Nonprofit Organizations Update Spring 2007

ARNSTEIN & LEHR LLP Attorneys at Law

Nonprofit Organizations Update About our Nonprofit Practice Group Arnstein & Lehr LLP provides legal services to trade associations, professional societies, public charities, private foundations, fraternal organizations, group insurance trusts, political action committees, schools, hospitals, medical staffs, "captive" insurance companies, and other organizations exempt from federal income tax under Section 501(c) of the Internal Revenue Code. The Firm's attorneys help such clients deal with a wide array of issues, including: •

Corporate and trust formation and maintenance

•

Development of bylaws

•

Obtaining and maintaining federal and state tax exemptions

•

Avoiding and minimizing unrelated business income taxes

•

Registrations and annual filings with attorneys general and other government officials

•

Proper conduct of organization elections

•

Avoiding antitrust problems

•

Fund raising campaigns, including use of professional fundraisers

•

Self-dealing, inurement and intermediate sanctions

•

Relations with subsidiary groups, including group tax exemptions

•

Protection of intellectual property

•

Charitable gaming

•

Limitations on political and legislative activity

•

Professional ethics matters

•

Public and member disclosure requirements

•

Deductions for donors

•

Nonprofit mailing permits

•

Partnerships and joint ventures with forprofits

•

Employment issues

•

Insurance issues

IRS Proposes Forms for Reporting of Nonprofit's Insurance Transactions The Internal Revenue Service has issued tax forms that would be used to collect information from charities and certain other exempt organizations with respect to certain structured insurance contracts. The reports from the nonprofits are to be used by the IRS in conducting a Congressionally mandated study as specified in the Pension Protection Act of 2006. Section 1211 of the Act imposes a new requirement on organizations to which contributions are deductible for federal, estate or gift tax purposes, and which acquire an applicable insurance contract as part of a structured transaction involving a pool of such contracts. An applicable insurance contract is any life insurance, annuity or endowment contract in which both the exempt organization and someone else have directly or indirectly held an interest, whether or not at the same time. But an exception applies in the case of exempt organizations whose sole interest in an insurance contract is as a named beneficiary. The study is to be conducted with respect to insurance contracts acquired in a reportable acquisition after August 17, 2006, but on or before August 17, 2008. The IRS has now proposed new Form 8921 and Form 8922 to be used by exempt organizations reporting information to be used in the study. The penalty to be imposed on exempt organizations failing to report information concerning transactions as required by the new law is $50 for each return with respect to which a failure to file occurs, with higher penalties applying in the case of an intentional disregard of the filing requirements. Depending upon the nature of the transaction, more than one of the proposed new forms may have to be filed with respect to a single insurance contract acquisition. The Act requires the IRS to conduct the study on the use of insurance contracts by exempt organizations for the purpose of sharing with investors the benefits of the exempt organization's insurable interest in individuals insured under such contracts. It also requires the IRS to address in the study whether such activities are consistent with the tax-exempt status of such organizations. FTC Orders Company Not to Mislead Standard -Setting Organizations To update an article previously reported in this newsletter, the Federal Trade Commission has ordered Rambus Inc., which develops and licenses computer technologies, to stop making misleading statements and omissions of information in presentations to standard-setting organizations and to comply with certain licensing obligations under a previous FTC order. Last summer, the Continued on Page 2 Nonprofit Organizations Update |Spring 2007

FTC concluded that Rambus had engaged in monopolistic practices violating the federal FTC Act by manipulating the standard-setting processes of a nonprofit organization in order to ensure that its design for certain chips was adopted by the industry as a standard. In doing so, Rambus had failed to fully inform the organization or other participants in the standardsetting process concerning its own patents for chips, thereby violating the organization's rules. In the latest order, the FTC prohibits Rambus from misrepresenting its patents or patent applications to standard-setting organizations or their members, and it requires Rambus to abide by the requirements or policies of those organizations relating to disclosure of patents or patent applications. In addition, the new order requires Rambus to employ a Commission-approved officer to ensure that Rambus fully discloses its patent rights to standard-setters and to verify the accuracy of reports Rambus is required to make to the FTC, and the FTC has barred Rambus from trying to collect more than a maximum amount of royalty from companies using its technology. Tax Deed for Church Parking Lot Could Be Challenged in Suit by Church, Even If Church Corporation Was Dissolved When Church's Petition to Vacate Was Filed The Illinois Appellate Court, Sixth Division, has reversed a lower court's order dismissing a church's petition to vacate the granting of a tax deed for a parking lot used by the church, as the Appellate Court found that the church had standing to challenge the legality of the tax deed, even if the church corporation was dissolved when the petition to vacate was filed. The ruling came in an action filed by New Holy Temple Missionary Baptist Church, seeking to vacate a tax deed issued in favor of Discount Inn, Inc., which had purchased the parking lot at a foreclosure tax sale for delinquent real estate taxes. In this case, the parking lot had been listed as tax-exempt on the assessor's rolls from 1986-1988, but was assessed and taxed from 1999-2003. The church successfully filed with the county board of review to have the parking lot again declared exempt for certain tax years. But, in the meantime, the parking lot was sold in the forfeiture sale.

Nonprofit Organizations Update | Spring 2007 | Page 2

Addressing the church's petition to vacate the granting of a tax deed to Discount Inn, the lower court ruled that the church had no standing to file a petition, because when the petition was filed, the church corporation had been dissolved, leading the lower court to believe the church had no legal ability to bring an action in court. But the Appellate Court rejected that reasoning for the lower court dismissal of the church's petition to vacate, noting that, by the time the lower court ruled, the church corporation had been reinstated to good standing retroactively, as if it had never been dissolved in the first place, and the Appellate Court also found that, even as a dissolved corporation, the church was operating as an unincorporated entity that had a right to sue on its own behalf, including the right to bring the petition to vacate. To file the petition, the Appellate Court noted that the church needed only a real interest in the action and the capacity to sue, and the church certainly had a general interest in the outcome of its petition to vacate the tax deed judgment, because it was using the parking lot at the time it filed its petition to vacate. Discount Inn also argued that the church was not diligent in bringing its petition to vacate because it was served notice of the tax deed proceeding and failed to redeem its property at the tax sale or appear in court to attempt to prevent issuance of the tax deed. However, the Appellate Court was unimpressed by that argument, finding that the church had exercised diligence in attempting to correct assessment records to reflect the parking lot's exemption, and was in the process of cleaning up the exempt status of the property when the tax deed was issued, the property eventually being declared exempt. Finally, Discount Inn argued that the church did not have a meritorious defense against issuance of the tax deed because, at the time of the tax sale, the parking lot had not been restored to exempt status. But the Appellate Court found that the church had presented sufficient evidence to show that it could defeat Discount Inn's claim to the property, because the parking lot had been used solely and continuously for church purposes and without a view for profit, and the church had filed for a restored exempt status for the tax years in question. Discount Inn's argument that the property should not have been declared exempt because it was not fenced, had no signs, and was not improved was rejected by the

Appellate Court, which found that such facts had little significance because the property was a parking lot. Private School Denied Tax Exemption for Failure to Show Operation on Nondiscriminatory Basis In a private letter ruling, the Internal Revenue Service has refused to grant recognition of a federal income tax exemption under Internal Revenue Code Section 501(c)(3) for a private school that had failed to demonstrate it was operating on a racially nondiscriminatory basis. The school had been formed or substantially expanded at a time of public school de-segregation in its locality, and it had operated for over 30 years without adopting policies guaranteeing that it would operate on a racially nondiscriminatory basis, until 2004 when it had revised its bylaws to include a statement of the school's facially nondiscriminatory policy.

lengthy period of time without enrolling any AfricanAmerican students or employing any African-American faculty or administrators, and without adopting or publishing a facially nondiscriminatory policy, the IRS found that an inference was raised by such facts that the school was presently discriminating against blacks. Furthermore, the school had failed to demonstrate that it had taken sufficient steps to overcome that inference. Because racially discriminatory private schools had been held to violate a fundamental public policy and could not be viewed as conferring a public benefit within the meaning of Section 501(c)(3), the IRS concluded that the school in this case did not qualify for a Section 501(c)(3) exemption. Michigan Real Estate Brokers Agree to Settle FTC Antitrust Suit

In its ruling, the IRS noted the adoption of the new policy, which the school had publicized through various newspapers over a period of years, and through its student handbook and brochure, as well as a brochure provided to high school counselors. In addition, the IRS commended the school on undertaking certain positive steps in reaching out to the African-American community, such as receptions that were open to all community members.

Updating an article previously published in this newsletter, a group of real estate brokers in southeastern Michigan has agreed to enter into a consent order with the Federal Trade Commission that would settle FTC charges of antitrust violations by the group in adopting and enforcing certain rules governing property listings in the local multiple listing service. The FTC had filed a complaint last fall in which the group was charged with barring the listing of properties subject to a listing agreement other than the traditional "exclusive right-to-sell" a listing agreement.

On the other hand, the IRS noted that, in its over 30 years of existence, the school had not enrolled even one African-American student, and had never employed an African-American faculty member or administrator. In addition, the IRS said that the school had not made intensive and comprehensive efforts at outreach directed specifically to the African-American community that could possibly result in the enrollment of black students and employment of black teachers and administrators, such as active and vigorous recruitment of African-American students and teachers, providing financial assistance for African-American students, or engaging in on-going communication with members of the African-American community.

The traditional agreement gives a broker the right to a commission if and when listed property is sold, regardless of whether the broker or the homeowner caused the sale. But, many home sellers are now preferring to use an alternative form of listing agreement that denies a commission, or provides for a reduced commission, if the listed property is sold by the homeowner without assistance from the broker other than the listing of the property with the multiple listing service, in exchange for which the listing broker may charge an up-front fee. It was this kind of agreement the FTC charged the brokers' group with excluding from their multiple listing service.

Considering that the school was formed at a time of desegregation of a public school district in which it was located, and considering that the school operated for a

Under the terms of the consent order, the real estate brokers would be forbidden to adopt or enforce any rules or policies denying or limiting the ability of the multiple listing service members to enter into alternative listing

Nonprofit Organizations Update | Spring 2007 | Page 3

arrangements, as long as they are lawful. The order also requires the group to give notice of this prohibition to its members. Homeowners' Association's Section 501(c)(4) Tax Exemption Revoked Because Property Not Accessible to General Public In a private letter ruling, the Internal Revenue Service has held that the tax exemption of a homeowner's association under Section 501(c)(4) of the Internal Revenue Code should be revoked because property owned by the organization was not accessible to the general public due to the installation of a security gate. The IRS noted that, since the time the organization received its exemption under Section 501(c)(4), the tax law had been "clarified" to indicate that an exemption under Section 501 is available to homeowners' associations only if they meet certain requirements, namely, that the "community" served by the organization must bear a reasonably recognizable relationship to an area ordinarily identified as a governmental subdivision or unit, that the organization may not conduct activities directed to the exterior maintenance of any private residences, and that property maintained by the organization must be open for the use and enjoyment of the general public. The last of these three requirements was not met by the homeowners' association in this case, requiring revocation of the exemption. But, the IRS noted that the organization might elect to modify its tax exemption so as to qualify under Code Section 528, which provides special tax relief to qualified homeowners' associations by excluding certain parts of their income from taxation. Non-Use for Personal Gain by Physicians Does Not Necessarily Qualify Nonprofit's Medical Offices for Property Tax Exemption The Indiana Tax Court has held that a nonprofit organization could not claim a charitable purposes property tax exemption for its primary care associate medical offices, since the organization had not demonstrated that the offices were substantially related to or supportive of the organization's hospital in-patient facilities. The nonprofit had contended that it was entitled to the exemption because (1) the offices were used for traditional medical services, (2) the medical

services provided at the offices were offered as part of the non-profit's overall continuum of care, and (3) the physicians using the medical offices did not use them for personal gain. But the court found that the physicians' use of the offices for other than personal gain was irrelevant to the relationship or degree of support that existed between the offices and the taxpayer's in-patient facilities, and it could not be presumed that a substantial relationship or supportive network existed between the offices and the in-patient facilities simply because the offices and those facilities were used in the same type of activity. Exchange of Burial Plots Will Not Have Adverse Tax Consequences for Fund Preserving and Maintaining Cemetery The Internal Revenue Service, in a private letter ruling, has found that a proposed transaction under which the owner of certain burial plots in a cemetery would exchange them for plots located elsewhere in the cemetery would not jeopardize the exempt status of a fund for cemetery preservation and maintenance under Section 501(c)(3) of the Internal Revenue Code by violating that section's prohibition on private benefit. The IRS noted that the exchange was part of a planned transaction in which the owner of the plots would contribute publicly traded securities to the fund in order to purchase cemetery land for creation of a public park within the cemetery. Furthermore, the IRS noted that the transaction had been approved by the state's attorney general and a state court, and that the owner of the lot had agreed to take no charitable deduction in connection with the transfer, pay all legal and other fees associated with the exchange of plots, and compensate the fund for any excess in the value of plots received over the owner's original plots. Insufficient Number of Charitable Beneficiaries Costs Retirement Community Property Tax Exemption The New York Supreme Court, Westchester County, has refused to restore a charitable use property tax exemption previously lost by a continuing care retirement community, because the court found that there was a insufficient number of residents actually needing

Nonprofit Organizations Update | Spring 2007 | Page 4

charitable benefits, and the community was no longer honoring its original benefactor's intentions that the community care for indigent senior women. On the other hand, the court did allow a partial tax exemption for the property based on its use as a hospital, which was calculated on the square footage of the facility actually put to that use. Organization Denied Section 501(c)(3) Exemption After Lending Money at Below-Market Interest Rates to Founders The Internal Revenue Service, in a private letter ruling, has denied a tax exemption under Section 501(c)(3) of the Internal Revenue Code to an organization whose founders transferred a limited partnership interest to it and received back loans at below-market interest rates. The IRS noted that the loan agreements allowed the founders to regain the bulk of the funds they originally transferred to the organization, the loans constituted 97% of the organization's assets, the loans were secured by collateral with no monetary value, no principal and negligible interest had been paid on the loans, and the organization had no recourse if the loans were not repaid. Outside Employment by Rabbi Prevents Property Tax Exemption for Congregation's Property Used as Residence The New York Supreme Court, Rockland County, has held that a Sephardic Jewish Congregation was not entitled to a state property tax exemption for the residence of a rabbi and his family. The congregation failed to show that the property was used primarily for congregational purposes, rather than as a residence, which made the property ineligible for a religious or charitable purpose tax exemption. Furthermore, the court held that the property was not entitled to a special rectory or parsonage exemption because the rabbi was not considered an "officiating clergyman" due to his substantial outside employment as a special education teacher on a full-time basis, which would make it unlikely that he would be able to fulfill the duties of someone in an "officiating clergyman" position.

Nonprofit Organizations Update | Spring 2007 | Page 5

Planned Use Qualifies Nonprofit's Property for Tax Exemption, Even if Exempt Purpose Never Accomplished The Ohio Board of Tax Appeals has recognized a property tax exemption for land that was acquired by a nonprofit corporation for the purpose of starting a religiously affiliated school, even though, in this case, funding for the project subsided and the school was not constructed. The Board said the property met the requirements of Ohio's prospective use test, in that, as of the tax lien date, the nonprofit was still actively proceeding toward construction and raising money for the project. Further, even after funding subsided, the nonprofit merely attempted to scale down the project, instead of abandoning it, and the Board held that the property was entitled to exemption until the nonprofit either abandoned its exempt purpose or ceased efforts to realize that purpose, even if it was never accomplished. Religious Organization's Right to Property Tax Exemption Should Not Have Been Determined Based on Illegality of Use Under Zoning Ordinance The Pennsylvania Commonwealth Court has held that a lower court improperly refused a state property tax exemption to a religious organization because its use of the property was not permitted under local zoning laws. The court noted that a local zoning ordinance did not allow First Korean Church of New York, Inc., to use its property for a church or seminary, but held that the illegality of use under local zoning ordinances was irrelevant to the determination of whether property was entitled to tax exemption. Since the lower court had made no finding as to whether the property would be considered exempt if local zoning ordinances did not prohibit the church's use of the property, the Pennsylvania Commonwealth Court remanded the case for further consideration of the church's claims that it was entitled to place of worship, charitable use, and seminary exemptions.

Nursing and Assisted Living Facilities Granted Charitable Use Property Tax Exemption The New Hampshire Supreme Court has held that nursing and assisted living facilities operated by a nonprofit were entitled to a charitable use exemption from state property taxes, since both facilities provided services of public good, namely, nursing and assisted living facilities for the aged, and since the facilities provided a level of care or services beyond that provided by mere residential facilities. Also important to the court's decision were its findings that fees charged at the facilities were reasonably necessary for achievement of the nonprofit's charitable purposes and the nonprofit was not operated in such a way to provide financial benefits to insiders, such as officers and directors, or members.

County follows a highly publicized denial of exemption to Provena Covenant Medical Center in Urbana and several other exemption denials involving nonprofit healthcare organizations. The summary decision by the Department was apparently based on the relationship between the hospital and physician groups engaged in for-profit enterprises, which led the Department to conclude that the hospital was not exclusively used for charitable purposes. Also factoring into the Department's decision was the amount of free care provided at the hospital, the hospital pricing for uninsured patients, and the hospital's collection activity.

Another Illinois Nonprofit Hospital Denied Property Tax Exemption The Illinois Department of Revenue has denied another property tax exemption sought by a nonprofit hospital. The denial of exemption for a group of properties used by Carle Foundation Hospital and other entities as part of the Foundation's healthcare delivery system in Champaign

If you would like further information about any of the topics mentioned in this publication, please contact James F. Gossett at [email protected] or 312.876.7833.

ARNSTEIN & LEHR LLP Chicago, Illinois 120 South Riverside Plaza, Suite 1200 Chicago, IL 60606 phone 312.876.7100 fax 312.876.0288

Hoffman Estates, Illinois 2800 West Higgins Road, Suite 425 Hoffman Estates, IL 60169 phone 847.843.2900 fax 847.843.3355

Fort Lauderdale, Florida 200 East Las Olas Boulevard, Suite 1700 Fort Lauderdale, Florida 33301 phone 954.713.7600 fax 954.713.7700

Miami, Florida 200 South Biscayne Boulevard, Suite 3600 Miami, FL 33131 phone 305.374.3330 fax 305.374.4744

West Palm Beach, Florida 515 North Flagler Drive, Suite 600 West Palm Beach, FL 33401 phone 561.833.9800 fax 561.655.5551

Boca Raton, Florida 2424 North Federal Highway, Suite 462 Boca Raton, FL 33431 phone 561.322.6900 fax 561.322.6940

Tampa, Florida Two Harbour Place 302 Knights Run Avenue, Suite 1100 Tampa, Florida 33602 phone 813.254.1400 fax 813.254.5324 Milwaukee, Wisconsin 7161 North Port Washington Road Milwaukee, WI 53217 phone 414.351.2440 fax 414.352.6901

www.arnstein.com © 2007 ARNSTEIN & LEHR LLP

Nonprofit Organizations Update | Spring 2007 | Page 6