May 4, 2000 | Read Time: 3 minutes
A high-profile, nine-year battle between the Internal Revenue Service and the United Cancer Council — a small Indianapolis charity with ties to a controversial fund-raising company — has ended with an out-of-court settlement. The agreement requires the organization to donate its assets only to charities that have never had a relationship with the fund-raising company, Direct Response Consulting Services, in McLean, Va., which was originally called the Watson and Hughey Company.
The settlement was announced by a lawyer for the charity, Leonard J. Henzke Jr.
The case was watched closely by charities in part to see how far the revenue service could go in finding fault with the relationship between a charity and its fund-raising consultant.
The I.R.S. pulled the United Cancer Council’s tax exemption in November 1990, a few months after the charity declared bankruptcy, and made the action retroactive to 1984. Last year, the U.S. Court of Appeals for the Seventh Circuit ruled that the government was wrong to revoke the exemption (The Chronicle, February 25, 1999). The service had argued that Watson and Hughey was an “insider” that had improperly seized control of the charity. The company’s contract with the charity ran from 1984 to 1989.
The appeals court said that that part of the I.R.S.’s rationale didn’t pass legal muster, but that the U.S. Tax Court should assess the validity of a second reason the I.R.S. gave for revoking the charity’s exemption: that the terms of the fund-raising contract meant, in effect, that the charity’s board of directors ran the organization for “the private benefit” of Watson and Hughey.
The settlement means that the Tax Court will not rule on whether the I.R.S. was right in arguing that the charity was operated largely for Watson and Hughey’s benefit.
Under the agreement, the cancer council lost its tax exemption from 1986 through 1989 but got it back as of January 1, 1990.
The settlement requires that any assets remaining in the United Cancer Council’s bankruptcy estate — after the charity pays a sum of money to the I.R.S. and to settle other claims — and any bequests received in the future be used “solely for payment of expenses of direct care of cancer patients.” The cancer council must donate the money to health charities that “have never been associated with Watson and Hughey or its successors, agents, or related entities.” United Cancer Council agreed that from now on it would not solicit contributions from the general public.
“Although the Tax Court didn’t render a final final decision, the case provided a certain clarity to the law,” said Mr. Henzke. “The I.R.S. took a certain position and the courts have upheld the position to a certain extent, so charities and fund raisers will find a way to follow those guidelines set forth by tax authorities.”
Marc Owens, who recently retired as director of the I.R.S.’s Exempt Organizations Division, said that all eyes are now on the way the revenue service writes final regulations to a 1996 law that gave the tax agency an enforcement weapon short of revoking a charity’s tax exemption. The statute allows the I.R.S. to fine people or companies, called “disqualified persons,” who receive overly generous financial benefits — such as high salaries and “sweetheart” contracts — through their involvement with charities.
The law does not limit the definition of a disqualified person to an insider who controls a charity, which was at the center of the appellate court’s ruling, but describes such a person as one who has the “ability to exercise substantial influence” over the affairs of a charity.
Mr. Owens, who is now in private practice, said the I.R.S.’s rules could make clear that the government is prepared to fine fund raisers as well as charity officials. “If the regulations ultimately are written broadly, they will have a significant legal effect,” he said, “and the cancer council case will probably fade to a footnote.”
