Addendum to Form 211, Application for Award for Original Information Melanie Sloan is filing this IRS Whistleblower complaint to bring to the Service s attention a series of questionable transactions involving three related parties: the James Madison Center for Free Speech ( JMCFS ), a section 501(c)(3) organization that was classified as a public charity until 2008, and currently is classified as a private foundation 1 ; the individual who founded the charity, and served as its sole manager, Mr. James Bopp; and the Bopp Law Firm, a business owned and controlled by Mr. Bopp. 2 Media reports, JMCFS s filings with the IRS, and other public documents suggest that JMCFS, under the control of Mr. Bopp an attorney who claims substantial experience and expertise in the tax laws affecting nonprofit organizations 3 is misrepresenting its activities to the IRS and the public in order to divert funds through the Bopp Law Firm to enrich Mr. Bopp personally. This submission will demonstrate that, for each of the last six years, Mr. Bopp as the sole manager of JMCFS, and operating unchecked by its Board of Directors caused the organization to pay essentially all of its income to the Bopp Law Firm. By directing the diversion of charitable funds for his own benefit, Mr. Bopp caused JMCFS to fail some of the most fundamental tax requirements applicable to section 501(c)(3) organizations, and has subjected himself, JMCFS and the Bopp Law Firm to more than $6.2 million in excise tax liability under sections 4941, 4945 and 4958 of the Code. Put simply, JMCFS is a private law firm masquerading as a charity. It serves private purposes to an extraordinary degree and thus should not be recognized as tax-exempt under section 501(c)(3). The information in this submission also suggests, quite strongly, that the conduct of JMCFS and Mr. Bopp violates other civil and criminal tax laws and may violate other federal and state criminal statutes as well. Thus, Ms. Sloan urges the Service to investigate immediately and, after verifying this information, assess penalties and other appropriate sanctions including revocation of JMCFS s tax-exempt status and assessment of penalty taxes on Mr. Bopp and the Bopp Law Firm. Indeed, given the visibility of the organization, the significant dollars involved, and the continuing nature of Mr. Bopp s and JMCFS s troubling activities, any inaction on the part of the Service will undermine the integrity of the law itself. 1 All section references are to the Internal Revenue Code of 1986, as amended (the Code ), and all regulatory references are to the Treasury Regulations currently in effect under the Code (the Regulations ). 2 The Bopp Law Firm was a sole proprietorship from 1992 to April 2012, when Mr. Bopp incorporated it as an Indiana professional corporation. See https://secure.in.gov/sos/online_corps/name_search_results.aspx?search_name=bopp+law+firm&search_type=exact &client_id=&submit.x=0&submit.y=0&search_mode=search (Exhibit A). 3 See The Bopp Law Firm, PC, Summary of Resume of James Bopp, Jr. (Exhibit B). This document was submitted by Mr. Bopp to a federal district court in Washington state in 2012, as part of a fee petition.
-2- Consistent with the requirements of section 3.03(7) of Notice 2008-4, 2008-1 C.B. 253, the Background section of this submission sets out the factual background supporting Ms. Sloan s claim, including the amounts and tax years of excise taxes at issue. And, as required by section 3.03(8), this submission both above, and in the Background section explains that these facts came to Ms. Sloan s attention through the various public documents described herein. The Discussion section applies the legal authorities supporting Ms. Sloan s contention that JMCFS, Mr. Bopp, and the Bopp Law Firm are liable for Chapter 42 excise taxes and calculates the excise taxes owed by each. Throughout this submission, various documents are cited that substantiate Ms. Sloan s claim, all of which are publicly available. For convenient reference, copies of certain of these documents are enclosed as exhibits to this submission. Also enclosed is a Form 2848, authorizing Ms. Sloan s attorneys to represent her before the IRS. Summary of Key Findings JMCFS, under the control of Mr. Bopp (who, by his own admission, single-handedly controls JMCFS s operations), paid nearly all of its income over a period of years to the Bopp Law Firm then a sole proprietorship owned by Mr. Bopp in violation of the prohibitions against private inurement and substantial private benefit that are fundamental requirements for exemption under section 501(c)(3) of the Code. The repeated diversions of JMCFS s income to Mr. Bopp s sole proprietorship in 2006 and 2007, at Mr. Bopp s direction, constituted excess benefit transactions which, to date, have not been corrected subjecting Mr. Bopp and the Bopp Law Firm to more than $2.9 million in section 4958 excise taxes in 2006 and 2007. The repeated diversions of JMCFS s income to the Bopp Law Firm in 2008, 2009, 2010, and 2011 resulted in numerous self-dealing transactions between JMCFS and the Bopp Law Firm, and taxable expenditures through the use of JMCFS s charitable assets for the benefit of the Bopp Law Firm none of which has been corrected subjecting JMCFS, Mr. Bopp, and the Bopp Law Firm to more than $3.3 million in excise taxes under sections 4941 and 4945 of the Code. A pattern of filing inaccurate Forms 990-PF and 990 including affirmative statements that JMCFS has no independent contractors to which it pays more than $50,000, even though JMCFS annually paid the Bopp Law Firm well in excess of that amount subjects JMCFS and Mr. Bopp (who signed JMCFS s information returns under penalties of perjury) to civil, and potentially criminal, penalties.
-3- Background A. Overview of JMCFS s Mission, Governance, and Activities. Formerly called The Caring Foundation, 4 JMCFS is a corporation exempt from federal income tax under section 501(c)(3). 5 It has been classified as a private foundation under section 509(a) since 2008, although the organization was previously classified as a public charity. 6 JMCFS was founded by James Bopp, Jr., an attorney who represents numerous not-forprofit organizations and has long held himself out as an expert on not-for-profit corporate and tax law, on campaign finance and election law... [and] on federal and state trial and appellate litigation. 7 Media reports and JMCFS s website confirm that Mr. Bopp founded JMCFS in 1997. 8 However, the corporation to which JMCFS s EIN was assigned (the Caring Foundation) existed long before; indeed, JMCFS s Business Master File confirms that the IRS recognized the corporation as exempt in April 1975. 9 Accordingly, it appears that, rather than founding JMCFS, and applying to the IRS for recognition of the new organization s tax-exempt status, Mr. Bopp simply repurposed an existing corporation that already had been recognized by the IRS as exempt, ostensibly for JMCFS s stated purposes. JMCFS s stated mission is to protect the First Amendment right of all citizens to free political expression in our democratic Republic. Its purpose is to support litigation and public education activities in order to defend the rights of political expression and association by citizens and citizen groups as guaranteed by the First Amendment of the United States Constitution. 10 According to its most recently available Form 990, JMCFS s sole activity is to 4 See JMCFS 1998 Form 990 (Exhibit C). 5 JMCFS states on its website that it is an internal educational fund of the James Madison Center, Inc., a District of Columbia non-profit corporation. See http://www.jamesmadisoncenter.org/donate.html (Exhibit D). While this statement could be read to imply that JMCFS is not a separate organization from the James Madison Center, Inc., the organizations were separately recognized by the IRS as tax-exempt entities in April 1975, with JMCFS recognized under section 501(c)(3) and the James Madison Center, Inc. recognized under section 501(c)(4). See www.irs.gov/uac/soi-tax-stats-exempt-organizations-business-master-file-extract-(eo-bmf) (Exhibit E). 6 See, e.g., JMCFS 2008 Form 990-PF; JMCFS 2007 Form 990, Sch. A (filing as section 509(a)(1) and 170(b)(1)(A)(vi) organization); JMCFS 2006 Form 990, Sch. A (filing as section 509(a)(2) organization). Copies of JMCFS s 2006 through 2011 information returns are enclosed as Exhibit F. 7 Exhibit A ( Summary of Resume of James Bopp, Jr. ). 8 Jon Campbell, James Bopp Jr. Gets Creative: How Does the conservative maestro of campaign finance fund his legal work?, Slate (Oct. 5, 2012), available at http://www.slate.com/articles/news_and_politics/jurisprudence/2012/10/james_bopp_jr_s_unusual_relationship_wit h_the_james_madison_center_.html (Exhibit G); see also JMCFS, About Us, available at http://www.jamesmadisoncenter.org/cases/02-10-2012/853/cert-petition-final-2/ ) (Exhibit H) (confirming that Mr. Bopp s affiliation with JMCFS began in 1997). 9 See Exhibit E. 10 See www.jamesmadisoncenter.org/about/mission.html ( Mission Statement of the James Madison Center for Free Speech ) (Exhibit I).
-4- provide funding for legal services, specifically, defending the first amendment free speech rights of nonprofit organizations and providing compliance advice to churches nationwide. 11 JMCFS ostensibly is governed by a five-member Board of Directors. 12 Mr. Bopp has served as JMCFS s general counsel since founding the organization 1997, 13 and he has signed its annual Forms 990 and 990-PF nearly every year since 1998. Interestingly, although JMCFS is located in Terre Haute, Indiana, and JMCFS stated on Part VII-A, Line 8a, of its 2008-2011 Forms 990-PF that it is registered with, or reports to, Indiana and the District of Columbia, no record of the organization can be found with the Indiana Secretary of State or the District of Columbia. 14 Although JMCFS lists Wanda Franz as its president on its website and 2006-2011 annual returns, the organization has no paid staff 15 and Mr. Bopp is evidently the only person managing JMCFS s operations. 16 Indeed, in a 2012 interview, Mr. Bopp told a Slate reporter that he could not remember the last time the Board met. 17 Further, despite representations to the contrary on JMCFS s last five annual information returns, Ms. Franz denied that she was JMCFS s president, maintaining that she was only a trustee. 18 Claiming that JMCFS s Board delegated all management authority to him, Mr. Bopp said he is free to pursue litigation on his own initiative and that his law firm handles JMCFS s management, bookkeeping, filing IRS returns, and provision of legal services. 19 Consistent with Mr. Bopp s assertions that he alone is responsible for JMCFS s management effectively serving as the organization s principal officer JMCFS has published press releases that refer to Mr. Bopp as the organization s President ; however, they were removed earlier this year from the organization s website. 20 Those assertions by Mr. Bopp and JMCFS s press releases directly 11 JMCFS 2011 Form 990-PF, Part IX-A, line 1 (summary of direct charitable activities). 12 Id. Part VII, line 1 (referring to Board members as trustees ); see also www.jamesmadisoncenter.org/about/officers.html (referring to Board members as directors. ) (Exhibit J). 13 See www.bopplaw.com/attorney-profiles (profile of James Bopp, Jr.) (Exhibit K); www.jamesmadisoncenter.org/about/counsel.html (Exhibit L). 14 See https://secure.in.gov/sos/online_corps/name_search.aspx; https://corp.dcra.dc.gov (Exhibit M). The District of Columbia does, however, have record of the James Madison Center, Inc.: the Center was organized on May 17, 1973, is registered as a corporation, and last filed reports with the District in 2012. See https://corp.dcra.dc.gov/ (Initial File Number 731423) (Exhibit N). No record of the Center can be found on the Indiana Secretary of State s website. 15 See Exhibit J (www.jamesmadisoncenter.org/about/officers.html); JMCFS 2011 Form 990-PF, Part VII, line 1; JMCFS 2006 Form 990, Part V-A. 16 Exhibit G (Jon Campbell, James Bopp Jr. Gets Creative: How Does the conservative maestro of campaign finance fund his legal work?, Slate (Oct. 5, 2012)). 17 Id. 18 Id. 19 Id. 20 See, e.g., http://web.archive.org/web/20060201221252/http://www.jamesmadisoncenter.org/test/content.html (Exhibit O). See also http://web.archive.org/web/20051113030750/http://www.jamesmadisoncenter.org/ (Exhibit P).
-5- contradict JMCFS s representations on its annual returns filed with the IRS and signed under penalties of perjury by Mr. Bopp. B. JMCFS s Relationship with the Bopp Law Firm. Founded in 1992 by Mr. Bopp as Bopp, Coleson & Bostrom, the Bopp Law Firm was a sole proprietorship until its recent incorporation. 21 The Bopp Law Firm and JMCFS share the same address, phone number, and fax number. 22 Consistent with Mr. Bopp s assertion that he is JMCFS s sole manager, his email address and his law firm s phone number are the main contacts listed on JMCFS s website. 23 Further, the list of attorney bios of JMCFS s general counsel are essentially identical those on the Bopp Law Firm s website. 24 And, it appears that the Bopp Law Firm is financially dependent on charitable dollars flowing through JMCFS to the firm; indeed, it has been publicly reported that half of the Bopp Law Firm s litigation work is funded by JMCFS. 25 In another example of the blurring of the lines between JMCFS and the Bopp Law Firm, JMCFS lists cases on its website apparently representing that these are the cases JMCFS funded and provides links to court filings. In these filings, Mr. Bopp and his associates state that they represent various clients in their capacities at the Bopp Law Firm, JMCFS, or both. 26 JMCFS s annual filings with the IRS, which were reviewed and signed under penalties of perjury by Mr. Bopp, underscore the reality that the organization is little more than a front for, or alter ego of, the Bopp Law Firm. On its Form 990 and Form 990-PF information returns, JMCFS claims that providing funding for legal services as opposed to providing direct legal representation is its sole activity. 27 Troublingly, however, the revenue and expenditure schedules to those returns reveal that virtually all of JMCFS s revenue is passed on to the Bopp Law Firm to fund the legal services by Bopp and his associates for cases such as those listed on 21 See Bopp v. Brames, 713 N.E.2d 866, 868 (Ind. Ct. App. 1999) (after the October 1992 dissolution of the partnership, Brames, Bopp, Abel & Oldham, Bopp proceeded to form a sole proprietorship entitled Bopp, Coleson & Bostrom ) (Exhibit Q); www.bopplaw.com (Exhibit R) (stating that The Bopp Law Firm was founded by Bopp in 1992). On April 23, 2012, Mr. Bopp incorporated the Bopp Law Firm, P.C., as an Indiana professional corporation with one authorized share. See https://secure.in.gov/sos/online_corps/name_search.aspx (Exhibit S). Mr. Bopp is presumably the sole shareholder, as he was the sole proprietor of Bopp Law Firm for nearly 20 years, and Indiana law requires that at least one share of a professional corporation rendering legal services be owned by an Indiana-licensed attorney. Ind. Code. 23-1.5-2-3. 22 See JMCFS 2011 Form 990-PF; www.bopplaw.com/contact-us (Exhibit T); www.jamesmadisoncenter.org/donate.html. 23 See www.jamesmadisoncenter.org/ (jboppjr@aol.com is JMCFS s contact) (Exhibit U). 24 Compare www.jamesmadisoncenter.org/about/counsel.html with www.bopplaw.com/attorney-profiles. 25 See Terry Carter, The Big Bopper, ABA Journal (November 24, 2006), available at www.abajournal.com/magazine/article/the_big_bopper/ (Exhibit V). 26 See www.jamesmadisoncenter.org/cases.html (Exhibit W) (providing links to various petitions, briefs, and filings that list Mr. Bopp and his associates as working for the Bopp Law Firm, JMCFS, or both). 27 See, e.g., JMCFS 2011 Form 990-PF, Part IX, Stmt. 5 (describing the organization s sole charitable activity as provid[ing] funding for legal services to litigate First Amendment cases and to assist churches with legal compliance).
-6- JMCFS s website. These payments are reported as legal fees on the organization s information returns. Table 1. Year Total Revenue Total Expenditures Payments to Bopp Law Firm Bopp Payments as % of Total Revenue Bopp Payments as % of Total Expenses 2006 $1,018,689 $1,018,781 $1,011,000 99.2% 99.2% 2007 $277,956 $277,524 $276,355 99.4% 99.6% 2008 $317,853 $319,328 $317,678 99.9% 99.5% 2009 $127,082 $77,127 $77,052 60.6% 99.9% 2010 $135,000 $184,435 $183,361 135.8% 99.4% 2011 $255,879 $256,173 $255,879 100% 99.9% Total $2,132,459 $2,133,368 $2,129,014 99.5% 99.4% As Table 1 reveals, approximately 99.5% of JMCFS s annual revenues from 2006-2011 were used to fund legal services performed by the Bopp Law Firm on behalf of third parties. 28 Despite making substantial payments to its founder s law firm year after year, JMCFS took the position in its 2008-2011 Forms 990-PF that the organization did not engage any independent contractors to which it paid more than $50,000 per year. 29 JMCFS s position that the Bopp Law Firm is not an independent contractor suggests that JMCFS likely did not file 28 See JMCFS 2011 Form 990-PF, Part I, Lines 12, 16a (Stmt. 1), and 26; JMCFS 2010 Form 990-PF, Part I, Lines 12, 16a (Stmt. 1), and 26; JMCFS 2009 Form 990-PF, Part I, Lines 12, 16a (Stmt. 1), and 26; JMCFS 2008 Form 990-PF, Part I, Lines 12, 16a (Stmt. 2), and 26; JMCFS 2007 Form 990, Part I, Lines 12 and 17, and Schedule A, Part II-A; JMCFS 2006 Form 990, Part I, Lines 12 and 17, and Schedule A, Part II-A. It appears that it has long been JMCFS s practice to pay nearly all of its expenses to the law firm where Mr. Bopp works. For example, in 2005, JMCFS paid 102.9% of its revenues and 98.5% of its expenses to Bopp, Coleson & Bostrom. JMCFS 2005 Form 990, Part I, Lines 12 and 17, and Schedule A, Part II-A. From 1998-2004, while JMCFS did not disclose to which firm it paid legal fees, its legal fees accounted for 97.6% of its revenues and 95.5% of the organization s expenses. JMCFS 2004 Form 990, Part I, Lines 12 and 17; JMCFS 2003 Form 990, Part I, Lines 12 and 17; JMCFS 2002 Form 990, Part I, Lines 12 and 17; JMCFS 2001 Form 990, Part I, Lines 12 and 17; JMCFS 2000 Form 990, Part I, Lines 12 and 17; JMCFS 1999 Form 990, Part I, Lines 12 and 17; and JMCFS 1999 Form 990, Part I, Lines 12 and 17. Given JMCFS s consistent pattern of paying most of its revenues to Mr. Bopp s law firm, it appears likely that JMCFS paid nearly all such legal fees to Mr. Bopp s firm. 29 See JMCFS 2011 Form 990-PF, Part VIII, Line 3; JMCFS 2010 Form 990-PF, Part VIII, Line 3; JMCFS 2009 Form 990-PF, Part VIII, Line 3; JMCFS 2008 Form 990-PF, Part VIII, Line 3.
-7- Form 1099-MISC with respect to these payments and the Bopp Law Firm may not have paid employment taxes on these payments. The Service should investigate this potentially substantial employment tax issue. More troubling, JMCFS s position that the Bopp Law Firm is not an independent contractor suggests that that JMCFS considers the firm and itself as one and the same a sentiment that has been echoed by Mr. Bopp s public statements and business decisions. For example, Mr. Bopp himself has described organizations he represented as clients of JMCFS even though JMCFS, as a funder of legal services, does not provide legal services and thus has no clients. 30 And, although JMCFS represents itself as a funder of legal services, the organization claimed in its 2006 and 2007 information returns that JMCFS itself provid[ed] legal representation, rather than funding for such services. 31 Further, under Mr. Bopp s sole direction, JMCFS shares the firm s offices, has no paid staff, pays nearly all of its revenues to the firm, and considers all of the attorneys at the firm as its general counsel. Thus, there appears to be little, if any, meaningful distinction between JMCFS and the firm itself. In sum, Mr. Bopp admits that he is the sole manager of JMCFS and the organization s Board has delegated him authority over the organization s operations including the authority to choose the cases with which JMCFS is involved; JMCFS shares offices, phones, faxes, and personnel with the Bopp Law Firm; nearly all of JMCFS s revenues are paid to the Bopp Law Firm; and JMCFS does not report the Bopp Law Firm as an independent contractor on the organization s annual information returns. Given these circumstances, it is difficult to characterize JMCFS as anything other than an instrument Mr. Bopp uses to pay his firm s legal fees. 32 Because JMCFS is currently exempt from federal income tax under section 501(c)(3), donors have been able to take charitable deductions for what would otherwise be non-deductible payments to the Bopp Law Firm. 30 See, e.g., James Bopp, Jr. & Richard E. Coleson, Electioneering Communication Versus Abortion, Election Law Journal, Vol. 3, No. 2 (2004) 205, 205 ( The authors represented the following parties before the Supreme Court in National Right to Life Committee v. FEC (02-1733; consolidated with McConnell v. FEC) as clients of the James Madison Center for Free Speech: U.S. Representative Mike Pence, Alabama Attorney General Bill Pryor, Libertarian National Committee, Inc., Club for Growth, Inc., Indiana Family Institute, Inc., National Right to Life Committee, Inc., National Right to Life Educational Trust Fund, National Right to Life Political Action Committee, Trevor M. Southerland, and Barret Austin O Brock. ), available at online.liebertpub.com/doi/pdfplus/10.1089/153312904322907720 (Exhibit X). 31 See JMCFS 2006 and 2007 Forms 990, Part III, Line a. 32 See Jonathan Salant, Election Spending to Exceed $6 Billion Thanks Partly to Jim Bopp, Bloomberg, Sept. 21, 2011, available at http://www.bloomberg.com/news/print/2011-09-21/election-spending-to-exceed-6-billion-thankspartly-to-jim-bopp.html (Exhibit Y) ( To help pay his legal fees, Bopp set up the James Madison Center for Free Speech in 1997. ).
-8- Discussion A. JMCFS Operates for the Private Benefit of Mr. Bopp and the Bopp Law Firm, in Violation of Section 501(c)(3). 1. The Private Benefit Doctrine. As you are well aware, organizations that are exempt from federal income tax under section 501(c)(3) must be organized and operated exclusively for charitable, educational, or other exempt purposes. Indeed, the Supreme Court has held that the presence of a single non-exempt purpose, if substantial in nature, will disqualify an organization from tax-exempt status, even if the organization also conducts charitable activities. 33 The Regulations further clarify that an organization is not operated exclusively for exempt purposes unless it serves a public rather than a private interest. 34 To meet this requirement, the organization must establish that it is not operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests. 35 Accordingly, although a section-501(c)(3) organization may have as its sole purpose the providing of funds to defend constitutional rights, in turn furthering charitable purposes, an organization conducting such activities like any other section 501(c)(3) organization is not exempt if it does not comply with the Regulation proscribing private benefit. 36 In determining whether such an organization meets this requirement, the IRS has cited as an important criterion whether the selection of cases by the organization for its support is made by a board or committee that is representative of the public and is not controlled by employees, persons who litigate on behalf of the organization, or by any commercial entity. 37 Moreover, the social welfare aspect of such an organization s funding of cases may be negated by a finding of overriding private benefit. 38 Courts have interpreted this regulation to create a private benefit test that prohibits taxexempt organizations from conducting more than insubstantial activities that confer nonincidental benefits... that serve private interests. 39 In other words, if an organization serves private interests other than incidentally, it will not meet the standard for tax-exemption, 33 See Better Business Bureau v. United States, 326 U.S. 279, 283 (1945). 34 Treas. Reg. 1.501(c)(3)-1(d)(1)(ii). 35 Id. 36 See id.; Rev. Rul. 73-285, 1973-2 C.B. 174. 37 1984 EO CPE Text, D. Litigation by IRC 501(c)(3) Organizations. 38 Id. 39 Am. Campaign Acad. v. Comm r, 92 T.C. 1053, 1069 (1989); Rev. Rul. 2006-27, 2006-21 I.R.B. 915.
-9- even if it otherwise appears to conduct charitable activities. 40 Based on the foregoing, this appears to be precisely JMCFS s situation. While the most common examples of impermissible private benefit involve a charity conferring financial benefits to individuals, the doctrine is substantially broader than this paradigm. Significantly, for purposes of our analysis, the IRS and courts have long recognized that a charity may create an impermissible private benefit and, accordingly, jeopardize its exempt status if it has a substantial purpose of generating business or providing pecuniary support for one or more nonexempt entities. 41 In one case, for example, the Tax Court upheld the IRS s revocation of the section 501(c)(3) status of the International Postgraduate Medical Foundation because a substantial purpose of its operations was to benefit a for-profit company owned by an officer of the charity. 42 In its decision, the Court explained: When a for-profit organization benefits substantially from the manner in which the activities of a related organization are carried on, the latter organization is not operated exclusively for exempt purposes within the meaning of section 501(c)(3), even if it furthers other exempt purposes. 43 Further, the Tax Court noted that the officer had control of [the charity] and exercised it for the benefit of [his for-profit company]. 44 The IRS takes a similar approach. Thus, when an organization s principal expenditures were to purchase products and services from a for-profit company that controlled it, the IRS denied exemption because the organization was totally dependent on one for profit for [its] operations and, although the organization indicated that after three years it would only account for 10% of the company s sales, the organization s purchases would produce a substantial amount of revenue for [the company]. 45 Accordingly, the IRS found that the organization was formed for the substantial non-exempt purpose of providing a related commercial entity with business revenue. 46 Similarly, when an organization s principal activity was purchasing the books of one of its founders and making them available for public use, the Service held that the organization failed to operate exclusively for section 501(c)(3) purposes. 47 Moreover, impermissible private benefit exists when a charity allows private interests to dictate the charity s internal operations and policies. Thus, in Columbia Park & Recreation 40 See Columbia Park & Recreation Ass n v. Comm r, 88 T.C. 1, 25 (1987) (explaining that under the section 501(c)(3) Regulations, a private interest exists if any person having a private or personal interest in [the organization s] activities is the focus of [the organization s] benefit ). 41 E.g., Int l Postgraduate Med. Found. v. Comm r, 56 T.C.M. (CCH) 1140 (1989); KJ s Fund Raisers Inc. v. Comm r, 74 T.C.M (CCH) 669 (1997), aff d, 166 F.3d 1200 (2d Cir. 1998); Rev. Rul. 76-206, 1976-1 C.B. 154. 42 Int l Postgraduate Med. Found., 56 T.C.M. (CCH) 1140 (1989). 43 Id. 44 Id. 45 Priv. Ltr. Rul. 201148008 (Aug. 17, 2011). 46 Id. (citing Int l Postgraduate Med. Found.). 47 Rev. Rul. 55-231, 1955-1 C.B. 72.
-10- Association v. Commissioner, the Tax Court ruled that a nonprofit civic association created to provide park, recreation, and other services to a planned community failed to qualify for exemption because it was operated principally to promote the private interests of the homeowners residing in the community. 48 The court rejected the argument that this benefit was incidental to a greater benefit to the public at large, which had access to some of the development s facilities, as the residents and property owners formulated the organization s budget and defined its goals and policies. 49 2. JMCFS Provided Impermissible Private Benefits to Mr. Bopp and the Bopp Law Firm. Here, it appears that JMCFS is operated to confer nonincidental benefits that serve private interests namely those of the Bopp Law Firm and Mr. Bopp, thus running afoul of the requirement that charities be operated for a public interest. 50 Indeed, JMCFS s sole activity is to further the private and pecuniary interests of Mr. Bopp by providing funding for legal services performed by his business, the Bopp Law Firm. As in International Postgraduate Medical Foundation, Mr. Bopp, as the individual controlling the daily operations of JMCFS, has caused the organization to operate for the benefit of his for-profit business by directing approximately 99.5% of JMCFS s revenues to the business. Accordingly, because his law firm benefits substantially from the manner in which the activities of JMCFS are carried on, JMCFS fails to be operated exclusively for exempt purposes, even if it furthers some exempt purposes. 51 Because Mr. Bopp controls JMCFS and nearly all of JMCFS s revenues are paid to his law firm, the social welfare aspects of JMCFS s operations are negated by the nonincidental indeed, substantial private benefit JMCFS provides to Mr. Bopp and his firm. 52 For example, if JMCFS s cases were selected by a board or committee independent of Mr. Bopp or his firm, and the independent board made a decision that Mr. Bopp was the best choice to conduct the litigation, this would weigh in favor of a finding that JMCFS benefits a public, rather than private interest. 53 In fact, however, one individual Mr. Bopp selects JMCFS s cases, serves as the main litigator of these cases, and is the principal of the firm to which essentially all of JMCFS s business is driven. Given that Mr. Bopp controls both JMCFS and the Bopp Law Firm, JMCFS pays nearly all of its revenues to the Bopp Law Firm, and the firm s work for JMCFS accounts for half of the firm s business, it is clear that JMCFS has a substantial purpose of providing pecuniary support for a non-exempt entity, an impermissible private benefit. 54 Indeed, its principal activity is the 48 Columbia Park & Recreation Ass n, 88 T.C. at 25 26. 49 Id. 50 See Treas. Reg. 1.501(c)(3)-1(d)(1)(ii). 51 See Int l Postgraduate Med. Found., 56 T.C.M. (CCH) 1140 (1989). 52 See 1984 EO CPE Text, D. Litigation by IRC 501(c)(3) Organizations. 53 See id. 54 See Int l Postgraduate Med. Found., 56 T.C.M. (CCH) 1140 (1989); Priv. Ltr. Rul. 201148008.
-11- purchase of services that directly benefit its founder. 55 Accordingly, JMCFS fails to operate exclusively for exempt purposes. B. JMCFS Engaged in Excess Benefit Transactions and Violated the Prohibition Against Private Inurement. 1. The Inurement Prohibition and the Intermediate Sanctions Excise Tax Regime of Section 4958. As you are well aware, every organization exempt under section 501(c)(3) is subject to a requirement that none of its assets or income inure to insiders of the organization. 56 The IRS has stated that the inurement prohibition serves to prevent anyone in a position to do so from siphoning off any of a charity s income or assets for personal use. 57 Specifically, a charity is not to siphon its earnings to its founder, or the members of its board, or their families, or anyone else fairly to be described as an insider, that is, as the equivalent of an owner or manager. 58 Applying this principle, the Tax Court has held that an organization s fee-for-service contracts with companies owned by the two individuals that managed it were inconsistent with section 501(c)(3). 59 In another case, the Tax Court held that when for-profit companies exerted considerable control over an organization and its programs, the organization operated as the instrument to subsidize the for profit corporations, and therefore failed to qualify for tax-exempt status. 60 And, when an organization entered a transaction in order to benefit an insider even though the organization ultimately benefitted from the transaction the Tax Court held that the transaction nonetheless caused the organization to fail to be exempt. 61 Furthermore, the Tax Court held that an organization operated to promote a business owned by its two directors, who were free to set policy for their own benefit without objection from the board, failed to qualify as exempt. 62 More recently, the IRS has observed that extensive dealings of exempt organizations with back-office service providers and other for-profit businesses, often owned by the principals, are fact patterns indicative of inurement. 63 When an arrangement involving a public charity and an insider is particularly egregious, the IRS may revoke a charity s exemption, retroactive to the year of the bad acts. In less egregious cases, however, the IRS may look to the intermediate sanctions rules of section 4958 55 See Rev. Rul. 55-231, 1955-1 C.B. 72 (discussing the purchase of a founder s books, which the organization distributed for public use). Analogous to the facts in the revenue ruling, JMCFS s principal activity is the purchase of services for the benefit of its founder. 56 See Treas. Reg. 1.501(c)(3)-1(c)(2). 57 Gen. Couns. Mem. 39862 (December 2, 1991). 58 United Cancer Council, Inc. v. Comm r, 165 F.3d 1173, 1176 (7th Cir. 1999). 59 Church by Mail, Inc. v. Comm r, 48 T.C.M. (CCH) 471 (1984). 60 est of Hawaii v. Comm r, 71 T.C. 1067, 1082 (1979). 61 See Beeghly Fund v. Comm r, 35 T.C. 490, 523 (1960). 62 KJ s Fund Raisers Inc. v. Comm r, 74 T.C.M (CCH) 669 (1997). 63 C.C.A. 200431023 (July 13, 2004).
-12- of the Code, which impose tiered excise taxes on excess benefit transactions involving a charity and one or more of its officers, directors, or other disqualified persons. Under section 4958, disqualified persons who wrongly participate in excess benefit transactions are liable for an initial 25-percent tax on the amount of the excess benefit (e.g., the amount by which the economic benefit provided to the disqualified person exceeds the value of the consideration provided in exchange). If the disqualified persons fail to correct the excess benefit transaction by returning the excess to the charity, they owe an additional 200-percent tax. 64 Further, managers of the organization who knowingly approve such impermissible transactions are liable for a 10-percent tax. 65 Immediately upon the IRS s assessment of the 25- percent tax on a disqualified person for an uncorrected excess benefit transaction, the disqualified person is also liable for a 200-percent tax. 66 And, when multiple disqualified persons receive an excess benefit from a transaction, they are jointly and severally liable for the 25- percent and 200-percent tax, as applicable. 67 The term excess benefit includes a benefit obtained by a disqualified person by an unauthorized diversion of assets for example, by theft or fraud which is an automatic excess benefit transaction not treated as provided in consideration for the performance of services. 68 Thus, in these situations the full economic benefit is the excess benefit that is provided by the charity. The treatment of such benefits is a corollary to the rule that if payment is intended as compensation for services, a charity or the disqualified persons must clearly indicate this intent or the payment will be considered automatically an excess benefit transaction. 69 These Regulations reflect the IRS and Treasury Department s position that any economic benefit received by a disqualified person from the assets of the organization even if not authorized under the organization s regular procedures is provided by the organization with the meaning of section 4958, and thus unauthorized transfers are excess benefit transactions. 70 Accordingly, the diversion of funds by an insider, such as a founder, in unauthorized transactions with an organization produces excess benefit transactions. 71 For purposes of section 4958, a disqualified person is any person or entity in a position to exercise substantial influence over the charity at any time during the five-year period ending on the date of the transaction. The Regulations identify certain categories of persons who are 64 I.R.C. 4958(a)-(b). 65 I.R.C. 4958(a)(2). A manager who knowingly participates in such a transaction is liable for the 10-percent tax, unless his or her participation was not willful and due to reasonable cause. Section 4958(d)(2) limits the tax imposed for one transaction to $20,000. 66 I.R.C. 4958(b), (f)(5), (f)(6). 67 Treas. Reg. 53.4958-1(c)(1)-(2). 68 Treas. Reg. 53.4958-4(c)(1). 69 Id. 70 See Explanation of Provisions, T.D. 8920, 66 Fed. Reg. 2144, 2149. 71 See Treas. Reg. 1.501(c)(3)-1(f), Example 3 (a diversion of assets benefiting a disqualified person is an excess benefit transaction).
-13- automatically deemed to have substantial influence over a charity, and thus are per se disqualified persons, which include: anyone holding the ultimate responsibility for implementing the decisions of the governing body or for supervising the charity s management, administration, or operation (i.e., President, CEO, or COO); or anyone holding the ultimate responsibility for the finances of the organization (i.e., Treasurer or CFO); 72 and any entity in which 35 percent or more of the combined voting power (in a corporation), profits interest (in a partnership), or beneficial interest (in a trust) is owned by persons described in the first category ( 35-percent controlled entities ). 73 The Regulations under section 501(a) similarly define a private shareholder or individual as a person with a personal and private interest in the activities of the organization. 74 Chief executives, corporate officers, and other insiders in a position to control or influence an organization s activities are generally considered private shareholders or individuals for purposes of the inurement rule. 75 The section 4958 excise taxes are generally imposed as an alternative to revocation; however, where the circumstances warrant, intermediate sanctions and revocation may both be imposed simultaneously. 76 The Regulations clarify that, in determining whether to continue to recognize the tax-exempt status of an organization that engages in one or more excess benefit transactions, the Service will consider all relevant facts and circumstances, including, but not limited to, the following: the size and scope of the excess benefit transaction or transactions (collectively, if more than one) in relation to the size and scope of the organization's regular and ongoing activities that further exempt purposes; whether the organization has been involved in multiple excess benefit transactions with one or more persons; whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions; and 72 Treas. Reg. 53.4958-3(c)(2)-(3). 73 Treas. Reg. 53.4958-3(b)(2). 74 Treas. Reg. 1.501(a)-1(c). 75 See United Cancer Council, Inc., 165 F.3d at 1176. 76 See Treas. Reg. 1.501(c)(3)-1(f)(2); 53.4958-8(a).
-14- Whether the excess benefit transaction has been corrected, or the organization has made good faith efforts to seek correction from the disqualified person(s) who benefited from the excess benefit transaction. 77 An example in the Regulations helpfully illustrates the type of situation that warrants both the imposition of section 4958 excise taxes and revocation of the organization s exemption: (i) O conducts educational programs for the benefit of the general public. Since its formation, O has employed its founder, C, as its Chief Executive Officer. Beginning in Year 5 of O s operations and continuing to the present, C caused O to divert significant portions of O s funds to pay C s personal expenses. The diversions by C significantly reduced the funds available to conduct O s ongoing educational programs. The board of trustees never authorized C to cause O to pay C s personal expenses from O s funds. Certain members of the board were aware that O was paying C s personal expenses. However, the board did not terminate C s employment and did not take any action to seek repayment from C or to prevent C from continuing to divert O s funds to pay C s personal expenses. C claimed that O s payments of C s personal expenses represented loans from O to C. However, no contemporaneous loan documentation exists, and C never made any payments of principal or interest. (ii) The diversions of O s funds to pay C s personal expenses constitute excess benefit transactions between an applicable tax-exempt organization and a disqualified person under section 4958. Therefore, these transactions are subject to the applicable excise taxes provided in that section. In addition, these transactions violate the proscription against inurement under section 501(c)(3) and paragraph (c)(2) of this section. 78 2. JMCFS s Tax-Exempt Status Should be Revoked for Prohibited Private Inurement. The facts in this case strongly suggest that JMCFS, through its relationship with Mr. Bopp and the Bopp Law Firm, has violated the prohibition against private inurement. JMCFS has long been controlled by Mr. Bopp, who says that the organization s governing body delegated away all management authority to him. As JMCFS s founder and sole manager, Mr. Bopp is certainly an insider. 79 Moreover, Mr. Bopp is a private shareholder or individual for purposes of the inurement prohibition he unquestionably has a personal and private interest in the activities of the organization. 80 Mr. Bopp has caused JMCFS under his sole control pay over nearly 99.5 percent of JMCFS s revenues to his firm. This is textbook private inurement. 81 77 Treas. Reg. 1.501(c)(3)-1(f)(2)(ii). 78 Treas. Reg. 1.501(c)(3)-1(f), Example (3). 79 See United Cancer Council, Inc., 165 F.3d at 1176. 80 Treas. Reg. 1.501(a)-1(c). 81 See United Cancer Council, Inc., 165 F.3d at 1176.
-15- Mr. Bopp s absolute control over both JMCFS and the Bopp Law Firm has opened the door to this abuse. Under the authorities discussed above, such control is an important factor in determining whether an organization is entitled to retain its tax-exempt status 82 ; the facts in JMCFS s case practically compel revocation. Here, Mr. Bopp alone controls JMCFS and the Bopp Law Firm, and thus is free to set JMCFS s policies for his own benefit without any objection from the Board. Because JMCFS directs virtually all of its revenues to its founder s business, it also appears that the organization operates to promote the business of an insider. 83 Further, it appears that JMCFS operates as an instrument to subsidize the Bopp Law Firm s business by providing about half of its funding, inconsistent with the inurement prohibition. 84 As the IRS has noted, such extensive dealings with a for-profit business owned by an exempt organization s principals is a strong indicator of inurement. 85 The Service should investigate whether as the facts quite strongly indicate JMCFS has allowed its net earnings to inure to the benefit of Mr. Bopp and the Bopp Law Firm, in violation of the inurement prohibition. 3. Mr. Bopp and the Bopp Law Firm Have Engaged in Substantial Automatic Excess Benefit Transactions and are Liable for Section 4958 Excise Taxes. Mr. Bopp claims, in essence, that he has ultimate responsibility for the management of JMCFS and the execution of its self-proclaimed sole activity providing funding for legal services. As the sole individual responsible for the organization s management and day-to-day operations, he is a per se disqualified person with respect to JMCFS under section 4958. 86 Moreover, because the Bopp Law Firm was a sole proprietorship, wholly owned by Mr. Bopp, the firm is also a per se disqualified person with respect to JMCFS. 87 Accordingly, any transaction between JMCFS and Mr. Bopp, or JMCFS and the Bopp Law Firm, is subject to section 4958. Mr. Bopp claims that JMCFS s Board has delegated all management authority to him. He admits that the Board does not regularly meet and thus, presumably never reviewed or authorized any particular case, or guidelines as to which cases JMCFS should fund. Further, Mr. Bopp notes that he alone chooses cases the Bopp Law Firm will take on, and which JMCFS will evidently fund without question. Accordingly, Mr. Bopp operates JMCFS alone and unchecked by any JMCFS officer or trustee, and has caused JMCFS to repeatedly and continuously fund commercial legal services provided by the Bopp Law Firm to third parties. The facts strongly suggest that the JMCFS Board never authorized these services or their funding by JMCFS. 82 See Church by Mail, Inc., 48 T.C.M. (CCH) 471 (1984). 83 Compare KJ s Fund Raisers, Inc., 74 T.C.M. (CCH) 669 (1997). 84 Compare est of Hawaii, 71 T.C. 1067 (1979). 85 See C.C.A. 200431023 (July 13, 2004). 86 See Treas. Reg. 53.4958-3(c)(2)-(3). 87 See Treas. Reg. 53.4958-3(b)(2).
-16- When a disqualified person, such as a sole manager, like Mr. Bopp, causes a charity to provide him with an economic benefit, without Board authorization indicating that the payment is intended to be made as compensation for services, the entire benefit conferred is deemed to be an automatic excess benefit. 88 Here, it appears that the Board abdicated all of its authority, and has never considered or approved the funding of any of JMCFS s cases, let alone repeated payments to the Bopp Law Firm to litigate those cases. Rather, it appears the Board stood by while Mr. Bopp caused JMCFS to transfer its charitable assets to his private law firm. Even if some Board members knew that Mr. Bopp diverted JMCFS s charitable assets for his personal benefit, however, the Regulations make clear that such diversions are automatic excess benefit transactions. 89 The Regulations also make clear that such diversions of assets violate the inurement prohibition where as here (1) the size and scope of the excess benefit transactions dwarfs the size and scope of the organization s other charitable activities, (2) the organization has not implemented safeguards to prevent future diversions, (3) the transactions have not been corrected, and (4) the organization has failed to seek correction of such transactions. 90 Accordingly, it appears that JMCFS engaged in excess benefit transactions in 2006 and 2007, resulting in a liability for Bopp Law Firm for a 25-percent excise tax of $321,839 and immediately upon the IRS s assessment thereof an additional 200-percent tax of $2,574,710. 91 With respect to any of these excess benefit transactions, Mr. Bopp would certainly be considered to knowingly have approved such transactions under the standards described in the Regulations, 92 and would thus be personally liable for a 10-percent tax on the 2006 and 2007 excess benefit transactions, totaling $40,000. 93 C. JMCFS Engaged in Acts of Self-Dealing and Made Significant Taxable Expenditures. 1. Self-Dealing and Taxable Expenditures. As you know, section 4941(a)(1) imposes a tax on the disqualified person for any act of self-dealing with a private foundation. Disqualified persons include foundation managers, (e.g., officers, directors, trustees) and any corporation, partnership, trust, or unincorporated entity more than 35-percent owned by a foundation manager. 94 For each act of self-dealing, the disqualified person participating in the act is liable for a 10-percent tax on the amount involved, subject to an additional 200-percent tax for failure to correct the benefit by returning it to the 88 See Treas. Reg. 53.4958-4(c)(1). 89 See Treas. Reg. 1.501(c)(3)-1(f), Example 3 (a diversion of assets benefiting a disqualified person is an excess benefit transaction). 90 See Treas. Reg. 1.501(c)(3)-1(f)(2)(ii)-(iii). 91 See I.R.C. 4958(b), (f)(5), (f)(6). 92 See Treas. Reg. 53.4958-1(d)(4). 93 The amount of tax on foundation managers for any one excess benefit transaction is limited to $20,000. 94 I.R.C. 4946(a)(1)(B), (E)-(G); Treas. Reg. 53.4946-1(a)(1)(ii), (v)-(vii).
-17- foundation. 95 Further, a foundation manager who knowingly approved such a transaction is liable for a 5-percent tax, subject to an additional 50-percent tax when the disqualified person fails to correct such a transaction. 96 Under section 4941(d)(1)(D), the payment of compensation by a private foundation to a disqualified person is an act of self-dealing subject to penalty unless the payment is for the performance of personal services which are reasonable and necessary to carry out the exempt purpose of the private foundation and the compensation is not excessive. 97 Personal services include the professional services of a broker serving as an agent for a foundation, but not the services of a dealer buying from the foundation and reselling to third parties. 98 Thus, the Regulations distinguish between services performed for a foundation, which are personal services, and independent actions of a disqualified person, which are not. Indeed, an example in the Regulations provides that a law firm that is a disqualified person may perform legal services for a foundation and payments for such services will not give rise to acts of self-dealing if the services performed are reasonable and necessary for the carrying out of the foundation s exempt purposes and the amount paid for such services is not excessive. 99 The reasonable and necessary standard is a core federal tax-law concept originally developed by the IRS and the courts under section 162 for purposes of determining the deductibility of business expenses. 100 The IRS has indicated that the conceptual standards for judging whether an expense is reasonable and necessary for purposes of the self-dealing rules are essentially the same as for purposes of the business-expense deduction. 101 Whether the amount of a payment is reasonable and not excessive is a factual determination for which there is no bright-line test. 102 The Treasury Regulations state that reasonable compensation is only such amount as would be paid for like services by like 95 I.R.C. 4941(a)(1), (b)(1). 96 I.R.C. 4941(a)(2), (b)(2). Section 4941(c)(2) subjects both the first- and second-tier tax imposed on a foundation manager to $20,000 with respect to each act of self-dealing. 97 I.R.C. 4941(d)(2)(E); Treas. Reg. 53.4941(d)-3(c)(1). 98 Treas. Reg. 53.4941(d)-3(c)(1). 99 See Treas. Reg. 53.4941(d)-3(c)(2), Example (1). 100 See I.R.C. 162(a). Section 162(a) actually uses the phrase ordinary and necessary, but as a leading commentator has observed, in the context of payments between related parties (as with JMCFS s payments to the Bopp Law Firm), the requirement that expenses be reasonable in amount is inherent in the broader requirement that they be ordinary and necessary. Bittker & Lokken, Federal Taxation of Income, Estates, and Gifts 20.1.5. 101 See, e.g., Treas. Reg. 53.4941(c)-3(c)(1) (cross-referencing Treas. Reg. 1.162-7 for the determination of whether compensation is excessive under the same section of the private foundation Regulations applicable to reimbursement of expenses); Priv. Ltr. Rul. 9546020 (Aug. 18, 1995) (considering whether reimbursement for services is necessary within the meaning of section 4941(d)(2)(E) and stating that the term necessary has been construed in substantially the same manner as it is used with respect to deductible expenses under section 162(a) of the Code ). 102 Treas. Reg. 1.162-7(b)(3) (the allowance for compensation may not exceed what is reasonable under all the circumstances ); 53.4945-6(b)(2) (the determination of whether an administrative expense is unreasonable shall depend upon the facts and circumstances of the particular case ).
-18- enterprises under like circumstances. 103 As this formulation suggests, the reasonableness of a payment is generally judged based on whether the payment is consistent with the prevailing practice of comparable entities. 104 To qualify as necessary, services must be appropriate and helpful, in the sense of being plainly adapted to advancing JMCFS s charitable purposes. 105 A leading commentator has summarized the test as follows: a business expense is necessary if it is appropriate and helpful with respect to the taxpayer s trade or business. 106 Section 4945(a)(1) imposes a tax on taxable expenditures made by a private foundation. Under section 4945, the foundation is liable for an initial 20-percent tax on each taxable expenditure, plus a 100-percent tax that is due immediately upon assessment of the initial tax, if the taxable expenditure has not been corrected. 107 A foundation manager who knowingly approves of a taxable expenditure is liable for a 5-percent tax, and, immediately upon assessment thereof, he or she is also liable for 50-percent tax on the uncorrected taxable expenditure. 108 Taxable expenditures include any amount a foundation pays for non-charitable purposes, which in turn include unreasonable administrative expenses, unless the taxpayer can establish that the costs were incurred in the good faith belief that they were reasonable and... consistent with ordinary business care and prudence. 109 Accordingly, both section 4945 and section 4941 employ a reasonable and necessary standard to determine whether expenses are appropriate. 2. JMCFS, Mr. Bopp, and the Bopp Law Firm are Liable for Section 4941 and 4945 Excise Taxes. Mr. Bopp and the Bopp Law Firm are disqualified persons with respect to JMCFS, and any payment provided to either of them by JMCFS, after JMCFS became a private foundation in 2008, is subject to the self-dealing rules. 110 Accordingly, the question is whether the legal services the Bopp Law Firm to provided to various third-party clients are personal services 103 Treas. Reg. 1.162-7(b)(3). 104 See, e.g., Rutter v. Comm r, 853 F.2d 1267, 1271-75 (5th Cir. 1988); Bittker & Lokken, Federal Taxation of Income, Estates, and Gifts 22.2. 105 See, e.g., Comm r v. Tellier, 383 U.S. 687, 689 (1966) ( Our decisions have consistently construed the term necessary as imposing only the minimal requirement that the expense be appropriate and helpful for the development of the [taxpayer s] business. ) (quoting Welch v. Helvering, 290 U.S. 111, 113 (1933)) (alteration in original). 106 6 Mertens Law of Fed. Income Tax n 25:12; 25:13. 107 I.R.C. 4945(a)(1), (b)(1), (i). 108 I.R.C. 4945(a)(2), (b)(2), (i). Section 4945(c)(2) limits the first-tier tax on a foundation manager to $10,000 for any one taxable expenditure, and $20,000 for the second-tier tax. 109 I.R.C. 4945(d)(5); Treas. Reg. 53.4945-6(a), (b)(2). 110 See I.R.C. 4946(a)(1)(B), (G); Treas. Reg. 53.4946-1(a)(1)(vii). Mr. Bopp is a foundation manager and the Bopp Law Firm is a 35-percent controlled entity.
-19- which are reasonable and necessary to carrying out JMCFS s exempt purposes. The answer to this question must be no. Mr. Bopp, as principal of the Bopp Law Firm, decides cases the firm will take on. And, as sole manager of JMCFS, Mr. Bopp also directs the payment by JMCFS of the firm s fees for providing these legal services to third parties not to JMCFS itself. When the Bopp Law Firm under Mr. Bopp s control acts as a principal by choosing the cases to take on, and JMCFS then funds services the Bopp Law Firm provides to third parties, such an arrangement appears to fall outside of the personal services exception in the Regulations. 111 Indeed, the example in the Regulations discussing legal services provides that a law firm that is a disqualified person provides personal services when it performs various legal services for the foundation. 112 Here, by contrast, the legal services performed by the Bopp Law Firm services performed for third parties on the firm s own initiative are more analogous to services of a dealer acting as principal operating on its own behalf. Such services do not qualify as personal services 113 and, accordingly JMCFS s payments to the Bopp Law Firm for these services run afoul of sections 4941 and 4945, as acts of self-dealing and taxable expenditures. Because JMCFS s payments to the Bopp Law Firm, a disqualified person, appear to be acts of self-dealing, the Bopp Law Firm is subject to an initial tax of 10 percent of the amount of compensation upon the payment of compensation and a 10-percent tax each year thereafter until correction or assessment of the tax, for a total of $379,241 for the 2008-2011 payments to the Bopp Law Firm. Further, immediately upon the IRS s assessment of the 10-percent tax, the Bopp Law Firm is also subject to a 200-percent tax on each act of self-dealing, for a total of $1,667,940 for 2008-2011. Moreover, for knowingly approving acts of self-dealing, Mr. Bopp is subject to 5-percent tax on the amount of compensation for the initial payments of compensation and a 5-percent tax each year thereafter, for a total of $79,263 for the 2008-2011 payments to the Bopp Law Firm. 114 And, immediately upon the assessment of the 5-percent tax, Mr. Bopp is also liable for a 50-percent tax on each such act of self-dealing in 2008-2011, for a total of $80,000 in excise taxes. 115 The payments to the Bopp Law Firm also appear to be taxable expenditures, as discussed above, producing a liability for JMCFS under the 20-percent tax, totaling $166,794 for the 2008-2011 payments to the Bopp Law Firm. JMCFS is also liable for the 100-percent tax on these expenditures, immediately upon assessment of the 20-percent tax, totaling an additional $833,970. Further, for knowingly approving such taxable expenditures, Mr. Bopp is subject to a 111 See Treas. Reg. 53.4941(d)-3(c)(1) (broker services as an agent of a foundation are personal services, a dealer s purchases from a foundation and re-sales to third parties are not). 112 Treas. Reg. 53.4941(d)-3(c)(2), Example 2 (emphasis added). 113 See Treas. Reg. 53.4941(d)-3(c)(1). 114 The initial tax on a foundation manager is subject to a $20,000 limit for each act of self-dealing. I.R.C. 4941(c)(2). 115 The second-tier tax on a foundation manager is subject to a $20,000 limit for each act of self-dealing. Id.