Exempt Organizations: Will Wright Patman Ride Again?

We are advising our friends in the world of private foundations that now is the time to put your house in order. Certain signs precede certain events, and a meaningful Congressional review of certain current practices of private foundations and would-be public charities may fairly be projected for the not too distant future.

More than a generation has past since Wright Patman stood on the floor of the House of Representatives, declared his concern for the power of private foundations, and began an eight-year fight against private foundations. Aggressive foundation lobbying defeated some of the most stringent of Patman's proposals, but the resulting Tax Reform Act of 1969 has given us the regulatory excise taxes of Chapter 42 of the Internal Revenue Code and they have proven far from toothless. It is clear that the Tax Reform Act of 1969 has been effective to its purpose, oversight of foundations has increased sharply, the prevalence of abuses, particularly at the major foundations, has been reduced, and our friends who are today's foundation managers and CEOs trumpet their increased distributions as if the increases had not been dictated by the very law their predecessors opposed.

But times change and so do abuses, or the perception thereof. There would appear to be at least three reasons which individually or in the aggregate might tempt a legislator today to revisit the glories of Wright Patman with new hearings on the practices of private foundations. Perhaps more will occur to you and I will appreciate your thoughts in that regard. I have considered the following: The Increased Politicization of Private Foundations, The Elevation of Form Over Substance, and The Temptation to Increase Minimum Distributable Amounts.

The Increased Politicization of Private Foundations

One stated objective of the Tax Reform Act of 1969 was to exclude private foundations from the political process. Under Section 4945 of the IRC, it is said the intent was to exclude private foundations from the political process by defining their involvement in grass roots lobbying, direct lobbying and influencing legislation as "taxable expenditures" upon which excise taxes would be imposed. Nonpartisan analysis, study and research were protected as exceptions. Public charities, thought by definition to be the subject of closer public scrutiny, were exempted from these restraints and given greater latitude for legislative and other lobbying. Now thirty years later there may be enough evidence to suggest that the bright lines of the 1969 TRA are not so clear.

Consider the Christian Broadcasting Network (CBN), the religious broadcasting operation headed by Pat Robertson. The EOTR Weekly reports that the CBN has reached an agreement with the IRS concerning the network's tax exempt status and its alleged participation in partisan political activities. The agreement as reported allows CBN to retain its tax-exempt status under section 501(c)(3) and preserves the deductibility of donations the network receives. The EOTR Weekly reports, however, that because CBN intervened in partisan politics, the network will lose its exempt status for 1986 and 1987. Also, three former CBN affiliates - the Freedom Council, National Perspectives Institute, and National Freedom Institute - are reported to be stripped of their tax exemptions.

Consider "Empower America," headed by former Republican vice presidential candidate and Housing and Urban Development Secretary Jack Kemp, which has now been granted tax-exempt status by the IRS as a section 501(c)(4) social welfare organization. In an exception ruling released December 1, 1997, the IRS noted that Empower America's original request for exemption had been turned down because the Service concluded that the group was a "partisan issues-oriented organization" that substantially benefited the Republicans. Upon the presentation of additional information on its activities, the Service revoked its original adverse ruling.

Consider The Rutherford Institute with its distinguished history. Founded in 1982, it is an international civil liberties legal and educational organization that defends persons whose constitutional rights have been violated. It derives its name from Samuel Rutherford, a 17th century Scottish intellectual who resisted the idea of the divine right of kings. In his book, Lex Rex, Rutherford argues that all people are subject to a higher law, or God's law, including the king. It was natural, therefore that the Institute might become involved in the Paula Jones affair. But tell me whether you think it is reasonable to assume that the political mind will forget the role played by the Institute in the Paula Jones affair when next they cast about for targets to review.

Consider the Tides Foundation with its accomplishments as a unique funder of environmental causes. Founded in 1976 by Drummond Pike, it seeks among other stated objectives to foster an enlightened stewardship of our national environment. We understand that Tides is not a traditional foundation and that legally it may be described as a grantmaking charity, which means in practice that Tides is both a grantmaker and a grant-taker, raising money in order to support assorted projects undertaken by those who come to it. We understand that Tides money comes from other foundations, individuals and corporate grants, and even government sources. This dual role should give Tides an unusual place among foundation funders of environmental groups. But Foundation Watch, in reporting on selected activities of Tides, captions one section of their report with the broadside: "Money Laundered by the Tides Foundation." The point here, as raised by Foundation Watch, is both their own accusing rhetoric, and, right or wrong, their presumption that a foundation is not taking sides on the issues but on a political agenda.

Consider the Capital Research Center and its 1995 study through Robert Lerner and Althea Naqai who reportedly examined annual grants from Pew Charitable Trusts from 1986 to 1994. They are reported to have found that in 1986 Pew was giving more than three times as much money to liberal groups than to conservative ones. By 1994, they report Pew was dispensing 40 times as much money to liberal groups and causes. I mention this report not only because it presumes that some causes are inherently liberal or conservative but to underline its presumption of greater politicization in the foundation world today.

Nonprofit organizations play a vital role in the development and implementation of public policy. The Alliance For Justice has published an interesting study by Thomas Asher, "Myth v. Fact: Foundation Support Of Advocacy" that carves out the safe harbors for private foundations in advocacy and the formation of public policy. But is any harbor really safe when there are too many boats in the harbor? Foundation Giving, 1997 Edition, reports that the number of grantmaking foundations in 1995 exceeded 40,000, nearly doubling since 1980 alone.

I have chosen the few examples set forth above from the hundreds of others available, not to comment adversely in any way on their activities, but rather because in the increasingly "crowded harbor" of foundation world somehow their actions or comments thereon caught my eye and underline the point that many see...whether it is real or not... that there is an increased politicization in the programs of private foundations. I am not forgetting the page of history and the publication of Patman's reports more than a generation ago which coincided with the concern, on the part of liberal, over the inequities of the tax laws in general and, on the part of conservatives, over revelations of leftist tendencies in the grant programs of several foundations, especially the Ford Foundation. I suggest only that it appears succeeding generations may have to answer the same questions in a somewhat revised format.

The Elevation of Form Over Substance?

Reference the February 12, 1998 article in The Wall Street Journal (WSJ) on Fidelity Investments Charitable Gift Fund. WSJ reports that "The fund's success depends in large measure on blurred distinctions between public and private charities." Private foundations must pay 2% excise taxes on investment income and must pay out 5% of foundation assets every year. Public charities are exempt from these requirements. WSJ reports that Fidelity avoids these regulations by creating a public charity, presumably based on the overwhelming percentage of support received from aggregating public contributions, also known as customer accounts. The donors get an immediate deduction for the contribution. They pay no capital-gains tax on the appreciated value of any stocks donated to the fund, the money grows tax free. If I missed something here, please bring it to my attention but it would appear reminiscent of one of the problems that Wright Patman sought to address, i.e. the uncertainty as to when and if any of these funds will reach a charitable purpose.

There is also thought to be a difference between "donor directed" and "donor controlled" funds. The WSJ article referenced above has some unnerving examples of current practice in this regard.

We urge our friends in the foundation world to review the reality of their current practices. In the final analysis, substance can be expected to prevail over form. The ruling of the Tax Court in December, 1997 that the United Cancer Council's use of a professional fundraiser resulted in inurement of the organization's net earnings to the fundraiser -- and therefore, loss of tax exemption -- carries a great deal of significance for the community of exempt organizations. The Court looked at the reality, that the fundraiser came in when UCC was close to bankruptcy, and not the form to conclude that the fundraiser was an insider. And so it may be the appropriate time to reexamine the reality of our current practices before others do it for us. Are your programs donor directed or are they truly donor controlled? Are you renting public charity status as such by paying an 8% administrative fee when you really control the program? I will appreciate your thoughts in this regard.

The Temptation To Increase Minimum Distributable Amounts

In an era of conservative government when we have retreated from public funding for a long and varied list of providers in the arts and social services, it may be tempting for some to think that private foundations will take up the slack. Indeed, the foundations have been clear and to the point in denying that role for themselves.

Against this background, our legislators are also fully aware of the quantum leap in giving by private foundations commencing in 1969 when the Tax Reform Act of 1969 first imposed on private foundations the concept of minimum distributable amounts, now set at 5% of aggregate fair market value of foundation assets. Prior to 1976, the distributable percentage was annually established by the Secretary of the Treasury. The recent years of double digit increases in stock market returns have clearly benefited the foundations and so we have this vast new accumulation of wealth sitting in the hands of our private foundations. Some may say the stage has been set for a new Wright Patman to emerge who will focus public attention not only on the ways private foundation circumvent the restrictions of the 1969 TRA, but also on their vast new wealth. I would appreciate your thoughts and comments.