And then they came for the veterans. On Day 120 of the perennial never ending IRS scandal (September 6, 2013) (As I write this on New Years Eve, we are on Day 601 according to the TaxProf) stories were featured on the IRS investigating veterans groups to determine if the people involved in them were, you know, veterans. On WND, we could read
The Internal Revenue Service, which has been caught harassing conservative organizations with demands for personal ideological details, such as the content of prayers, now is doing the same to veterans’ groups.
Probably the most moving section of [Irony Alert] Craig Berman's cinematic masterpiece Unfair: Exposing the IRS w as the interview with Russell Montgomery of American Legion Post 447 in Round Rock, Texas.
Dogs That Don't Bark
One of the rather curious things about the IRS scandal narrative is that the investigation of groups causes quite a bit of angst, but when the IRS actually takes action either denying or revoking exempt status, there is hardly a ripple on the tax blogosphere. There have been a few denials of 501(c)(4) status, that have gone largely unremarked and now we have two revocations of 501(c)(19) status - Veterans Organizations. The rulings Private Letter Ruling 201451042 and Private Letter Ruling 201451041 give a history of the evolution of the tax treatment of Veterans' Organizations and highlight the abuse that the IRS was concerned about in the audits that created the flurry of stories last year and perhaps a chance to reflect on how the road to hellish tax complexity is paved with good intentions .
Why Is There A Special Section For Veterans Organizations?
That may seem like an irreverent question, but it is really not. The IRS Manual notes
Veterans' organizations may also qualify for exemption under IRC 501(c)(3) as charitable organizations, 501(c)(4) as social welfare organizations, 501(c)(7) as social clubs, or 501(c)(8) or 501(c)(10) as fraternal organizations, if they meet the requirements for exemption under those sections.
So why did we need a special section? One of the rulings explains.
In 1972, Congress enacted I.R.C. § 501(c)(19) and I.R.C. § 512(a)(4) to address the concern that a veterans organization exempt under I.R.C. § 501(c)(4) or (7) may be subject to unrelated business income tax on the provision of insurance to its members. S. Rep. No. 1082, 92d Cong., 2d Sess. 2 (1972) reprinted in 1972-2 C.B. 713.' Section 512(a)(4) excludes amounts attributable to, or set aside by a §501(c)(19) veterans organization for the payment of life, sick, accident, or health insurance benefits for their members and their members' dependents.
The way the world looks today, as time goes on, there will be fewer and fewer veterans. According to this table over half of today's over 22 million veterans are Vietnam Era or earlier. The VA projects that the number of veterans will decline by about a third between now and 2043. Organizations exempt under other sections that don't want to dwindle can probably adapt to this by expanding membership to non-veterans sympathetic to the goals of that particular organization. It is worth noting that the Grand Army of The Republic, an organization of Union veterans that peaked at 400,000 and was quite influential, decided not to take that course and dissolved in 1956 when Albert Woolson, a drummer boy in the First Minnesota Heavy Artillery Regiment, died at the age of 106.
501(c)(19) organizations have a pretty stiff statutory requirement to have a high veteran percentage. 75% of the members must be actual veterans and 90% of the rest have to be cadets or spouses, widows, ancestors or lineal descendants of past or present members of the Armed Forces. The latter is rather an expansive group when you consider the lineal descendants, but the 75% will be a tougher and tougher standard to meet.
And of course, if there is a statutory requirement, at some point, you expect that there should be some effort to determine that the standard is actually being met. That was the cause of the controversy noted back on Day 120 of the scandal. Posts were up in arms about IRS auditors who were challenging them to prove that their members were veterans. There were concerns about privacy since the forms that establish veteran status have other information on them.
I think it is rather unfortunate that we have come to rely on the IRS to bless organizations for purposes that have nothing to do with federal income tax. Organizations get an undeserved credibility boost from 501(c) status and sometimes state regulatory actions hinge on federal tax exempt status. In the states where the two revoked organizations, which I will collectively call Have Another Drink (HAD),that includes the right to serve liquor to the public without having a substantial restaurant. The facts are similar in both cases. This narrative is drawn From PLR 201451042.
There are eight purposes that a 501(c)(19) organization can serve. It does not have to do all of them, but some of them need to predominate. The are providing for community social welfare, assisting needy and disabled veterans, providing entertainment, care and assistance to hospitalized service members, ceremonies, programs of a religious, charitable, scientific, literary or educational purpose, patriotic activities, providing insurance benefits for members and their dependents and providing social and recreational activities for members.
What HAD mostly did was run a bar for the general public and members. Mostly the general public.
The President had purchased the bar from someone else sometime after 2000. HAD paid mortgage interest and auto expenses on behalf of the President. As far as HAD being a membership organization:
[HAD] did not charge membership fee to any members. The general membership has little to do with the operations and financial matters. The general membership is not required to attend any membership meetings. The officers were named by rather than voted for. [Somebody or other] has been the president of [HAD] since he bought the business from prior owner. For the years under examination, [HAD] provided ten copies of DD- 214 and other alternative military forms. The [bar] is open to general public. The membership is not required to purchase food and drink from the for consumption on- site or off site. [HAD] does not have adequate records to represent membership sales. It is certain that over 80-90% of sales were from nonmembers.
Section 501(c)(19) of the Code does not define the meaning of member as being an individual who has the right to control the day-to-day operations of the organization, such as having the right to vote. Membership in a section 501(c)(19) organization is based upon analyzing the organization's organizing document, which defines the rights and obligations of membership.
In determining whether an individual is a member of a veterans' organization for purposes of section 501(c)(19) of the Code, such an individual must be involved in the organization in such a manner as to further the organization's exempt purposes, rather than joining to receive a personal benefit, such as the right to receive free food while being a patron at the bar.
So it seems that in order to be able to legally have a bar, somebody got some veterans to sign a membership book and provide a copy of their discharge papers. Apparently, they get a free hamburger with their beer or something like that.
501(c) Has Way Too Many Flavors
There are 29 different types of 501(c) organizations, each with their own peculiar quirks. At the heart of the main IRS scandal and the veteran mini-scandal are people exploiting the quirks for reasons that have nothing to do with the federal income tax. Organizations were seeking 501(c)(4) status so that they could engage in political activity without disclosing donors - the "dark money" groups. Of course the organizations have to devote 51%of their efforts to "social welfare". My impression is that the "social welfare" could be educating people about how the Founding Fathers would have hated or perhaps loved Obamacare making it relatively easy to segue seamlessly to the 49% political piece.
Here we have somebody setting up a faux veterans group, because they live in a state that has issues with bars being open to the general public. In both cases we end up with scarce IRS enforcement personnel making intrusive inquiries into groups that are not even trying to avoid federal taxes. They covet exempt status for other reasons and we are charging the approximately 20,000 people , mostly accountants by training, who should be working on closing a tax gap estimated as being in the $400 billion range with trying to determine how political groups are or whether the purported veterans group is actually run by veterans.
How To Fix It
In my mind, the solution is to have only two types of not-for-profits. One would be the traditional 501(c)(3) groups - religious, charitable, scientific, etc- that can receive tax deductible contributions. The balance would be the rest - social clubs, trade organizations (like the NFL), fraternal organization - basically any group that is not organized to make a profit and that does not have inurement. Many of those organization operate at break-even and would not be harmed by requiring them to file Form 1120, the corporate income tax form. Give them a deal similar to what cooperatives have. If the organization has a profit let it either borrow legitimate expenses from the first six months of the following year or issue a rebate to its members. If the American Institute of Certified Public Accountants or the American Bar Association or the United States Chess Federation want to accumulate reserves beyond six months worth of expenses, let them pay taxes. In the case of the AICPA, I would hope they would go with the rebate, but that's just me.
Not Going To Happen
If you want to know why a proposal like the one above will never come to pass, take a look at the Comments to the Tax Reform Working Group of the House Ways and Means Committee. A large number, if not the majority, of the letters take the form of approving of simplification in general while pointing out how that particular group's favorite special provision needs to stay and probably be beefed up a bit, what with all the money that will come in from getting rid of all those other special provisions. If you scroll down you will find the Knights of Columbus explaining why 501(c)(8), which I bet many of you have never heard of, is so important.
The role we play in the health of our communities is a critical one, and we ask that our lawmakers commit themselves to protecting the 501(c)(8) designation during the ongoing discussions over tax reform.
At any rate, now we know that perhaps the IRS was not actually targeting veterans organizations. Rather, they were trying to discern which of the purported veterans organizations were actual veterans organizations. Of course, there is nothing scandalous about that, so why bother mentioning it. I guess that is what the rest of the tax blogosphere is thinking.
Some Unrelated Notes
Happy New Year, as this turns out to be my first post of 2015. December 2014 was my highest traffic month ever, so I look forward to 2015 being perhaps the breakthrough year in which I become the first tax blogger to give up his day job.
Writing about the veterans groups, reminded me of something else that I see rarely commented on. That is the effect that having many veterans in a group has on the non-veterans. Samuel Johnson remarked that "Every man thinks meanly of himself for not having been a soldier or been to sea ". I expanded on that idea a bit with something of a memoir of my first sort of accounting job which had me hanging around with a veteran heavy group, which included one who was rather inspiring. It is a pretty meandering story, but if you want to sample my writing when I am entirely off the tax reservation, you might want to check it out. The title is "How I Accidentally Impersonated A Veteran".