IRS Respects Form of Transaction in Charity’s
Prompt Sale of Donated Stock

In a recent private letter ruling (2008-21-024) issued by the IRS, the IRS found that a charitable organization that intended to promptly sell donated stock was not used as a prohibited conduit through which the original owner of the stock passed title thereto to the ultimate purchaser. One of the most popular items of property donated to charities is appreciated stock in a corporation, either publicly traded or closely held. With such donations, the donor generally avoids having to recognize the gain inherent in the donated stock and obtains a charitable contribution deduction measured by the full fair market value of the stock.

In Comm’r v. Court Holding Co., 324 U.S. 331 (1945), the United States Supreme Court stated that “[a] sale by one person cannot be transformed . . . into a sale by another [person] by using the latter as a mere conduit through which to pass title . . . ." Thus, in cases where property is transferred from one person to another, frequently by means of a gift, and the latter person sells the property, the sale will be charged to the transferor in cases where the intermediate owner of the property can be dismissed as a “mere conduit” through which the original owner transferred title to the property to the ultimate purchaser.

Based on these principles, the taxpayer in Priv. Ltr. Rul. 2008-21-024 sought to confirm that its donation of appreciated stock to a charity that had indicated it would sell the shares would not cause the donation to be recharacterized as a sale to the ultimate purchaser of the stock.

In the ruling, a taxpayer (T) owned “b” shares of X Corp’s (X) voting common stock and members of T’s family owned additional shares of X’s voting common stock. X’s stock was not widely held or publicly traded. T planned to establish a “donor advised fund.” The fund would be a separately identified perpetual fund, within Y, a charitable organization. T contributed “g” shares of X voting common stock to Y in Year 1 and planned to contribute the remainder of his directly held shares in the two succeeding years.

Y had indicated that it “may sell shares of closely-held stock that it receives as contributions.” Z, a trust of which T was the Trustee, planned to possibly purchase a portion of the shares if Y would offer them for sale. Thus, the X shares that T was to contribute to Y possibly would wind up back in his possession in his capacity as the trustee of Z.

The ruling observed that T’s contributions of “g” shares were not subject to “any condition” or “legally binding obligation” requiring Y to sell the shares or offer them for sale. Moreover, the contributed shares would not be subject to any option or right by any person to acquire them from Y. The ruling, citing both Palmer v. Comm’r and Rev. Rul. 78-197, reached the conclusion sought by T. It observed that at the time T contributed the shares, Y possessed the sole discretion to decide whether or when to sell the shares and could not be compelled, by T or by any other individual, to sell such shares. The fact that Y might have intended to sell the donated shares was, for purposes of the conduit test, found to be wholly irrelevant.

The ruling therefore concluded that T would not be treated as selling to Z the “g” shares of X voting common stock that T contributed to Y and that Z could purchase from Y. The form of the transaction was respected because the charity, upon receiving the donated property, was neither legally bound nor could be compelled, by any person, to sell such donated property.

The ruling cited Palmer v. Commissioner, 62 T.C. 684 (1974), in which the Tax Court held that a gift of stock to a private foundation followed by a redemption of that stock from the foundation was not to be recharacterized as a redemption (from the donor) followed by a gift of the redemption proceeds (to the foundation), even though the taxpayer had voting control of both the corporation (the stock of which was donated to the foundation) and the foundation itself. The form of the transaction was “respected” simply because the foundation was under no legal obligation to redeem the donated stock at the time that it received such shares.

Surprisingly, the Internal Revenue Service agreed to follow the Palmer decision, and in Revenue Ruling 78-197, it announced that it would treat the proceeds of a redemption under “facts similar to Palmer” as income to the donor only if the donee is either legally bound or can be compelled by the corporation to surrender the shares for redemption.

Quick Hits

Giving USA Foundation Reports Charitable
Giving Record and Slowing Growth
According to the annual report of the Giving USA Foundation, a nonprofit educational organization in Illinois, Americans gave a record amount of more than $306 billion to charity in 2007 despite mounting economic worries. However, indications suggest that slowing growth is taking a toll on giving. The 3.9% increase in donations last year was far less than the 2004 and 2005 increases of 10% and 13%.

The $307 billion donated last year, when accounting for inflation, rose only 1% from the roughly $295 billion donated in 2006. The report considers data from the IRS and Bureau of Economic Analysis. Every subsector covered by the report except giving to private foundations grew in nominal terms, a first since 2001.

The following are some statistics from the report:

• Donations accounted for 2.2% of U.S. gross domestic product.

• Giving by individuals accounted for about 75% of the 2007 donation total.

• Foundation grants made up 12.6%.

• Religious congregations received $102.32 billion, an increase of 4.7% and about a third of all donations.

• Giving to educational organizations rose 6.4 %.

• Human-services charities garnered a rise of 8.4%.

• Health organizations received $23.15 billion, a 5.4% increase.

• Arts, culture and humanities organizations received $13.67 billion, a 7.8% increase.

• Giving to private foundations fell 9.4%, in part because of a tough comparison with substantial increases over the past two years.

Coordinated Issue Paper Addresses Blue Cross
Blue Shield Conversions
On June 4, the IRS released a coordinated issue paper (LMSB-04-0408-024) discussing the conversion of Blue Cross Blue Shield organizations into for-profit organizations. The paper explained that BCBS plans were developed as nonprofit organizations but that the Tax Reform Act of 1986 and later legislation changed the taxability of the organizations. They were granted special benefits with the change. Some of the organizations converted into charitable trust organizations and others changed into for-profit stock companies. The paper explained that tax issues arose because the taxpayers claimed deductions and noted that the cases are fact-specific. The common element, the paper explained, is the assertion that the organization has been or will be converted from nonprofit to for-profit status, and a payment or transfer for value by the organization will be made in the process.

The government’s arguments for disallowing the deductions fall into various categories, the paper noted, including not allowing deductions for the following: a transfer to a successor trustee; a capital expenditure; expenses allocable to tax-exempt income; the fair market value of stock transferred in a conversion transaction; and where no deduction is claimed or allowed at the time of a conversion payment, no deduction is allowed at the time of a subsequent merger or acquisition. The paper said that the positions described in it could apply to any taxable nonprofit organization that converts to for-profit status.

Bright Line Called For on Banned Political Activity;
Merging of FEC-IRS Rules Proposed
OMB Watch called on June 3 for the the IRS’s 2008-2009 guidance priority list to include the creation of a bright line standard for exempt organizations in the 3 area of prohibited political activity. According to the group, a clear definition of what is and is not allowed for issue advocacy and voter education efforts by 501(c)(3) organizations is needed to guarantee basic constitutional rights of free speech and association. Calling vague the current facts and circumstances test, in which the IRS considers the individual circumstances of each case to determine if it should open an investigation of a charity or church, or take actions against them for political intervention, the group stated that the test is keeping organizations from becoming fully engaged in election reform.

Section 501(c)(3) organizations are allowed to take positions on public policy issues, including ones that divide candidates in an election for public office; however, their statements cannot expressly tell an audience to vote for or against a specific candidate, or deliver any message favoring or opposing a candidate. Last November, the FEC approved allowing nonprofits to run issue ads during election periods, even if they mention specific candidates, if the funding sources are disclosed. The IRS could adopt guidelines similar to those of the FEC as permissible issue advocacy, as some have proposed.

Potential Collaboration of Northeast Ohio United Way Agencies
Seventeen United Way agencies in Northeast Ohio are discussing collaboration to save money and provide better services in a tight economy with lower revenues. Lead volunteers from each of the agencies are part of a task force called the Northeast Ohio Regional United Way Collaboration Initiative, which this summer will hire a consultant to study how the United Way agencies could work together. The task force expects to receive proposals from consultants by July 1 and to hire someone soon after. A report with recommendations on ways to collaborate, save money and improve services should be completed by the end of the year.

The United Way organizations involved in the task force are United Way of Greater Cleveland; and United Way agencies in Summit, Ashland, Ashtabula, Geauga, Lake, Lorain, Medina, Portage, Richland, Stark, Trumbull and Wayne/ Holmes counties, the Youngstown Mahoning Valley, the Orrville area, southern Columbiana County and northern Columbiana County.

Possible Legislation Requiring 5 Percent Payout By Wealthy Colleges
Legislation requiring the wealthiest colleges and universities to have an annual 5 percent endowment payout requirement is still a possibility, Sen. Charles Grassley (R-Iowa), ranking member of the Senate Finance Committee, stated on May 30. Increased reporting about endowment payout and expenditures is also a possibility. Grassley said his office is in the process of analyzing responses from 136 institutions with endowments of $500 million or more to questions he and Senate Finance Committee Chairman Max Baucus (D-Mont.) asked in January about endowment spending. Grassley argued that private foundations, which are subject to a 5 percent payout requirement, are thriving.