As Senate tax writers continue to look at ways to make the tax code simpler and fairer for individuals and businesses, Sen. Charles Grassley (R-IA) recently suggested Congress first calculate the cost of the nonprofit tax exemption, which is not currently considered an expenditure.
Grassley, who long used his position as chair and then ranking member of the Senate Finance Committee to scrutinize various charitable scandals and nonprofit governance issues, said at a Senate Finance hearing on tax reform this month that the nonprofit sector has experienced tremendous growth in recent years and warrants congressional review. According to the Bureau of National Affairs (BNA), Grassley said Congress should specifically consider whether fee-for-service organizations such as hospitals and universities should continue to enjoy the same tax exemption as other types of charities.
“Let me be clear … I am not referring to those charities that are on the ground feeding the hungry, sheltering the homeless,” Grassley said at the hearing. “I’m talking about those charities which there may be no discernible difference between commercial, for-profit entities.”
Grassley said that getting a handle on the value of tax exemption can help legislators more accurately assess the extent to which charitable organizations are supported by the tax code, and weigh that against the charitable services that are provided. Over the years, Grassley has targeted inquiries at nonprofit hospitals and universities because they charge fees for their services similar to for-profit entities and yet enjoy tax-favored status. Nonprofit hospitals have to abide by a community benefit standard defined by the Internal Revenue Service (IRS) but Grassley has questioned that criteria and whether nonprofit hospitals are providing enough uncompensated care and other benefits to justify their tax exemption.
Senate Finance Committee Chairman Max Baucus (D-MT) has vowed to hold one hearing a week this year on tax reform, which he said is needed both to reduce the estimated $300 billion tax gap – the difference between the amount of taxes owed and taxes paid – and to make U.S. businesses more competitive in the global economy.
Professor John Colombo of the University of Illinois College of Law is sounding the alarm about the latest threat to exempt organizations in the Nonprofit Law Prof Blog (www.lawprofessors.typepad.com/nonprofit/). Here’s part of what Professor Colombo had to say:
“A report in BNA Daily Tax report is sending shivers down the spines of tax-exempt organizations. Sen. Charles Grassley, who has often used his perch as either the ranking majority or minority member of the Senate Finance Committee to impose reforms on (or to attack unnecessarily, depending on your viewpoint) tax-exempt organizations, is at it again. The BNA report indicated that Grassley wants an estimate of the cost of tax exemption and wants to put the issue of tax exemption on the table in the ongoing budget/tax-reform talks.
“Grassley’s immediate target appears to be exempt organizations that engage in fee-for-service activities (he apparently cited the case of OCLC, an Ohio nonprofit provider of library software services, which has been the subject of a lawsuit filed by California-based for-profit SkyRiver Technology Solutions), but his request that Congress estimate the cost of tax-exemption and treat it as a ‘tax expenditure’ has far-reaching implications.
“Unlike the deduction for charitable donations under section 170, tax exemption has never been treated as a ‘tax-expenditure’ in the budget process. Though the whole concept of ‘tax-expenditure’ is still somewhat controversial, it has been a part of the budget and tax policy landscape since Stanley Surrey pushed the concept during his tenure as Assistant Secretary for Tax Policy at the Treasury Department in the late 1960’s and oversaw the first tax expenditure budget in the US in 1968. In general, the concept of a ‘tax-expenditure’ is based on the notion that certain tax benefits are the equivalent of government grants -- that they are in essence ‘expenditures’ by the government cloaked in the form of tax benefits. Thus the tax expenditure budget includes items such as the charitable deduction, the home mortgage interest deduction, and similar items that are widely accepted today as ‘government subsidies’ and deviations from the normative base for the income tax.
“But exempt status under 501(c)(3) has never been considered a tax expenditure, in part because characterizing exemption as a ‘subsidy’ or ‘deviation’ from the normative tax base has always been a controversial issue among tax policy experts. It is not clear whether exemption is a ‘deviation’ from the normative tax base or simply a part of defining that base. For example, would one consider our decision not to impose tax on the partnership as a separate taxable entity a ‘deviation’ from the normative tax base (since we do impose an entity-level tax on most corporations)? Or would we just say that considering partnerships pass-through entities is simply a part of the overall definition of the normative base? And isn’t it a little odd to call tax exemption a ‘subsidy’ for organizations that spend all their income on a charitable class like the poor?
“While I [Professor Colombo] am certainly sympathetic to Grassley’s comment that some ‘charities’ today look an awful lot like for-profit businesses, Grassley’s request to estimate the cost of exemption seems to move in the direction of including exemption as a tax expenditure, and is a really, really big deal from the tax theory/policy side.”
Sources: ASAE’s Inroads, March 12, 2011 and Paul Streckfus EO Tax Journal March 18, 2011