The US District Court for the District of Columbia, in a decision dated September 24, held that an organization cannot qualify as a tax-exempt charitable entity because it confers private benefits on an insider and is operated with a commercial hue (Family Trust of Massachusetts, Inc. v. United States).
The Family Trust of Massachusetts (FTM) is a trustee for over 300 disabled and elderly individuals who participate in a pooled-asset special needs trust program. This type of trust that meets the requirements of the Medicaid law allows a disabled beneficiary or his or her family to establish an account that supplements the benefits that the beneficiary receives from supplementary security income (SSI), Medicaid, and other government benefits programs. These trusts allow disabled beneficiaries to maintain their federal Medicaid and/or SSI eligibility, despite having assets in excess of general federally allowed limits.
FTM was founded by a lawyer in private practice, specializing in elder law. He is the president, treasurer, and executive director of the FTM. The FTM has a board of directors; their number is not referenced in the opinion. The FTM’s office is located within his law firm’s premises. He works about 250 hours annually for the FTM. His current annual salary is $70,000. Annual FTM revenue started at about $6,000 and has grown to about $680,000.
The lawyer refers his disabled clients to the FTM if they meet applicable criteria. Additional clients have been obtained by means of legal or health care referrals, through word-of-mouth in the elder law legal community. The FTM began with 20 clients.
The IRS alleged that the lawyer has “complete and effective control” over the FTM. The court appears to have accepted at least most of that argument, writing that he “has afforded himself a position of considerable influence in the organization.” The court found that this organizational structure, “entailing dominance by the founder,” raises “concern about the potential for abuse unless allayed by other information in the record.”
The court turned to the matter of the lawyer’s compensation from the FTM. It noted that the FTM “does not actually offer authoritative comparability data for the Court to determine whether the salary is, in fact, reasonable.” It wrote that it is not enough for the FTM to “simply say that disinterested directors determined that the compensation was reasonable given the scope of [the lawyer’s] duties, the number of beneficiaries served by [the] FTM and looking at comparable positions.” The court observed that this salary has “steadily increased in conjunction with the expansion of the services provided by the FTM and the infusion of funds into the trust.” (The starting salary was $9,000.)
Because of the control factor and the insufficiency in the record, the court concluded that private inurement is taking place.
The court bought the IRS’s argument that the fact that the FTM is funded solely by fees is evidence of unwarranted commerciality. It noted that the FTM did not “mitigat[e] the costs to beneficiaries by soliciting charitable contributions or implementing other creative measures to amass funds.” The court wrote that it “can only wonder why a purported charitable organization seeking qualification for tax-exempt status would not capitalize on the possible benefit of contributions that might offset operating costs for its beneficiaries.”
The court held that the FTM’s profit margin (without discussing what it is) “begins to appear more a product of a growing commercial enterprise than a tool for expanding the pooled investments that might enable beneficiaries to reap a greater return or enjoy reduced fees.”
The court noted the “absence of any evidence regarding whether [the lawyer’s] legal practice is acquiring clients in the first place due in part because of his connection to the FTM and the services it provides.” But the court then referenced the “manner” in which this lawyer and other members of the legal community go about connecting eligible individuals with the FTM’s services, without discussing what this “manner” is. Whatever it is, it “suggests” to the court that “those services are a commercial product in disguise being touted by [the lawyer] and others who make referrals to the trust.” The court wrote that the “facts that [this lawyer] founded the program as a result of his law firm’s specialization in advice regarding trusts, estate planning, guardianship, and probate matters for elderly clients, … and his legal office remains listed as the FTM’s principal place of business, … only reinforces the idea that its services provide a marketable product to offer potential clients.” The court concluded, on this point, that the FTM “can easily be viewed as a selling point for legal professionals” and that “imbues it, at least somewhat, with a commercial hue.” [4.11, 20] Commentary:Where to begin with this troubling opinion? Let’s start with the facts. This is a case study in how not to structure an arrangement like this. The lawyer who founded the FTM did not need to be its president, treasurer, and executive director; executive director would presumably have sufficed. This, of course, led the court to conclude that he has “substantial influence” over the FTM (although that is not a basis for finding private inurement). This matter was further negatively (from the FTM’s standpoint) influenced by the fact that the nonprofit organization’s offices were in the lawyer’s law firm. It should be located elsewhere.
The court tells us almost nothing about the FTM’s board. We know it has one and that some members are “disinterested.” We do not know their number and whether the lawyer is on the board. Surely, however, the IRS overstated its case (although it worked) in asserting that the lawyer has “complete” control over the FTM.
The administrative record did not contain sufficient comparability data as to the lawyer’s compensation (although the court did not discuss what was missing). The lawyer is surely faulted for not beefing up the record on that point. But, a reality check is in order: $70,000 for 250 hours of work (lawyer or not) hardly seems excessive.
As to application of the law, the opinion is flawed in that it is rife with speculation. The finding of private inurement seems overdone under these facts. The court muses as to why the FTM does not have a fundraising program, without discussing the ample body of law that states it does not have to. The opinion is full of words and phrases such as “begins to appear” (concerning the profit margin), an “idea” (that the FTM is a front for the lawyer in the face of no evidence to support that portrayal), “might,” and “suggests.” This sentence is telling: “That the FTM can easily be viewed as a selling point for legal professionals [in the absence of any evidence for that] imbues it, at least somewhat, with a commercial hue.”
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