My Claim to Fame: IRC 4965 and Charities in Tax Shelters
Let’s just be honest. Not too many people read law review articles. But every now and again something one of us writes causes a little ripple. An article I wrote more than 20 years ago was like a tree falling in the forest with nobody around. I found out years later that someone heard it anyway.
True story. In 2001, I wrote “When Charity Aids Tax Shelters.” You can find it on the UF Law Scholarship Repository where it is incorrectly listed as having been published in 2023. The header shows it actually came out in 2001. Shortly before or after publication, I spoke at an ABA Tax Section meeting about my argument that exempt orgs should pay an excise tax for knowingly participating in tax shelter transactions. I was really into partnership tax then, so I had seen some egregious examples. So I get up to the podium to give my 15 or 20 minute soundbite about the article and there are a buncha TEGE and Treasury folks sitting in the front row staring at me as though I have a piece of spinach caught in my teeth. Or my fly is open or something. What?! I wondered. I couldn’t even speak coherently about the article knowing all the real experts were in the audience. Seriously, on the front row. I remember it like it was yesterday.
So I did my thing, got some polite applause and didn’t think much more about it. Six years later, Congress enacted IRC 4965 and then four years after that Treasury adopted implementing regulations. I still didn’t pay much attention and I certainly didn’t claim any credit. I was off on some other fruitless deanship hunt by then, don’t ask me why. And then a few years later somebody from the Joint Committee sent me an email suggesting I write a follow-up to my article in light of Congress’ enactment of IRC 4965 and Treasury’s adoption of the regulations. I think I remember who sent me the email (completely out of the blue) but I can’t find it and don’t want to name him. But I swear its true. So yeah, a tree falling in a forest makes a sound sometimes and I claim ownership of IRC 4965. Harken unto me, you puny humans, for I have achieved tax immortality.
Well. I remember all that because Treasury released newly proposed regulations Monday. The proposed regulations list a new abusive transaction involving charitable remainder annuity trusts. The newly listed transaction is so transparently illegitimate that its not even worth describing here. I tell my students that if a tax strategy requires a lie at any point, its doomed. The big lie in this strategy is that the gift of appreciated property to the trust results in a stepped up basis. I don’t think exempt organizations have much to worry about even though the proposed regulations single out charities for possible IRC 4965 taxes. Here is part of the preamble:
III. Tax-Exempt Entities as Parties to Prohibited Tax Shelter Transactions
Section 4965 of the Code is intended to deter certain “tax-exempt entities” (as defined in section 4965(c)) from facilitating “prohibited tax shelter transactions,” which include listed transactions. Section 4965(a)(1), in part, imposes an excise tax on a tax-exempt entity for the taxable year in which the tax-exempt entity becomes a party to a transaction that is a “prohibited tax shelter transaction” at the time it becomes a party to the transaction, and for any subsequent taxable year, in the amount determined under section 4965(b)(1) (section 4965 tax). Tax-exempt entities subject to the section 4965 tax are listed in section 4965(c)(1) through (3) and include, among others, entities and governmental units described in sections 501(c) and 170(c) of the Code (other than the United States). A tax-exempt entity that is a party to a prohibited tax shelter transaction generally also is subject to various reporting and disclosure obligations.
Additionally, section 4965(a)(2) imposes an excise tax on an “entity manager” if the manager approves the tax-exempt entity as a party (or otherwise causes the tax-exempt entity to be a party) to a prohibited tax shelter transaction and knows or has reason to know that the transaction is a prohibited tax shelter transaction. The amount of this excise tax is determined under section 4965(b)(2) (entity manager tax).
A. The Section 4965 Tax
The amount of the section 4965 tax owed by a tax-exempt entity depends on whether the tax-exempt entity knows, or has reason to know, that a transaction is a prohibited tax shelter transaction at the time the entity becomes a party to the transaction. A tax-exempt entity is treated as knowing or having reason to know that a transaction is a prohibited tax shelter transaction if one or more of its entity managers knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the entity manager(s) approved the tax-exempt entity as (or otherwise caused the entity to be) a party to the transaction. The tax-exempt entity also is attributed the knowledge or reason to know of certain entity managers—those persons with authority or responsibility similar to that exercised by an officer, director, or trustee of an organization—even if the entity manager does not approve the entity as (or otherwise cause the entity to be) a party to the transaction.
Section 53.4965–4(a)(1) provides that a tax-exempt entity is a “party” to a prohibited tax shelter transaction if it facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax-indifferent, or tax-favored status. In addition, under § 53.4965–4(a)(2) and (b), the Secretary may issue published guidance to identify tax-exempt entities by type, class, or role that will or will not be treated as parties to a prohibited tax shelter transaction.
If the tax-exempt entity unknowingly becomes a party to a prohibited tax shelter transaction, the section 4965 tax generally equals the greater of (1) the product of the highest rate of tax under section 11 of the Code (currently 21 percent) and the tax-exempt entity’s net income attributable to the prohibited tax shelter transaction, or (2) the product of the highest rate of tax under section 11 and 75 percent of the proceeds received by the tax-exempt entity that are attributable to the prohibited tax shelter transaction. If the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the tax-exempt entity became a party to the transaction, the section 4965 tax increases to the greater of (1) 100 percent of the tax-exempt entity’s net income attributable to the prohibited tax shelter transaction, or (2) 75 percent of the tax-exempt entity’s proceeds attributable to the prohibited tax shelter transaction.
The terms “net income” and “proceeds” are defined in § 53.4965–8. In general, a tax-exempt entity’s net income attributable to a prohibited tax shelter transaction is its gross income derived from the transaction, reduced by those deductions that are attributable to the transaction and that would be allowed by chapter 1 of the Code (chapter 1) if the tax-exempt entity were treated as a taxable entity for this purpose, and further reduced by the taxes imposed by subtitle D of the Code (other than the section 4965 tax) with respect to the transaction. In the case of a tax-exempt entity that is a party to the transaction by reason of facilitating a prohibited tax shelter transaction by reason of its tax-exempt, tax-indifferent, or tax-favored status, the term “proceeds,” solely for purposes of section 4965, means the gross amount of the tax-exempt entity’s consideration for facilitating the transaction, not reduced for any costs or expenses attributable to the transaction. Published guidance with respect to a particular prohibited tax shelter transaction may designate additional amounts as proceeds from the transaction for purposes of section 4965. In addition, for all tax-exempt entities that are parties to a prohibited tax shelter transaction, any amount that is a gift or a contribution to a tax-exempt entity and that is attributable to a prohibited tax shelter transaction is treated as proceeds for purposes of section 4965, unreduced by any associated expenses.
B. Entity Manager Tax
The amount of the entity manager tax determined under section 4965(b)(2) on an entity manager (as defined in section 4965(d)) equals $20,000 for each instance that the manager approves the tax-exempt entity as (or otherwise causes such entity to be) a party to a prohibited tax shelter transaction and knows or has reason to know that the transaction is a prohibited tax shelter transaction. This liability is not joint and several.
We professors are always starving for validation ya know.
darryll k. jones