On May 17, 2021, the Tax Court issued a Memorandum Opinion in the case of Fumo v. Commissioner (T.C. Memo. 2021-61). The primary issue presented in Fumo was whether the petitioner, who was a very bad man who defrauded community charities, was liable for excise taxes under IRC § 4958(a)(1) as a “disqualified person.”
The petitioner, as noted above, was (and likely still is) a real jerk. He was elected to the Pennsylvania State Senate in 1978, representing the first district in Philadelphia. Reelected many times, he served as a State senator until 2008. His tenure ended in 2009 when he was convicted on Federal corruption charges and sentenced to 55 months in prison.
One victim of his fraud was Citizens Alliance for Better Neighborhoods (Citizens Alliance), an IRC § 501(c)(3) charity. In May 2013, the IRS determined that petitioner was liable for excise taxes under IRC § 4958(a)(1), which imposes, in the case of any “excess benefit transaction” involving a charity, a tax equal to 25% of the excess benefit, and provides that this tax must be paid by any “disqualified person” with respect to such a transaction.
The petitioner, himself, was never employed as an officer, director, trustee, or employee of Citizens Alliance. However, he used his power and influence as the chairman of a senate appropriations committee to obtain funding for the organization from a variety of public and private sources. The indictment of the petitioner alleged, in part, that he had conspired to use Citizens Alliance’s funds to purchase vehicles, farm equipment, tools, and consumer goods for petitioner’s use and make other expenditures on his behalf (e.g., for foreign travel, the services of a private investigator, and cell phone service for his chauffeurs and daughter), to the tune of $1.2 million.
Defining “Disqualified Person”
A “disqualified person” is anyone who was, during a five-year look-back period, “in a position to exercise substantial influence over the affairs” of the charitable organization. IRC § 4958(f)(1)(A). The IRS argued that the petitioner was a “disqualified person” with respect to Citizens Alliance during 2002-2004. Although he was not an officer, director, or employee of the organization, the Tax Court agreed with the IRS that the petitioner was “in a position to exercise substantial influence over [its] affairs.” Id.
Persons holding specified powers and responsibilities with respect to a charity are automatically deemed to be disqualified because of their position and influence. Treas. Reg. § 53.4958-3(c). These officials include voting members of the governing body, presidents, chief executive officers (CEOs), chief operating officers, treasurers, and chief financial officers (CFOs). Treas. Reg. § 53.4958-3(c)(1)-(3).
Family members of disqualified persons, down to the level of great-grandchildren, are also “disqualified persons” with respect to the charity. Treas. Reg. § 53.4958-3(b)(1). Other than these enumerated persons, the question whether an individual is a disqualified person generally “depends upon all relevant facts and circumstances.” Treas. Reg. § 53.4958-3(e)(1).
The regulation specifies a nonexclusive list of factors “tending to show that a person has substantial influence over the affairs of an organization.” Treas. Reg. § 53.4958-3(e)(2). These include whether the person “founded the organization,” is “a substantial contributor to the organization,” has or shares authority to determine a substantial portion of its capital expenditures or operating budget, or “manages a discrete segment or activity of the organization that represents a substantial portion of its activities, assets, income, or expenses.” Treas. Reg. § 53.4958-3(e)(2)(i)-(v).
Just Shut Up, Vinny
The petitioner admitted at his criminal trial that he “did have a significant role” in Citizens Alliance. While he “did not make all the decisions,” he “did make a lot of decisions on important topics.” As he explained: “I don’t have a title or a job. Do I have influence? Yes.” Well, then, I think it’s time to pack it on up and go home.
But wait. There’s more.
During cross-examination the prosecutor read to petitioner the definition of “disqualified person” as it appeared in the 2002 IRS Instructions to Form 990 (Return of Organization Exempt from Income Tax): “A disqualified person regarding any transactions is any person who is in a position to exercise substantial influence over the affairs of the organization at any time during a five year period ending on the date of the transaction.” Petitioner replied, and I quote,
“I did have substantial influence over the organization. So according to that I am a disqualified person.”
The Law of the Case
IRC § 4958 (Taxes on Excess Benefit Transactions) defines an “excess benefit transaction” to mean “any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit.” IRC § 4958(c)(1)(A). An “applicable tax-exempt organization,” in turn, is defined to include an organization (such as Citizens Alliance) described in IRC § 501(c)(3) and exempt from tax under IRC § 501(a). See IRC § 4958(e)(1).
IRC § 4958(a)(1) imposes on each excess benefit transaction an excise tax “equal to 25 percent of the excess benefit” and provides that this tax “shall be paid by any disqualified person referred to in subsection (f)(1) with respect to such transaction.” If the excess benefit transaction is not corrected in timely fashion, the disqualified person is liable for a second-tier tax equal to 200% of the excess benefit. See IRC § 4958(b). Because the petitioner paid the restitution before the notice of deficiency was issued, this payment constituted a “timely correction” of the excess benefit transactions.
The petitioner testified that he founded Citizens Alliance and that he was a “substantial contributor” to the charity within the meaning of IRC § 507(d)(2)(A). A person may be a “substantial contributor” to an organization if his annual contributions constitute as little as 2% of its total contributions. Even though the petitioner never donated money directly to the charity, he was responsible for virtually all of its funding. The Tax Court held that this indirect funding qualified the petitioner as a “substantial contributor.”
The (Most Obvious) Final Nail in the Petitioner’s Coffin
Judge Lauber succinctly states that “the clearest indication that petitioner was in a position to exercise substantial influence over the affairs of the organization is that he in fact exercised such influence and did so repeatedly over a period of many years. He could not have [defrauded the charity of over $1.1 million] without possessing substantial influence over the organization and its personnel.”
The Petitioner’s Hyper-Technical (and Unpersuasive) Arguments
Although the petitioner stipulated that “he and his Senatorial staff formed” Citizens Alliance, he argued that he “did not actually form the entity” because his staff members were the “literal incorporators.” Alternatively, assuming arguendo that he “formed the organization,” he urged that he was not “[t]he person [who] founded the organization” within the meaning of Treas. Reg. § 53.4958-3(e)(2)(i). The petitioner’s other principal argument was that he “was neither an officer, employee, nor director” of Citizens Alliance and “held no formal position with [it].”
“These hypertechnical arguments ignore the substance of what occurred,” and the Tax Court rejected them summarily.
In his view a person can be a disqualified person only if he is “formally affiliated with a charitable organization.” The test under IRC § 4958, the petitioner contends, is not whether the individual “in fact manipulated substantial influence” over a charity (he did), but whether he held a position that would enable him to wield substantial influence (he did, by analogy).
Judge Lauber, in typical Laubering fashion, cites the dictionary definition of “position” and then quotes the 1999 Senate report to prove his point. The bottom line, however, is that the regulation makes clear that a person need not be an officer, director, or high-level employee of a charity to be a “disqualified person.”
Bad Mr. Fumo.
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