Is Tax Exemption a Subsidy? Fourth Circuit Speaks from Both Sides of Its Mouth

In a sensible opinion that might just contain unnecessary dicta, the Fourth Circuit Court of Appeals ruled on Wednesday that exemption under IRC 501(c)(3) does not constitute “federal financial assistance” for purposes of Title IX. Ben talked about it yesterday and in doing so assuaged some but not all of my worries.  Like Ben, I like the conclusion.  But I am not comforted by the analysis.

The Court said tax exemption is a subsidy, just not a cash subsidy.  But what other kind of subsidy is there?  It seems to me that subsidies are only subsidies if they can be expressed in value.  Dead presidents.  Dollars and cents, like the picture.  Like gross income, the means by which value is delivered and received — direct or indirect expenditure —  should not make a difference to the question whether dead presidents are in fact received.  I worry that what seems like a strained and artificial distinction might relied upon in another case to defend government’s tax exemption of hate groups. 

Title IX makes “federal financial assistance” contingent upon recipients’ agreement to adopt and practice gender nondiscrimination policies.  Under Title IX, for example, a private university whose students are eligible for federal financial aid is obligated to adopt and follow a publicized sexual harassment policy. The Court might have simply concluded that Congress did not intend “federal financial assistance” to include tax exemption and left it at that.  The result is entirely sensible if you consider how deep Title IX would penetrate into civil society if “federal financial assistance” included tax exemption.  Every exempt organization would be potentially subject to federal supervision. 

But the Court went further, indulging what I think is a muddled and incomplete discussion of tax exemption and the charitable contribution deduction as those things relate to economic subsidies.  Of course tax exemption and the charitable contribution deductions are subsidy.  But the opinion leaves doubt about that basic and invariable economic and mathematical fact. Even as the Court’s own math proves the point.  Here is an extended excerpt from Donna Buettner-Hartsoe v. Baltimore Lutheran High School Association:

Tax exemption for charitable institutions is deeply rooted in American history. Bob Jones Univ. v. United States, 461 U.S. 574, 588 (1983) (“Tax exemptions for certain institutes thought beneficial to the social order of the country as a whole, or to a particular community, are deeply rooted in our history, as in that of England.”). Section 501(c)(3) provides that “[c]orporations . . . organized and operated exclusively for religious, charitable . . . or educational purposes” are entitled to tax exemption. 26 U.S.C. § 501(c)(3). Along with requiring that entities be organized and operated for an exempt purpose, §501(c)(3) prevents private inurement, limits lobbying, and prohibits electioneering. Id. Organizations that meet these requirements, and apply for exemption, are exempt from federal income taxes. Id. §501(c)(1)(A). And when taxpayers donate to organizations with § 501(c)(3) status, they can claim a charitable deduction. Id. § 170.  The requirement that organizations be operated for an exempt purpose disqualifies organizations that operate for illegal purposes or engage in activities contrary to clearly established public policy. Bob Jones, 461 U.S. at 592.7

Tax exempt status is a tax benefit. Bob Jones, 460 U.S. at 587–88. Tax exempt organizations keep the amount of tax they would have paid on their income. And by exempting organizations from tax, “all taxpayers are affected” because “other taxpayers can be said to be indirect and vicarious ‘donors.’” Id. at 591. But even though “exemptions and deductions . . . are like cash subsidies,” they are not “in all respects identical.” Regan v. Tax’n with Representation of Wash., 461 U.S. 540, 544 n.5 (1983). “A subsidy involves the direct transfer of public monies to the subsidized enterprise and uses resources exacted from taxpayers as a whole. An exemption, on the other hand, involves no such transfer.” Walz v. Tax Comm’n of New York, 397 U.S. 664, 690 (1970) (Brennan, J., concurring). 

The meaning of “receiving” financial assistance underscores our conclusion. Appellees argue that tax exemption is akin to the indirect grants in Grove City. They argue that because § 501(c)(3) status results in a monetary benefit to tax exempt entities, it is the same as the IRS granting funds to tax exempt entities. We are unconvinced. In Grove City, the college received federal education funding through its students. 465 U.S. at 559.

Even though it received the funding through indirect means, that is, its students, there was still a grant of federal aid to the school. Id. at 564. In contrast, with tax exemption, no funds actually change hands. Tax exemption merely allows organizations to keep the money they otherwise would owe in income tax. Therefore, tax exemption is distinguishable from the federal grants in Grove City as tax exemption is an indirect benefit, as opposed to federal financial aid through indirect means. See Nat’l Collegiate Athletic Ass’n, 525 U.S. at 468 (“Title IX coverage is not triggered when an entity merely benefits from federal funding.”). 2.

Appellees also argue that 26 U.S.C. § 170’s charitable contribution deduction is like the indirect grants in Grove City. They argue that because donors can receive a §170 deduction when they donate to tax exempt organizations like Concordia Prep, those organizations receive more money through donations than they otherwise would have if the donors received no deduction.

An example illustrates their argument. If a donor whose federal income tax rate is twenty percent wishes to donate $100 of their post-tax income, this $100 donation costs $125 pre-tax. But if the donor elects a §170 deduction, the donor effectively avoids paying tax on the $100 donation — meaning it costs only $100 pre-tax. Appellees argue that this $25 difference allows tax exempt organizations like Concordia Prep to receive higher donations. Appellees contend that these higher donations are functionally the same as the indirect grants in Grove City.

We disagree. Section 170’s charitable contribution deduction, like § 501(c)(3) tax exempt status, is far afield from Grove City’s funding-by-intermediary scheme. In Grove City, federal funds were dispersed, through students, to the school. 465 U.S. at 559. But here, donors do not actually receive any federal funds by claiming a charitable deduction. Instead, they are merely allowed to donate the full pre-tax amount of their donation. Thus, the charitable contribution deduction is not federal financial assistance for Title IX purposes. And even if it were, any benefit that Concordia Prep receives by donors potentially donating more after claiming § 170’s charitable contribution deduction is far too attenuated to constitute “receiving” federal financial assistance.

The opinion might reasonably be interpreted to mean that tax exemption is like, but not ever really a subsidy.  Actually, that might even be a reasonable conclusion despite my current certainty to the contrary.  I just think the question needs broader and deeper analysis admittedly because I don’t yet like where the conclusion might lead us. There were lots of amicus briefs and I bet we could find better discussion in some of them.  But the Court’s opinion on the matter is too brief and internally inconsistent to definitively resolve the question.  As Ben reports, another opinion is on the horizon.  Hopefully, that opinion will offer a better analysis.  

darryll k. jones