Charity Leaders Seek to Decipher New Rules Designed to Curb Abuses

The new tax law signed by President Bush last month contains numerous provisions designed to curb

abuses by nonprofit groups and donors.

But as legal experts and nonprofit officials analyze the law, many of them say that the legislation could also cause headaches for charities and contributors who are conducting legitimate activities.

“A lot of organizations are going to be going through a wake-up process this fall as they start to figure out how these rules affect them,” says Marc Owens, a Washington lawyer who formerly headed the tax-exempt division of the Internal Revenue Service.

Charities and donors can expect additional consequences from the new law next year. In the legislation, Congress asked the Treasury Department to study several issues, with the goal that it could then pass additional rules designed to crack down on activities that lawmakers oppose.

Among the key issues: Should donor-advised funds and supporting organizations — two popular giving approaches — be required to give away a minimum amount of money each year?

Following are some of the provisions designed to curb abuses that have attracted the most attention in the nonprofit world:

Supporting organizations. Lawmakers passed numerous new restrictions on so-called supporting organizations — charities set up by a donor to provide money to one nonprofit group, such as a college or hospital, or a group of affiliated organizations.

More than 21,400 such groups exist, with at least $240-billion in assets, and members of Congress say they have grown increasingly concerned that loose regulations have allowed some supporting organizations to become personal piggy banks for the rich.

In particular, they say they are concerned that some donors are giving money to the supporting organizations, taking a charitable write-off for the donation, and then borrowing back the money.

But charity leaders and tax lawyers say Congress may have gone too far, especially with a provision that bars supporting organizations from making grants, loans, compensation, or “other similar payments,” such as reimbursement of expenses, to a major donor and any related people or companies. The goal is to prevent donors and their friends and relatives from reaping undue gains from the charitable organizations.

Some lobbyists call that prohibition the “Leavitt rule” after Mike Leavitt, the U.S. secretary of health and human services. Congress added the provision following news reports in July that Mr. Leavitt and his relatives claimed millions of dollars in charitable deductions through a supporting organization that for many years paid out little to charity, while providing substantial benefits to the family and a for-profit company they own. (Mr. Leavitt has said that his supporting organization has not violated any laws.)

Some charities say the rule should have been limited, depending on the way a supporting organization is structured. They say now the rule could cause trouble at museums, universities, and other big institutions where relatives and friends might hold positions that the law says are not acceptable. For instance, experts say, the spouse of a major donor to a museum may not be allowed to serve as a paid employee of the institution’s fund-raising arm.

Aside from causing problems for such organizations, lawyers say they are concerned about the date the provision took effect: July 25, several weeks before President Bush signed the law. They say charity officials could owe penalties for arrangements made well before the law was passed.

Charity officials are also worried about another provision, under which some supporting organizations could lose their tax-exempt status if they accept gifts from top officials or major donors at the charity the organization supports, or if they receive gifts from relatives of the donors or officials.

Donor-advised funds. Charities that offer donor-advised funds, such as community foundations and Jewish federations, face several new rules. They must provide new types of financial information to the Internal Revenue Service and the public and they must help their donors understand new rules about what types of grants they can make through their funds.

Donor-advised funds allow people to donate money, stock, and other assets to special accounts, claim a tax deduction, and then recommend how the money in the accounts should be distributed to public charities.

“It’s a matter of us making sure that everything we’re doing is still kosher under the new definitions,” says Christopher Herrera, director of communications at the Tides Foundation, a nonprofit group in San Francisco. “We’re going through our three or four hundred funds now.” One fund, he adds, may make 1,000 or more grants each year.

Of more concern to some charities, says Cynthia R. Rowland, a San Francisco lawyer, is whether the law will be so confusing or intimidating to donors that it will reduce contributions. “For some donors, it will, because there are many who will think it’s just too iffy,” she says. They may decide to hold off contributing more money to a donor-advised fund.

Gifts of artwork. Donors who want to give artworks to a museum face new limits on their write-offs for such donations. The limits affect so-called fractional- interest gifts, in which donors transfer ownership of a piece of artwork over many years or even decades.

Now such fractional-interest gifts must be completed within 10 years. In addition, the law limits the deductibility of the fractional-interest gifts: If a work increases in value after the first partial donation of the gift, the donor still must base his or her deduction on the initial value.

For example, a donor whose painting is worth $1-million in the first year she makes a fractional gift bases the write-off on a percentage of $1-million. Five years later, when she gives another fraction, the painting might be worth $10-million, but she still can write off only a percentage of $1-million.

Lawmakers made the changes because they said they were troubled by reports that a donor could take a deduction for contributing a piece of art even though the artwork remained in the donor’s possession. In some cases, museums never received the works of art, even after donors had claimed partial deductions for them.

The Museum of Modern Art, in New York, says it is upset about the new rules. It owns 627 works outright that were contributed a little at a time as fractional gifts, according to Glenn D. Lowry, the museum’s director.

“These are works of art we would never have received without the vehicle of fractional giving,” Mr. Lowry says. “This is an eminently sensible way of allowing someone who has spent tens of millions of dollars acquiring a work to transfer it to a cultural institution that could never afford to buy it. The beauty is that at the end of the day, the museum owns the work outright.”

Gifts of goods and clothing. Starting next year, donors will have to make greater efforts to ensure that they don’t give clothing or other household items in bad condition to charities. Such donations will no longer be eligible for a tax write-off.

The Salvation Army says that may be good news, since it spends millions of dollars a year disposing of donations that are in such poor shape it can’t even give them away. It might not have to throw so much out if donors become choosier about what they give.

But the charity will run into trouble if it must provide itemized receipts for items it judges to be in “good” condition, says Major Todd Hawks, national public affairs officer for the Salvation Army. “If you have a line of people outside wanting to make a donation, you can’t look at every piece of clothing; you can only make a general valuation of what the items are,” he says.

Receipts for small gifts. Out of concern that too many people were claiming deductions for gifts they didn’t make, Congress decided to require receipts for cash gifts to charities of less than $250. Previously, receipts were only required for gifts of $250 or more.

The new law also allows donors to use cancelled checks as receipts for gifts of less than $250, although they may not use cancelled checks as receipts for larger gifts.

Although it is the donor’s responsibility, not the charity’s, to get a receipt, nonprofit consultants say they will advise organizations to begin providing receipts for all cash gifts if they don’t already do so.

“There is cost involved in giving a receipt, but my feeling is the cost of not doing it is potentially losing a donor,” says John Taylor, a fund-raising consultant in Cedar Rapids, Iowa.

Mr. Taylor says the requirement is less onerous for charities than the 1996 law that required receipts for all gifts of $250 or more. Because of that law, he says, many organizations now systematically provide receipts to donors.

Robert S. Tigner, general counsel of the Association of Direct Response Fundraising Counsel, says big organizations will need to send hundreds of thousands of additional acknowledgments to help donors comply with the law.

In addition, Mr. Tigner says, postal rules require charities to send receipts by first-class mail. “Charities need to pay attention to how these costs can mount up.”

Disclosure rules for small organizations. Charities that raise less than $25,000 a year must now file an annual electronic notice with the Internal Revenue Service that includes their name and current address and whether they still exist or have been disbanded. If they don’t, their tax-exempt status will automatically be revoked.

Lawyers and watchdog groups say that some con artists escaped notice by hiding behind such small groups because the groups are not required to file a Form 990, the federal informational return for charities. Now Congress hopes the IRS will be better able to keep track of small charities that might be fronts for illegal operations.

But Michael I. Sanders, a Washington lawyer and adjunct professor of tax law at Georgetown University Law School, says that a lot of otherwise law-abiding small charities could wind up losing their exemptions because they didn’t hear about the new requirement and inadvertently failed to send the Internal Revenue Service a notice within three years.

“Now they’re going to be required to file a statement that many of them don’t know about, and after three years of not doing it, it’s revocation [of their tax-exempt status]. It’s revocation for a foot-fault.”