February 5, 2004 | Read Time: 11 minutes
In 1998, the Muralt family of Missoula, Mont., started the Muralt Family Foundation to provide funds for a local children’s shelter.
Walter R. Muralt, and his father, Gary D. Muralt, owners of a highly successful truck-stop business, donated $1.4-million to their foundation over the next five years, taking tax deductions for the contributions. They and companies they control then borrowed $758,000 from the foundation, using the money to pay off a bank loan owed by Gary Muralt and to invest in real estate and a wireless-communications business. During that time, the organization used the repayments the Muralts made on the loans to donate $107,506 to charity.
Although it calls itself a foundation, the Muralts’ charity is actually a special legal entity known as a supporting organization, a type of nonprofit group that Congress established 35 years ago when it overhauled the laws governing private foundations. Gary and Walter Muralt both serve on the organization’s board.
Alternative to Foundations
Supporting organizations are designed to finance the work of specific charities. Many universities and other large nonprofit groups have supporting organizations that generate revenue for them by investing in stocks or by operating businesses.
In some cases, however, wealthy people who want to set up their own philanthropic groups use supporting organizations as an alternative to private foundations. Supporting organizations offer a number of advantages. While private foundations are barred from making loans to officers or directors or engaging in any other financial dealings with them, supporting organizations are not. Supporting organizations also are not required to pay the federal excise tax that most private foundations must.
Federal law also allows individuals to benefit financially from their involvement with their supporting organizations. They can donate hundreds of thousands or even millions of dollars to a supporting organization, get a tax deduction on the gift, appoint themselves along with family members, their lawyers, or business associates to the organization’s board, and borrow as much as the entire net assets of the organization as long as they have the board’s approval. Donors and their family members are not allowed to hold a majority of seats on the board, or appoint directors they “control.” Internal Revenue Service rules count a donor’s employee as someone subject to the donor’s control; however, they do not say whether a donor’s lawyer or business partner falls into the same category. Legal experts said tax lawyers disagree on whether business associates should be viewed as being under the donor’s control.
Borrowers can use the loan for any purpose — personal or business — and keep whatever profits flow from investing the money. The only legal requirements are that they pay off the loan at a rate no lower than the prevailing interest rate, and the supporting organization must award most of the repayments to charities.
IRS Examining Issue
Internal Revenue Service officials, who said the tax agency has begun to examine the potential for abuse by donors who set up supporting organizations, have no data on the number of such groups or the amount of loans they make.
But a Chronicle analysis of Form 990 informational tax returns found 18 supporting organizations that made loans of $100,000 or more to their officers and directors from 1998 to 2001. Together, the loans totaled nearly $7-million. And at 10 of those supporting organizations, the loans equaled half or more of the groups’ total assets.
After The Chronicle showed a summary of its findings on supporting organizations to Sen. Charles Grassley, the Iowa Republican who is chairman of the Senate Finance Committee, he denounced the loan practice. “We’ve seen the unending creativity of abusive tax transactions in corporations,” the senator said in a written statement. “It sadly appears that we’re seeing the same creativity with nonprofit corporations. Those involved should be ashamed of their conduct.”
Mr. Grassley, who has been investigating the financial activities of charities and private foundations for more than two years, said he would consider legislation to change the rules on supporting organizations. The practice at some supporting organizations of lending substantial portions of their net assets to an officer or director, he added, “appears to be an abusive transaction, far beyond what Congress intended.”
Lending Money
Among the supporting organizations that have made loans, according to The Chronicle’s investigation, is the Hill Family Foundation, in Salt Lake City.
In 1999 Spencer K. Hill, a Salt Lake City real-estate developer, created the organization, naming a local charity called the Wishes Are Forever Foundation as the group it supports. (See article on Page 14.)
Mr. Hill financed his organization by donating a duplex he owned in Newport Beach, Calif. In a written response to questions from The Chronicle, Mr. Hill said he “received a tax deduction for the fair market value of the property.” The supporting organization then sold the property for $225,917 in July 1999. The following year it lent almost all of its assets — $220,655 — in two loans to Mr. Hill and his company, SKH Properties.
Mr. Hill said he used the money “to pay off loans and invest in real estate.” He and his company are repaying the loans over 15 years — one at an interest rate of 14.5 percent and the other at 8 percent, with the family foundation using the payments to make grants to charity. Mr. Hill said the supporting organization has given approximately $70,000 to charity since it was set up. But he said that any profits generated by the investments he has made with the borrowed funds “revert back to SKH Properties and me.”
In Minnesota, Ken Malecha, who is former president of Best Brands Corporation, a baking-industry supplier in Eagan, Minn., established the Malecha Family Foundation in September 2000 to support a volunteer fire department that serves a small town and surrounding area. Four months after its formation, the charity lent Mr. Malecha $800,000 of its $1-million in net assets that year for reasons not specified on its 2000 Form 990 tax return. Mr. Malecha was to repay the money in one year at 8 percent interest.
“Mr. Malecha believed that under the investment climate then in effect, the terms of the loan significantly exceeded the foundation’s regular investment return” and thus were beneficial to the charity, said his lawyer, Thomas E. Brever, in an e-mail message.
But Mr. Brever added that the charity later decided the loan to Mr. Malecha was a “mistake” after getting an opinion from professional advisers that it could be viewed as unseemly.
“While he was factually correct in his beliefs and certainly did nothing violative of either the letter or spirit of the law, Mr. Malecha agrees that even an appearance of impropriety should be avoided,” said Mr. Brever. Mr. Malecha “has repaid the loan in full with interest, and has pledged not to take loans from the foundation in the future,” said Mr. Brever.
In its first two years, the Malecha Family Foundation gave a total of $15,000 to the fire department that it was established to support, according to the tax returns filed by the charity with the federal government.
In another Utah case, Rock T. Ballstaedt and his wife, Terri, of Salt Lake City, donated $186,000 in 1998 to set up the Rock and Terri Ballstaedt Charitable Supporting Organization on behalf of several Mormon charities. Days later the Utah organization lent Mr. Ballstaedt an identical amount. The organization has not listed on its federal tax returns what Mr. Ballstaedt, who is in the export-financing business, used the loan for, although federal regulations require it to do so. Mr. Ballstaedt declined to answer questions about what he did with the money. In its first four years of operation, the organization donated $24,610 to charity.
Altogether, 10 of the supporting organizations identified by The Chronicle are in Utah. Kirk Torgensen, chief deputy attorney general in the criminal division of the Utah attorney general’s office, said the loans and other activities of the groups are worthy of investigation by his office. Many supporting organizations, including the ones The Chronicle looked at in Utah, are commonly set up as trusts (a legal structure in which groups are overseen by appointed trustees rather than by corporate boards), and state law says trustees must invest and manage trust assets “solely in the interest” of the organization.
The circumstances of the loans raise questions about “state tax issues,” Mr. Torgensen said. Adding that “somebody ought to be looking into them,” he said that he would refer information about the loans to John McCarrey, who heads the attorney general’s tax and revenue division.
Lawyers for the supporting organizations identified by The Chronicle said that loans to officers and directors do not violate the letter or spirit of federal and state laws. Instead, they said, having the officials invest the borrowed money protects the organizations.
Miles E. Lignell, the lawyer for the Muralt Family Foundation, said the Muralts’ loan agreements guarantee that the supporting organization will be paid and require the borrowers’ personal property to be put up as security. Thus, he said, the loans work to the supporting organization’s advantage.
“Direct investment by the foundation in these projects [in which the Muralts invested the borrowed money] was considered by the board of directors to be too risky and would not generate the secure regular source of income needed for charity,” he said in a written reply to questions from The Chronicle.
Such arrangements are not always secure, however. Mr. Ballstaedt guaranteed his supporting organization’s loan by putting up his 17-room home in Salt Lake City as security. At that time, however, Mr. Ballstaedt and his wife already had liens against their house for home-equity loans totaling $855,000. In March 2000, the supporting organization released its claim on the home, leaving the loan to Mr. Ballstaedt unsecured. Fifteen months later the Ballstaedts defaulted on one of their earlier home-equity loans. The house was taken by the bank and sold at auction.
Mr. Ballstaedt acknowledged that the supporting organization’s loan is now unsecured. “There’s a plan to give additional security in the future, but it hasn’t been done,” he said.
Congressional Intentions
Legal experts say that loans to top officials were not what Congress had in mind in 1969 when it changed the laws on private foundations and, concurrently, established supporting organizations.
Congress’s original proposed definition of a private foundation would have included organizations like Princeton University Press, a publishing group that generates revenue for the university, and other organizations that existed to produce funds for nonprofit groups, said Stanley Weithorn, a lawyer who worked closely with the Congressional staff members who developed the legislation.
“There were a considerable number of those kinds of things all over the country,” said Mr. Weithorn, who now is a lawyer in Phoenix. “Congress was really after a lot of fraudulent structures that never were charitable at all that were set up as private foundations.”
The legislation ended up including a provision that created supporting organizations. The wording was fairly broad, he said, to allow a range of existing legal structures that had been used to create those organizations to escape the restrictions the legislation was imposing on foundations.
Under the changes made in 1969, donors can set up an organization that is very similar in structure to a private foundation. But by designating it as a supporting organization and naming a specific charity to which it will make grants, donors can avoid the restrictions on foundations, including the ban on loans to officers and directors.
More than three decades after the creation of supporting organizations, the Internal Revenue Service has begun a review of their activities. “We have found abuses in the supporting organizations area,” said Steven Miller, director of the revenue service’s Exempt Organizations office. “We have a series of cases that have been referred to us. We are taking concrete steps to figure out what’s going on and to do a study.”
Mr. Miller said he could not comment on any of the specific cases The Chronicle found in its review because of privacy laws designed to protect taxpayers. He added that the agency will not wait for the study to be completed before taking action in cases in which it concludes supporting organizations are abusing the law.
While most supporting organizations do not use significant portions of their assets to provide loans for top officials, according to experts in nonprofit law, when it does happen, “it begins to call into question what the organization is all about,” said Marc Owens, Mr. Miller’s predecessor at the IRS.
Added Mr. Owens, “The issue with a loan, particularly one going to an insider, is that it’s taking the assets of the organization away from doing something charitable.”
