IRS Considers Taxing Trustees of Funds That Were Victims of Madoff Scam

The Internal Revenue Service may take steps to tax board members of private foundations who placed all or some of their organizations’ assets with Bernard L. Madoff, the investor who ran a $65-billion pyramid scheme, according to Douglas Shulman, the Commissioner of the Internal Revenue.

Under federal tax law, foundation officers, directors, and trustees can be liable for tax if the organizations make any investments that would financially jeopardize their ability to carry out their missions. The law does not apply to charities.

“It is a tool that is available to us that we certainly will consider,” Mr. Shulman last week told a Senate Finance Committee hearing looking into the Madoff scandal.

Meanwhile, William Josephson, former head of the New York State Charities Bureau, told the committee that Congress should revise and extend that federal law, the so-called prudent-investor law, to cover charities, and should also extend to charities other key statutes that currently apply to foundations. Foundations have been living under stricter tax rules than charities since 1969, when the tax code was changed to crack down on perceived abuses by grant makers.

Existing state laws covering investments by charities have proved to be ineffective and “extremely difficult to enforce,” Mr. Josephson said.

“The Madoff scandal dramatizes the need for Congress to make the public-policy decision that has needed to be made for a long time but which it has deferred,” Mr. Josephson said. Otherwise, he said, “we can go on as we have been, paying lip service to the federal and state laws that affect fiduciary investment responsibilities.”

Sen. Charles E. Grassley, Republican of Iowa, has said that the scandal raises questions about “why the jeopardy investment excise tax should only apply to private foundations.”

$1-Billion Foundation

Many nonprofit organizations and donors were hurt by the Madoff scandal. Among the foundations that were forced to close their doors after the scandal erupted: the Picower Foundation, in Palm Beach, Fla., whose assets totaled nearly $1-billion, and the JEHT Foundation, in New York, which gave away $20-million to $30-million per year.

Mr. Josephson said in written testimony to the finance committee that the current federal prudent-investor law — set out in Section 4944 of the Internal Revenue Code — is unclear and needs to be reworked.

“No one knows what Code Section 4944 truly means, and the all-too-succinct regulations thereunder, which have not been revised since they were promulgated in 1972, are not helpful,” he said. If the law were to be rewritten and extended to all tax-exempt organizations, “future Madoff scandals could be deterred,” Mr. Josephson said.

He urged Congress to “clean up various anomalies in the code between the treatment of public charities and private foundations.”

Mr. Josephson told the hearing that Congress needs to provide the IRS with the money and resources that it should have had for decades “to do the necessary public-charity and private-foundation enforcement that 40 of the 50 states do not do at all and the other 10 do inadequately. Otherwise, the parade of charity scandals will continue endlessly.”

During the hearing, Senator Grassley said that some of the charities that invested with Mr. Madoff “would presumably have sophisticated advisers. This raises questions for me about whether the board members of these organizations were more interested in helping their friend than furthering charitable work.”