May 21, 2021
Tax Court concludes former State senator convicted of fraud also deemed a 'disqualified person' for intermediate sanctions purposes
Granting partial summary judgment for the IRS in Vincent J. Fumo v. Commissioner, the Tax Court found a former state senator was a "disqualified person," as defined in IRC Section 4958(f)(1)(A), with regard to a public charity he established. The court declined, however, to decide whether the petitioner had received an excess benefit from the charity, stating that decision would be made at trial.
Vincent Fumo served as a Pennsylvania state senator from 1978 to 2008. His term concluded with his conviction on federal corruption charges, including fraud involving an IRC Section 501(c)(3) entity that he established in 1991 to improve and maintain the appearance of his senatorial district by cleaning streets, removing graffiti, shoveling snow and removing trash. The IRS granted the organization IRC Section 501(c)(3) status in August 1999. At his direction, two members of Fumo's senatorial staff had incorporated the organization, Citizens Alliance, and continued to serve as its president, secretary and executive director. Fumo was never an employee, director or officer of Citizens Alliance, but he used his influence in the Pennsylvania Senate to obtain funding for the organization, including at least $15 million in public grants, "a comparable volume of funding from private sources" and a $17-million grant from a public utility.
A grand jury charged Fumo with 139 criminal counts in 2007, 34 of which related to a scheme to defraud Citizens Alliance with the help of a codefendant — one of his Senate employees who had incorporated the organization. The charges alleged that the employee, serving as executive director of Citizens Alliance, had conspired with Fumo to spend the organization's funds on vehicles, farm equipment, tools, and other things of value for his personal use. Fumo was convicted on all 34 counts and ordered to pay $1,165,317 in restitution.
In the criminal trial, Fumo testified that he considered Citizens Alliance to be his non-profit and "a 'constituent service' of his senate office and expected to derive political benefits from the work it performed in his district." Beyond performing work in his district, Citizens Alliance paid for $43,000 worth of tools, various automobiles, and a bulldozer for use on Fumo's farm. When the bulldozer broke down on the farm, the organization paid $16,000 to fix it.
Congress added IRC Section 4958 to the Code in 1996 as a means of sanctioning certain individuals (i.e., disqualified persons) who use their relationships with IRC Section 501(c)(3) or (c)(4) organizations to personally benefit. Under IRC Section 4958, excise tax (i.e., intermediate sanctions) may be imposed on each excess benefit transaction undertaken between an applicable exempt organization and a disqualified person. Intermediate sanctions are intended to give the IRS the ability to penalize errant individuals rather than having to take more extreme action by revoking the tax-exempt status of the organization.
Disqualified persons include the nonprofit's president, chief executive officer, chief financial officer, chief operating officer, treasurer, voting members of the board, and family members of a disqualified person. A 25% excise tax under IRC Section 4958(a)(1) may be imposed on the disqualified person or an organization manager who knowingly participates in an excess benefit transaction. Failure to correct the excess benefit within the tax period can result in an additional 200% tax on the disqualified person.
Tax Court decision
The IRS moved for partial summary judgment based on two questions: (1) whether Fumo was a disqualified person with respect to Citizens Alliance, and (2) whether he received excess benefits from the organization. Addressing the first question, the court noted that Reg. Section 53.4958-3 provides a nonexclusive list of factors that tend to show a person has substantial influence over the affairs of an organization, including whether the individual:
First, Fumo argued that he could not be a disqualified person because he was not the actual founder of Citizens Alliance. The court disagreed, finding that the "person [who] founded the organization" under section 53.4958-3(e)(2)(i) need not be the de facto incorporator. Although Fumo did not incorporate Citizens Alliance himself, he acknowledged that he effectively created the organization and that it would not exist without him.
Second, the court held that Fumo also misconstrued the word "position" in IRC Section 4958(f)(1) to mean "office" or "job title." Citing Webster's New World Collegiate Dictionary, the court clarified that the meaning of "position" includes "a location or condition in which one has the advantage." Therefore, under the statute, a person who is in a position to exercise influence over an organization's affairs need not have a formal affiliation with the organization to be characterized as a "disqualified person."
Although Fumo did not contribute his own funds to the organization, the Tax Court noted, he raised significant amounts of money for it. Citing Reg. Section 53.4958-3(e)(2)(ii), the court pointed out that a 2% contributor tends to have substantial influence over a charity. Further, the court stated that Fumo's "'proven conspiratorial relationship'" with his staff member who was also executive director of Citizens Alliance "alone establishes that he was 'in a position to exercise substantial influence over [its] affairs' during [the] period" at issue. Ultimately, Fumo agreed that he had "substantial influence over the organization" and acknowledged that he met the requirements of a disqualified person under IRC Section 4958(a)(1).
Turning to the IRS's second question, the court concluded that whether Fumo received excess benefits from Citizens Alliance was an issue that needs to be determined at trial. Therefore, the Tax Court denied summary judgment on this question.
This decision by the Tax Court provides a fairly straightforward interpretation of the factors necessary to establish that an individual is a disqualified person as enumerated in IRC Section 4958. Specifically, the court rejected the petitioner's "hypertechnical arguments" that one must be the literal incorporator of an organization or hold a formal title within the organization to be characterized as a disqualified person.
By focusing on the plain language of the regulations and ruling on their meaning, the court has effectively eliminated loopholes that persons receiving excess benefits may have previously tried to exploit. Thus, exempt organizations should use this decision as a guide for engaging in transactions with individuals who wish to rely on a narrow definition of the term "disqualified person" to avoid the claim that an excess benefit transaction has occurred.
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