
simply because the value of assets has increased while there may be no corresponding increase in
the services provided by the trustee.
I would like your general comments and response to the above and also please inform me as to
whether you are considering the issue of whether officers, directors and trustees are compensated for
their dual roles as a board member and as an executive or employee. I am particularly interested in
how IRC section 4958 would be applied to organizations that do not distinguish between these roles
and also whether Form 990 accuracy related penalties could be imposed in such cases.
I strongly believe that, given the rapidly changing nature of the health care industry, the regulations
and guidance with respect to tax-exempt organizations in this sector need to be monitored and
updated on a continuing basis. Some areas in which your office should be particularly engaged
include the definition of charity care, the requisite level of charity care, the definition and level of
community benefit, the definition of joint ventures, joint ventures involving non-profit hospitals, the
payment of excessive compensation and the use of tax-exempt bond proceeds.
I have provided Steve Miller, Commissioner, IRS Tax-Exempt and Government Entities division,
with a summary of the responses received in response to my letter to ten specific hospitals and have
invited his staff to review the supporting documentation. I encourage your staff to work closely with
his staff to study this sector. Please explain whether, and to what extent, your staff is involved with
the other projects and studies conducted by his staff, such as credit counseling, down payment
assistance and political activities.
I understand denials of new requests for tax-exempt status and revocations of tax-exempt status of
existing organizations must be approved by your staff. Please explain your staff’s involvement in
this process and provide statistics on the number of revocations and denials issued since 2000, the
types of organizations involved, and the length of time involved in issuing these revocations and
denials. Please also include the number of times that your office disagreed with the recommendation
of TE/GE staff as to a revocation or denial (or proposed significant modification in the
organization’s activities), year by year since 2000. Please also provide information as to the numbers
of lawyers dedicated to tax-exempt organizations and tax-exempt bonds each year since the IRS
reorganization in 2000 and include the number of retirements or losses from other causes and hires
for each of those years.
Please provide the information requested within thirty days.
Charles E. Grassley
June 1, 2006
Steven T. Miller, Commissioner
Internal Revenue Service
Tax-Exempt and Government Entities Division
1111 Constitution Avenue NW
Dear Mr. Miller:
I want to congratulate the Internal Revenue Service (“IRS”), and your staff in particular, on its
reports regarding the Political Activity Compliance Initiative (“PACI”) and the Credit Counseling
Initiative. These types of reports provide great insight and transparency into the work the IRS is
doing in the tax-exempt sector. I encourage the IRS to develop similar studies of other sectors and
industries. One I am particularly concerned about is tax-exempt hospitals.
As you are aware, the Committee is currently reviewing the practices of tax-exempt hospitals. As
a result of its review, the Committee staff has to come to agree with Commissioner Everson’s view
that often times it is difficult to distinguish the activities of a tax-exempt hospital from those of a forprofit
hospital. Areas of concern include pricing, billing and debt collection, use of tax-exempt bond
proceeds, payment of excessive compensation, definition and calculation of charity care and
community benefit, definition of joint ventures involving tax-exempt hospitals and reporting and
transparency with respect to all of these.
I understand that IRS Office of Exempt Organizations will be sending letters to several tax-exempt
hospitals to review certain practices. Please inform me as to what IRS plans to do with the
information obtained from the responses and whether there are plans to review the non-profit
hospital industry as the credit counseling industry was reviewed. I would appreciate receiving
updates on the responses from these letters. In order to further the IRS’ work in this area, I am
providing you with a summary of the responses I received from the ten hospitals to which I wrote
last year and I invite your staff to review all of the supporting documents.
I also applaud the recent guidance IRS issued with respect to seller-funded down payment assistance
programs. As you are aware, the Congress continues to consider several legislative proposals
affecting tax-exempt organizations. However, as you are also aware, legislation is not always the
easiest or quickest way to correct abuse by and within tax-exempt organizations. I urge the IRS to
issue guidance and to update regulations in order to curb abuses. I will be writing to Chief Counsel
Korb on this topic as well.
I understand that the Office of Exempt Organizations (“EO”) has increased its enforcement resources
during the past few years. Please provide me information as to the numbers of agents, lawyers and
determinations specialists EO has had each year since its reorganization in 2000 and include the
number of retirements or losses from other causes and hires for each of those years for each of these
categories of employees.
I am also interested in the results of the mandatory electronic filing program for large organizations.
I understand that certain large organizations are now required to file their annual Forms 990
electronically effective for tax years ending on or after December 31, 2005. Please provide me with
the most recent statistics of electronically filed exempt organization returns, including extensions.
I am particularly interested in whether any organizations have requested exemption from these
requirements and whether penalties have been assessed for organizations not complying with the
Please provide the information requested within thirty days.
Charles E. Grassley
cc: Senator Baucus
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