Common issues surrounding non-cash contributions

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1 Accepting Unique or Unusual Contributions By Laura J. Kenney and Nancy Murphy * It is not easy to say "thanks, but no thanks" to a donor. In some cases, however, "no thanks" may be the wisest answer for a tax-exempt organization. Sometimes accepting a unique or unusual gift from a well-intentioned donor can end up costing an organization more trouble than it is worth. Worse, it could put an organization's reputation at risk. Therefore, tax-exempt organizations need to make sure that they have appropriate procedures to review the acceptance of unusual gifts. A properly structured process will help avoid awkward situations with donors; provide guidelines and boundaries for development professionals, finance personnel, and board members; and help protect the organization from inadvertently accepting a bargain sale from a well-intentioned donor to its detriment. Well-structured gift review and acceptance policies also will help avoid rejection of a donation after it has been accepted by the organization, which is much worse than a wellreasoned "no thank you." Common issues surrounding non-cash contributions From stock options to intellectual property to installment receivables, the range of noncash contributions seems limited only by a donor's imagination. Some donors, however, are not familiar with the specific tax rules relating to their intended non-cash donations. They may sometimes be misinformed and expect certain tax results for gifts of specific types of property, and may be disappointed. Other donors may become overly enthusiastic in arranging for their tax deductions, or may even attempt to use a taxexempt organization to divest themselves of unwanted property. At the same time, organizations may be under financial pressure to obtain more charitable support for their mission and programs, which can result in pressure to accept donations that may not be appropriate for a particular organization. Organizations face difficult situations when their largest donors request special concessions or particular restrictions that are not beneficial to the overall mission of the organization. What types of problems can occur with regard to non-cash charitable contributions? Consider a donor who wants to contribute a gift of real estate, perhaps undeveloped land. What about potential environmental liability? What compliance obligations arise for an organization that accepts a gift of real estate in a state where it has no other activity? What ongoing costs will the organization incur to maintain the property? Will the real estate be easy to sell, or does it come with restrictions, such as an existing lease to a tenant? Did the donor create the restriction, or do restrictions run with the land? What if the gift is from a board member or a relative of a board member? Why does the donor want to donate the real estate? Similar issues can arise with other types of non-cash contributions. For example, what if a donor gives the organization an investment in a partnership interest with a negative basis, or a stuffed trophy owl both examples of real-life gifts that can be problematic? What legal obligations or liabilities come with those gifts, how costly will it be to maintain them, how easy will they be to liquidate? Also, what donor relation issues does the gift raise, including possible harm to an organization's relationship with a donating board member or other important volunteer if the donation proves costly for the organization and there are possible ulterior motives on the part of the donor?

2 Annual fundraising auctions also commonly cause headaches. For example, the donor of an antique vase for the auction may want to use the appreciated fair market value of the piece as the amount of his or her tax deduction. The bidder who buys it may want a charitable contribution receipt for the price paid because, after all, it was purchased to support the charity. What the donor may not realize is that he or she does not get a fair market value deduction if the charity does not use the gift in its exempt purpose. Instead, the deduction will be limited to his or her basis in the vase. Similarly, the bidder may not get any charitable tax deduction if he or she paid less than the fair value of the vase (and if he or she paid more than the fair market value, the deduction would be limited to the overpayment). Another common situation is that of a donor with a buyer who is ready and willing to buy the property. On further reflection, an enthusiastic donor might think it best to donate the property to his or her favorite charity, so the charity can then sell it, perhaps even to the prearranged buyer. Thus, the charity will end up holding the cash from the sale, the buyer will end up holding the property he or she was going to buy in any event, and the donor will end up with a tax deduction. In such situations, the IRS may view transactions that appear prearranged as part of a predetermined understanding. It will look at substance over form and other factors, including the timing and the parties involved. It may apply the step transaction doctrine to collapse them, by looking at the binding commitment test, the end result test, or the interdependence test. New Form 990 and valuation The perception that many charitable contributions are overvalued, resulting in excessive tax deductions for donors, and therefore less funding available for government spending, has been a thorny issue for both the Senate Finance Committee and the IRS in recent years. In response, questions regarding non-cash gifts and related matters were added to the new Form 990 for The new questions are specifically designed to try to eliminate the risks of noncompliance and lost tax revenue. Part V of Form 990 now requires organizations to make statements regarding their IRS filings and other tax compliance matters. Exempt organizations will need to answer questions such as whether they sold, exchanged, or otherwise disposed of previously donated tangible personal property for which a Form 8282 was filed and, if so, how many Forms 8282 were filed during the year. Additionally, organizations must furnish information about filing the required forms for contributions of qualified intellectual property, as well as contributions of cars, boats, planes, and other vehicles to the extent the organization received such items. For the 2008 tax year, an organization must fill out the new Schedule M if it receives more than $25,000 of non-cash contributions; contributions of art, historical treasures, or other similar assets; or qualified conservation contributions. Schedule M requires reporting of in-kind donations, including publicly traded securities, art, cars, books, real estate, collectibles, and anything else that is not cash. Organizations must report the revenue from and number of contributions from the various types of non-cash of property received. (The amount of revenue from all noncash gifts must be reported on the core Form 990.) If an organization reports no revenue for any such property received, it must attach a narrative explanation of why no revenue is reported with respect to that item.

3 An organization also must answer questions regarding the number of Forms 8283 it received, and whether during the year it received any property contribution that (1) it must hold for at least three years from the date of the contribution and (2) it need not use for exempt purposes for the duration of that holding period. If such contributions are made to the organization, it will need to describe the arrangement. The obvious intent of this new question is to encourage and enforce compliance with the requirements contained in the Pension Protection Act of 2006 (PPA) that lengthened from two years to three years the period during which the sale of certain donated property must be reported to the IRS. 1 It is also worth noting that the PPA also provided a new $10,000 penalty (in addition to other penalties) for any person identifying applicable donated property as having a use that is related to the charity's exempt purpose while knowing that it is not intended for such use. 2 Another new question on the Form 990 is whether an organization has a gift acceptance policy that requires the review of any non-standard contributions. The draft instructions explain that a non-standard contribution includes "a contribution of an item that is not reasonably expected to be used to satisfy or further the organization's exempt purpose and for which (a) there is no ready market to which the organization may go to liquidate the contribution and convert it to cash and (b) the value of the item is highly speculative and difficult to ascertain." Non-cash contributions and 'transactions of interest' The Fiscal Year Implementing Guidelines of the Service's Exempt Organization division is its annual business plan or blueprint for the upcoming year. 3 One focus of the FY 2008 guidelines is non-cash donations and opportunities for overvaluation by donors. As part of its education and enforcement efforts for tax-exempt organizations, the IRS has sent a series of tax compliance questionnaire check-up letters over the last few years. These include letters on: Fundraising. Compensation practices. Hospital tax compliance. Tax-exempt bonds. Last fall, the IRS sent a new, 41-question audit letter to certain Section 501(c)(3) organizations. 4 It also published a news release concerning a specific audit examination program focusing on unique or unusual contributions to charitable not-for-profit organizations. This particular examination questionnaire was targeted to organizations that have been involved in specific potential tax avoidance or evasion transactions in which donors may have claimed excessive charitable contribution deductions for donations of interests in limited liability companies that own real estate. The questionnaire is more broadly applicable, however, and should be reviewed by tax-exempt organizations. Of particular importance among the lessons to be learned from such a review is what the IRS may ask regarding the receipt of unique or unusual charitable contributions. Among the highlights of the exam letter are the following questions:

4 "Did your organization receive legal advice regarding accepting the [unusual gift]? If yes, describe the type and nature of the legal advice (e.g., real estate, taxexempt status, charitable solicitation laws, unrelated business income, etc.)." "Does your organization have bylaws or other guidelines for accepting unusual gifts..." If yes: "[D]escribe and submit your organization's guidelines for accepting unusual gifts... and indicate the date these procedures were adopted... Who wrote these procedures... Who approved them... "Who is responsible for monitoring the procedures." "Describe any due diligence your organization conducted before you received [the gift] including any assessment you made of the property or obligations against the property. Please submit your due diligence report and any accompanying exhibits or attachments." "Did your organization file Form 8282 and provide a copy to the donor when you disposed of [the gift]? If no, please explain why the form was not filed or a copy was not provided to the donor." "Was your organization's Form 990 reviewed by an independent accountant or by outside counsel for the year of receipt or the year of the sale... of [the gift]? If yes, what was their opinion or advice to your organization with respect to the Form 990 reporting of the receipt and sale... of [the gift]?" The transactions in the recent IRS news release (and variations of those transactions that have been in recent news reports) may or may not be "substantially similar" to difficult unique donation situations in which an organization may find itself. At a minimum, however, the IRS questions listed above should be read as best practices to be considered by tax-exempt organization leaders to ensure that the charitable interests of the organization are protected. Best practices According to a 2007 Grant Thornton LLP National Board Governance Survey for Not-for- Profit Organizations, 5 68% of responding organizations have a gift acceptance policy in place, compared to 44% in The survey report suggests that gift acceptance policies should also address gifts from vendors and potential vendors, and that there should be policies in place to review non-cash donations. As a best practice, organizations should decline gifts from a potential vendor during the bidding process and only accept gifts from a vendor if there is a business purpose and the gifts are nominal in value. In the case of non-cash donations, the policy should outline the procedures the organization performs prior to accepting gifts. For example, potential real estate gifts should be reviewed to ensure that there are no environmental hazards prior to gift acceptance. Interestingly, the Grant Thornton survey reports that 37% of those responding have updated their gift acceptance policies over the last four years. What should a gift acceptance policy include? It should include all of the best practices that are involved with respect to conflict of interest considerations. Organizations may want to consider: A written gift acceptance policy. Assigning a committee to review certain types of unique or unusual contributions. Periodically reviewing requirement for the gift acceptance policy every three years, for example.

5 Documentation of the date of approval of the policy (and by whom it was approved) plus dates for future reviews of the policy. A default to renegotiate; that is, if the proposed gift does not "fit" the organization, the norm should be to renegotiate something that fits both the organization and the potential donor, even if it is an influential board member. Always instructing a donor to obtain his or her own legal or tax counsel. Legal matters relating to donated property. Environmental matters relating to donated property. Appraisal matters the donor should be responsible for paying for appraisals. Reputational risk and exposure, as well as tax-exemption and mission matters. Review of potential conflicts of interests with respect to potential donors, including but not limited to donor board members, key employees, and advisors. Periodic reviews of fundraising events and processes. Other tax reporting and compliance considerations. Tax reporting and compliance considerations include appropriate language in the donation acknowledgments, proper Form 990 reporting, a determination of which department will be responsible for signing Forms 8283 when receiving donated property and filing Forms 8282 when selling it, UBIT matters relating to donated property, assignment of income issues, and avoiding an intermediate sanctions matter by preventing the charity from paying for the appraisal that the substantial donor uses for his or her individual tax return. Conclusion Tax-exempt organizations need to consider what can go wrong in a gift setting. It is important for organizations to create and maintain a policy for the careful review of potential gifts. Such a policy will help avoid the problems associated with a gift that cost more time, money, and aggravation than the gift is worth. With the new questions on the 2008 Form 990 and the increasing scrutiny of charities by Congress, the IRS, and the media, the timing could not be better. Tax-exempt organizations may want to review and update their gift acceptance policies or put policies in place if they have not done so already. Remember, such policies usually are not of the "one-size-fits-all" variety. Rather, the policy should be specific to the needs of the organization. * Laura J. Kenney is a senior manager in Grant Thornton's Boston tax practice. Nancy Murphy is a principal in Grant Thornton's Washington, DC, area tax practice. 1 Section 6050L(a)(1). 2 Section 6720B This article was originally published in Taxation of Exempts, Sept/Oct 2008, RIA.