Big Test for the IRS

A Mississippi health-care chain contests the tax agency’s multimillion-dollar levy — the first big penalty under a new law

The first test is under way for a 1996 law designed to crack down on people who receive improper personal benefits at the expense of non-profit organizations.

A Mississippi family and the group of health organizations it oversees are battling the Internal Revenue Service over as much as $240-million in penalties and other fees that they claim the revenue service is imposing on them under the so-called intermediate-sanctions law.

In a series of lawsuits filed in U.S. Tax Court, three health-care companies and their five officers contest the fines. At issue is whether the family undervalued the health organizations when they converted them from non-profit to for-profit status in 1995.

The Caracci family, of Jackson, Miss., created three companies — the Sta-Home Health Agencies of Carthage, Greenwood, and Jackson — to take over the assets of the non-profit groups they had started.

In each case, according to court documents, the appraiser hired by the family decided that the assets of the non-profit groups had a negative value because the organizations had been losing money for years. But the I.R.S. argued, based on its own appraisals, that each non-profit group was actually worth $5-million or more.

Jim Mallette, a Mississippi lawyer who represents the family and the companies, calls the I.R.S.’s position “absurd.”

He adds: “If the family could have sold the non-profit groups for even 30 per cent of what the government has assessed, they would have done it. This is not a business that makes money.”

Mr. Mallette says the Sta-Home Health Agencies, like most other home health-care groups in the state, changed their tax status after a change in Mississippi law permitted such organizations to be run as businesses. He says the reason for the change was to get access to new streams of capital, not to enrich the family.

“The Caraccis are extremely devoted Catholics who have a very, very, very well-run organization,” says Mr. Mallette, a long-time friend of the family. “This is like a slap in the face for the I.R.S. to do this to them.”

The lawsuits brand the fines levied by the I.R.S., which range up to $40-million for each of the five officers, “a mind-boggling windfall” for the tax agency.

Under the 1996 federal intermediate-sanctions statute, influential “insiders” who get inappropriately high compensation can be forced to pay fines, called excise taxes, as can trustees who approve the arrangements.

Companies that do business with charities and have significant influence with them can also be deemed to be insiders.

The penalties can equal 25 per cent of the portion of the compensation or other benefits considered excessive.

Insiders who fail to pay the penalties or return the portion of the compensation considered excessive can face fines of up to 200 per cent of the money they received improperly.

The lawsuits against the I.R.S. seek to have the fines overturned, arguing that they are unjust and that the conversion transactions were fairly valued by a well-regarded certified public accountant.

The suits also charge that the I.R.S.’s actions were motivated by a desire to retaliate against one of the officers of the companies, Victor Caracci, for previous complaints against the revenue service that he had lodged with Congress and the tax agency itself.

The suits call the I.R.S.’s penalties “excessive, erroneous, arbitrary, capricious, unjustified, and part of an eye-popping pattern of conduct … that can only be explained by malicious selective prosecution designed to retaliate against [the] family based on past grievances.”

In three related lawsuits, non-profit organizations started by the Caracci family dispute additional actions taken by the I.R.S.: the retroactive revocation of their tax-exempt status.

Marc Owens, the retiring director of the I.R.S.’s Exempt Organizations Division, recently referred to the intermediate-sanctions cases at a speech to lawyers in Washington, but he did not name the organizations involved because federal law prohibits the I.R.S. from disclosing such information.

At that time, Mr. Owens put the size of the fines at $83-million. He alluded to the large size of the fines by saying, “You might conclude that’s indicative of a looting of the charities by the individuals with substantial influence over them.”

The Sta-Home cases are the first known examples of the I.R.S.’s imposing hefty penalties under the 1996 law.

The tax agency issued proposed regulations on intermediate sanctions in 1998, but has not yet issued final rules. Even so, the law is in effect and generally applies to transactions that occurred after September 13, 1995.

The tax court cases are being closely watched by non-profit legal experts.

Bonnie Brier, general counsel of the Children’s Hospital of Philadelphia, says that if the non-profit health organizations were significantly undervalued when they were sold to insiders, then the Sta-Home Health Agencies example would be “the perfect situation” for applying intermediate-sanctions fines under the law.

But she says that it’s too early to say how the tax court will decide. “We just don’t know yet,” she says. “Just because a business is losing money doesn’t mean it doesn’t have a value. God knows Amazon.com is worth a fortune. So you don’t have to make money.”

On the other hand, she says, “home care can be a real mom-and-pop business. And if these principals are the key to the business and it’s losing money, it’s possible that the business had no value.”

The cases, she says, raise several interesting issues with the Caracci family’s contention that the conversions were part of a broad shift in tax status in Mississippi by home health-care groups and the family’s charge that it was unfairly singled out for scrutiny because of past complaints against the I.R.S.

“If in fact other home-care agencies converted because of the change in state law, then the I.R.S. should be in there looking at them as well,” says Ms. Brier. “And you don’t get immunity because you’ve criticized the I.R.S., but the I.R.S. also is not allowed to punish you for criticizing it.”