Giving Back -- Estate Planning for a Political Legacy

Transcription

1 Giving Back -- Estate Planning for a Political Legacy Illinois Institute of Continuing Legal Education August 26, :00 A.M. to 10:00 A.M. Boston Brussels Chicago Düsseldorf Frankfurt Houston London Los Angeles Miami Milan Munich New York Orange County Paris Rome Seoul Silicon Valley Washington, D.C. Strategic alliance with MWE China Law Offices (Shanghai) 2014 McDermott Will & Emery. The following legal entities are collectively referred to as McDermott Will & Emery, McDermott" or the Firm : McDermott Will & Emery LLP, McDermott Will & Emery AARPI, McDermott Will & Emery Belgium LLP, McDermott Will & Emery Rechtsanwälte Steuerberater LLP, McDermott Will & Emery Studio Legale Associato and McDermott Will & Emery UK LLP. These entities coordinate their activities through service agreements. McDermott has a strategic alliance with MWE China Law Offices, a separate law firm. This communication may be considered attorney advertising. Prior results do not guarantee a similar outcome.

2 Panelists James H. Cundiff McDermott Will & Emery 227 West Monroe Street Chicago, IL Sam C. Neel McDermott Will & Emery 500 North Capitol Street, NW Washington, DC

3 Notice The information contained in this presentation is not intended as legal advice and should not be relied upon as such. Participants and readers should seek specific legal advice from counsel before acting with regard to the subjects mentioned in this presentation. 3

4 Nuts and Bolts of Campaign Finance Law in the United States Campaign contributions and expenditures are subject to the Federal Election Campaign Act ( FECA ), which prohibits certain campaign contributions and expenditures and requires periodic disclosure by campaign committees. Federal campaign contributions are regulated by the Federal Election Commission ( FEC ). The FEC contains 3 Republican Commissioners and 3 Democratic Commissioners. The FEC may impose civil penalties on individuals and organizations that violate the FECA. The FEC may refer matters to the Department of Justice for criminal prosecution (although it rarely does). In the 2016 election cycle, individuals may not contribute more than $2,700 per election ($2,700 for primary; $2,700 for general) to Federal candidates; $5,000 to Political Action Committees ( PACs ) per year; $10,000 to state party committees per year; $33,400 to national party committees per year; $100,200 to separate party accounts per year. The FECA prohibits certain individuals and all corporations (including 501(c) organizations) from making campaign contributions to Federal candidates. State and local governments also have campaign finance laws that govern non-federal campaign contributions. Some states and local governments have laws that differ greatly from Federal law (e.g., the FECA strictly prohibits corporate contributions to Federal candidates, while the District of Columbia permits corporate contributions to city candidates). 4

5 Electioneering An electioneering communication is any broadcast, cable or satellite communication that fulfills each of the following conditions: The communication refers to a clearly identified federal candidate; The communication is publicly distributed by a television station, radio station, cable television system or satellite system for a fee; and The communication is distributed within 60 days prior to a general election or 30 days prior to a primary election to federal office. The Bipartisan Campaign Reform Act ( BRA ) (also known as McCain- Feingold ) requires an individual or entity paying for electioneering communications to disclose the names and addresses of all contributors who contributed an aggregate of $1,000 or more to [a political committee] established for the purpose of paying for an electioneering communication. 52 U.S.C (f)(2)(E). 5

6 Types of Political Committees PACs : Political action committees Two types: Separate segregated funds ( SSFs ) and non-connected committees. SSFs are established and administered by corporations, labor unions, membership organizations or trade associations. SSFs can solicit contributions from only within connected organization. Non-connected committees are independent and can solicit contributions from the general public. Contributions to PACs are subject to contribution limits ($5,000 per year). PACs must periodically report to the FEC their contributions and expenditures. Super PACs : Independent Expenditure-Only PACs Super PACs are permitted to raise unlimited amounts of contributions from the general public, and may spend unlimited amounts on independent expenditures. May receive unlimited contributions from corporations (including 501(c)(4) organizations) and labor unions. Prohibited from contributing directly to Federal candidates. Expenditures must be independent (i.e., the Super PAC is prohibited from coordinating with candidates or political parties). Must also disclose contributions and expenditures. 6

7 Types of Political Committees, cont. Hybrid PACs or Carey Committees : Hybrid Standard PAC/Super PAC Hybrid PACs maintain separate bank accounts: one contribution account for making contributions with Federal elections and another non-contribution account for making independent expenditures. The contribution account is subject to all contribution limits that apply to standards PACs. The non-contribution account may accept unlimited contributions from individuals, corporations, labor organizations, trade associates and membership organizations. Hybrid PACs must disclose contributions and expenditures for both accounts. 527s : Tax-exempt organizations organized and operated primarily for the purpose of influencing the selection, nomination or appointment of any individual to any federal, state or local public office, or office in a political organization. All political committees that register and file reports with the FEC are 527 (I.R.C. 527 (if omitted, refers to Internal Revenue Code)) organizations, but not all 527 organizations are required to file with the FEC. Some 527s file reports with the Internal Revenue Service (IRS). 527s may accept unlimited contributions from individuals and corporations, but they must disclose their donors. 527s must report to the FEC their electioneering communications. Note: Non-Super PAC 527s are not as relevant today in light of the Supreme Court s 2010 opinion in Citizens United v. Federal Election Commission. Citizens United, in a nutshell, provides that corporations and labor unions have the same First Amendment political speech rights as individuals. The Court s decision allowed corporations and unions to raise and spend unlimited amounts of money on independent expenditures in elections. 7

8 501(c)(3) Organizations 501(c)(3) organizations: non-profits for religious, charitable, or educational purposes. Prohibited: Directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for public office, including contributions to political campaigns or public statements of position made on behalf of the organization in favor of or in opposition to any candidate for public office. Exceptions: Certain voter education activities (e.g., hosting a candidate forum, publishing a voter education guide) and voter engagement efforts (e.g., voter registration, get-out-the-vote drives) are not prohibited political campaign activity if conducted in a non-partisan manner. A 501(c)(3) organization has two options for measuring I.R.C. lobbying restrictions: Substantial part test: lobbying activities may not constitute a substantial part of overall activities. The IRS considers a variety of factors in this vague, factual analysis, including the time devoted (by both compensated and volunteer workers) and the expenditures devoted by the organization to the activity. An organization that conducts excessive lobbying in any taxable year may lose its tax-exempt status, resulting in all of its income being subject to tax. 501(c)(3) organizations that lose their tax-exempt status due to excessive lobbying are subject to an excise tax equal to five percent of their lobbying expenditures for the year in which they cease to qualify for exemption. A tax of 5% of lobbying expenditures may be imposed against organization managers. 501(h) Expenditure test: lobbying activities measured based on the amount of money spent. Up to 20% of annual budget depending on amount of expenditures. Lobbying activities not considered substantial if under expenditure cap. Cannot spend more than $1 million in a year on lobbying activities. If it exceeds cap over 4-year period, it may lose its tax-exempt status, making all income for that period subject to tax. 25% excise tax if organization exceeds cap in a particular year. 8

9 501(c)(4) Social Welfare Organizations 501(c)(4) social welfare organizations: Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare Social welfare organization: must operate primarily to further the common good and general welfare of the people of the community. May further exempt purposes through lobbying as primary activity without jeopardizing exempt status; seeking legislation germane to organization's programs is permissible social welfare purpose. Earnings may not inure to the benefit of any private shareholder or individual. May be required to either provide notice to members regarding percentage of dues paid for lobbying activities or pay a proxy tax. Promotion of social welfare direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office. May engage in some political activities (less than 50%), so long as it isn t primary activity. Any expenditure made for political activities may be subject to tax. If an organization loses its 501(c)(3) status because of excess lobbying activities, it may not then qualify as a 501(c)(4) organization. 9

10 Income Tax Aspects of Political Organizations 501(c)(3) organizations: Contributions are tax-deductible. Contributions may be deductible as a business expense and are exempt from tax. Investment income exempt from tax. 501(c)(4) organizations: Contributions are not tax-deductible. Contributions may be deductible as a business expense and are exempt from tax if no political activities. Investment income exempt from tax if no political activities. PACs (standard, Super, and Hybrid PACs): Contributions are not tax-deductible. Contributions are not deductible as a business expense for the recipient but are exempt from tax. Investment income is not exempt from tax. 10

11 Disclosure Rules and Privacy Considerations 501(c)(3) organizations: Not required to disclose donors. Can receive unlimited contributions from individuals and corporations. 501(c)(4) organizations: Not required to disclose donors. Can receive unlimited contributions from individuals and corporations. Must report independent expenditures and electioneering communications to the FEC. PACs (standard, Super, and Hybrid PACs): Required to disclose donors. Must report independent expenditures and electioneering communications to the FEC. So What is Dark Money? 11

12 Dark Money A 501(c)(4) social welfare organization can spend unlimited amounts on independent expenditures and electioneering activities, so long as the activities are not the organization s primary purpose (essentially less than 50% of the organization s funds). Examples: Organizing for Action (the successor of President Obama s 2012 campaign arm); Crossroads GPS; National Rifle Association Action Institute for Legislative Action; League of Conservation Voters. A 501(c)(4) organization does not have to disclose the identities of its donors. A 501(c)(4) organization can create a Super PAC that can raise and spend unlimited amounts on independent expenditures and electioneering activities, so long as the activities are not connected with a candidate or party. (E.g., Crossroads GPS has an affiliated Super PAC, American Crossroads.) A Super PAC may receive unlimited contributions from individuals and corporations, including a 501(c)(4) organization. A Super PAC is required to disclose to the FEC the name of the contributing 501(c)(4) organization, but not the individuals or corporations that funded the 501(c)(4). QUESTION: Can an individual set up and fund a corporation to contribute to Super PACs for the purpose of shielding the individual s identity? 12

13 QUESTION: Can an individual set up and fund a corporation to contribute to Super PACs for the purpose of shielding the individual s identity? ANSWER: Democratic FEC Commissioners: No. That has always been unlawful; Republican FEC Commissioners: It depends, but most likely will be found to be unlawful in the future. After the Supreme Court s Citizens United decision in 2010, a number of individuals created or used LLCs to contribute to Super PACs in apparent efforts to mask their identities as the true sources of the contributions. Campaign finance watchdogs filed complaints with the FEC, alleging that among other violations, the contributions violated the FECA as contributions in the name of another (i.e., straw-man contributions). See 52 U.S.C The FEC s Office of General Counsel agreed with the complainants and shared its finding with the Commissioners. In April 2016, the Democratic FEC Commissioners agreed. See FEC MURs 6487, 6488, 6485, and Yet, the Commission deadlocked on the matter 3-3. The Republican Commissioners let the respondents off the hook, reasoning that principles of due process, fair notice, and First Amendment clarity counsel against enforcement proceedings. However, the Republican Commissioners warned individuals from attempting to evade disclosure requirements in the future: [T]he proper focus will be on whether funds were intentionally funneled through a closely held corporation or corporate LLC for the purpose of making a contribution that evades the Act's reporting requirements. If they were, then the true source of the funds is the person who funneled them through the corporate entity for this purpose. Where direct evidence of this purpose is lacking, the Commission will look at whether, for instance, there is evidence indicating that the corporate entity did not have income from assets, investment earnings, business revenues, or bona fide capital investments, or was created and operated for the sole purpose of making political contributions. See Statement of Reasons of Commissioners Petersen, Hunter, and Goodman on MURs 6485,6487, 6488, 6711, and

14 The Gift Tax Gift tax applies to the transfer of property by gift. 2501(a) The gift is determined when property is transferred for less than an adequate and full consideration in money or money s worth. 2512(b) Treasury regulations except sales, exchanges, or other transfers of property made in the ordinary course of business when bona fide, at arm s length and free of donative intent. 14

15 Statutory Exceptions to Gift Tax Not all gifts are taxable. There are many exceptions, for example a gift between spouses. Four exceptions are relevant for this analysis: Annual Exclusion: 2503(b) provides that certain gifts to recipients of up to $14,000 (2016) may qualify for the gift tax annual exclusion. Gifts to charities, 501(c)(4) organizations, etc qualify for this exclusion. Charitable Gifts: Gifts of any amount may be made tax-free to charitable organizations described in 501(c)(3). The gift is actually taxable, but a gift tax deduction is granted under 2522, effectively making the gift tax free. 527 Organizations: 2501(a)(4) specifically excepts from the gift tax transfers made to political parties or committees described in 527. Prior to the 1974 enactment of 2501(a) gifts to political organizations were taxable, but in two cases considering the issues the courts found in favor of the taxpayers. The above list does not include the popular 501(c)(4) 15

16 Transfer Taxation of Gifts to 501(c)(4)s May 2011: IRS confirmed it was examining donations to one or more 501(c)(4) organizations to determine whether gift tax should have been paid. July 2011: IRS Deputy Commissioner for Services and Enforcement announced that the audits had been halted and would consider need for further guidance. In a statement on its website, the IRS announced it would not use resources to pursue examinations on this issue while it reviewed the need for additional guidance or legislation. The website confirmed that any further action will be prospective and will be after notice is made to the public. August 2012: Congressional Research Service issued a report including legal analysis of whether contributions to 501(c)(4) organizations should be subject to gift tax. Report noted the IRS s lack of enforcement and the possible exemption of contributions that are made for advocacy-related purposes. The analysis carefully reviewed these general arguments: a) transfer is for full and adequate consideration; b) transfer is in the ordinary case of business; and c) a tax on advocacy-related transfers would violate First Amendment rights to free speech and rights to freedom of association. February 2016: IRS reviewed and updated its website, which continues to reflect the 2011 position. 16

17 What Does This Mean? Gifts to 501(c)(4) organizations should not be treated as taxable gifts pending further guidance from the IRS. Treatment of 501(c)(4) transfers for estate tax purposes has not been addressed. General view is that a transfer to a 501(c)(4) is taxable for estate tax purposes. There is a view that the gift tax and estate tax work in unison and that the gift tax is intended to prevent transfers that would be substitutes for testamentary transfers. The exclusion for gifts to 527 organizations is for immediate use and is not intended as a substitute for a testamentary transfer. Congress specifically provided an estate tax deduction for charitable gifts and intentionally limited deductions to organizations that would not be disqualified for tax exemption under 501(c)(3) by reason of attempting to influence legislation. 17

18 Watch Out for Hidden 501(c)(4) Issues A client s taxable estate includes all assets over which the client retains powers under As an example, in Rev. Rul , the value of property transferred to a foundation was includable in the decedent s gross estate under 2036(a)(2) because, as a director and the president of the foundation, he retained the power to direct the disposition of funds by designating the charitable recipients. The value of the property was included in estate under 2036 and offset by the charitable deduction. A client s 501(c)(4) organization may also be includable in his taxable estate if he retains the right to designate the persons who shall possess or enjoy the property but without an offsetting charitable deduction. Carefully watch this issue as many clients control 501(c)(4)s. The tax result could be very expensive: Incremental Estate Assets $16,666,666 Estate 40% $ 6,666,666 [TAX COST 66%] Value of 501(c)(4) $10,000,000 18

19 501(c)(4) Self-Dealing and Related Issues Private Inurement: Section 501(c)(4)(B) requires that no part ofthenetearningsoftheentityshall inure to the benefit of any private shareholder or individual. This is absolute and violation results in forfeiture of exemption. Private Benefit: This is not in the Internal Revenue Code. It is from common law which holds that charitable organizations may not be operated for private ends. Intermediate Sanctions (excess benefit): A 4958 sanction is imposed on the amount of the excess benefit when a tax-exempt organization engages in an excess benefit transaction directly or indirectly with a disqualified person. The value of the economic benefit provided by the exempt organization must exceed the value of the consideration received. This penalty is imposed on both the individual receiving the excess benefit (initially taxed at 25%) as well as the organization managers (taxed at 10%) who participated in the transaction with the knowledge that it was improper. Additional penalties apply if not corrected. Does not result in loss of exempt status. Self-Dealing: Private foundations face stricter rules than public charities regarding selfdealing. They face two-tier excise taxes that in practice prohibit transactions between the private foundation and certain insiders, even when the transaction would benefit the organization. These rules do NOT apply to 501(c)(4) organizations. Distribution Requirements: Unlike 501(c)(3) organizations, 501(c)(4) organizations are not required to make any specific annual distribution. 19

20 Case Study - Planning for a Political Legacy Donor and his family are active in politics. Donor has an interest in shaping the future of America. Donor has given to state and Federal political initiatives. Organizations have come to rely on Donor s gifts. Donor has established a charitable foundation for charitable giving. Much like his charitable foundation, Donor does not want political giving to stop at his passing and wants to support his descendants that have an interest in politics. Donor would like to set aside a portion of his estate to continue his legacy -- $10M. 20

21 Review a Few Planning Options Estate Bequest to Politically Oriented Organizations Testamentary Planning with Trusts Lifetime Transfer to a 501(c)(4) Foundation Lifetime Transfer to Trust for Descendants and Politically Oriented Organizations Supercharged Lifetime Transfer to Trust for Politically Oriented Organizations 21

22 Estate Bequest Favorable transfer tax treatment is provided for lifetime contributions to politically oriented 501(c)(4) organizations and Super PACs exempt under 527. Gifts are exempted from the gift tax. Testamentary transfers, on the other hand, are subjected to the estate tax. Estate Transfer: Donor s estate leaves $10M to a 501(c)(4) or Super PAC. The estate tax burden is prohibitive. State estate taxes could increase tax burden. Assets Committed to Plan $16,666,666 Federal 40% $ 6,666,666 Net to 501(c)(4) $10,000,000 22

23 Testamentary Planning with Trusts Donor s estate leaves property to trusts for descendants and grants each child a power to direct the trustee to transfer funds from his or her separate trust to charity and politically oriented organizations. Trust empowers descendants -- yet descendants feel the sacrifice by using assets otherwise held in trust for their benefit. The exercise of a power of direction should be treated as a contribution by the beneficiary. Under current law, beneficiary should be able to direct contributions to a 501(c)(3), 501(c)(4) and Super PAC. Contributions to traditional PACs and Federal candidates, however, will be heavily regulated by the FEC and subject to limits. These rules are evolving and may eventually eliminate or limit political transfers from irrevocable trusts. Cost of planning: Estate Assets Committed to Plan $16,666,666 Federal 40% $ 6,666,666 Net to Trusts $10,000,000 23

24 Lifetime Transfer to 501(c)(4) Foundation Donor gives during life $10M to a private 501(c)(4) Foundation. The lifetime transfer is NOT subject to gift or estate tax. Foundation carries out Donor s social welfare mission. Foundation may also be structured to benefit traditional charities. The Foundation is operated by Donor s children (Under current law, Donor s lifetime control of the Foundation could attract estate tax at his passing). Donor s gift is not publicly disclosed. Foundation is not subject to income taxation and its resources grow and appreciate tax-free. Donor could fund the Foundation with appreciated stock that could be sold tax-free and invested on a tax-free basis. Instead, Donor could make a similar gift to a powerful private Super PAC instead of a 501(c)(4) Foundation, but such a gift may involve additional issues, would be publicly disclosed, and would not enjoy favorable income tax treatment. Downside: Structure is favorable from a tax perspective --- but may be inflexible and unable to adapt as electioneering laws evolve over an extended time period. Transaction could result in a funded entity unable to carry out Donor s mission. 24

25 Lifetime Transfer to Trust for Descendants and Politically Oriented Organizations Donor establishes a trust for the benefit of her descendants and politically oriented organizations. Donor transfers wealth to the trust excluded from her taxable estate designed to carry out his political goals. Trust could be structured as a so-called grantor trust so that donor is responsible for the payment of income taxes associated with trust property. Donor transfers wealth to the trust via lifetime taxable gifts and through traditional leverage estate planning techniques designed to transfer wealth including grantor retained annuity trusts ( GRATs ) and installment sale transactions. Donor s next grantor retained annuity trust transaction could be structured to add politically oriented organizations as potential beneficiaries at the term ending date, thereby allowing the diversion of GRAT benefit to the new trust. Donor s advance planning could result in a significant political giving resource that is excluded from Donor s estate. Transfers from the trust to politically oriented organizations may not require public disclosure. The primary benefits of this structure are potentially reduced transfer tax costs and flexibility to adapt the structure to campaign finance laws as they evolve over an extended time period. The primary downside is the use of resources that are otherwise excluded from Donor s estate and that could be used to benefit descendants or others without further transfer tax. 25

26 Supercharged Wealth Transfers Donor establishes a trust that is excluded from her taxable estate and is structured to carry out her political desires (and potentially benefit collateral relatives). The irrevocable trust provides great flexibility and does not qualify as a 501(c)(4). The trust is taxed as a grantor trust as to Donor for income tax purposes. As no family members are beneficiaries, the supercharged trust would not be subject to the special valuation rules of I.R.C. Chapter 14. Donor could establish a special GRAT outside of the constraints of Chapter 14 with bells and whistles designed to maximize the transfer of wealth to the new trust for example, the GRAT could have deferred or flexible annuity payments. Donor could establish a freeze partnership with preferred equity interests and residual equity interests. Donor could transfer the residual equity interests to the new trust at a substantial discount and retain the partnership preferred interest with special liquidation rights and preferred rights to cash flows on a perpetual basis. Under current law, Donor could establish a partnership with bells and whistles that heavily discounts value for transfer tax purposes and sell that investment to the new trust. Donor could establish a grantor retained income trust structured to transfer wealth to the new trust. A variety of additional supercharged transactions are available if Donor establishes a trust that excludes family member beneficiaries and is structured to carry out political desires. 26