||||| Message-ID: <3CD15813.4040902@voicenet.com> From: Rod Keller User-Agent: Mozilla/5.0 (Macintosh; U; PPC; en-US; rv:0.9.4) Gecko/20011130 Netscape6/6.2.1 X-Accept-Language: en-us MIME-Version: 1.0 Newsgroups: alt.religion.scientology Subject: Taxes: Sklar and deductions for tuition Content-Type: text/plain; charset=us-ascii; format=flowed Content-Transfer-Encoding: 7bit Lines: 540 Date: Thu, 02 May 2002 15:12:49 GMT NNTP-Posting-Host: 209.71.20.3 X-Complaints-To: abuse@voicenet.com X-Trace: news2.voicenet.com 1020352369 209.71.20.3 (Thu, 02 May 2002 11:12:49 EDT) NNTP-Posting-Date: Thu, 02 May 2002 11:12:49 EDT Path: news2.lightlink.com!news.lightlink.com!gail.ripco.com!news.chaven.com!ord2-feed1.news.algx.net!jfk3-feed1.news.algx.net!allegiance!news.maxwell.syr.edu!nntp.abs.net!news.voicenet.com!news2.voicenet.com.POSTED!53ab2750!not-for-mail Xref: news2.lightlink.com alt.religion.scientology:1510364 M. Sklar: When may a taxpayer claim a charitable deduction for a child's religious school tuition? Taxes May 1, 2002 http://beta.yellowbrix.com/pages/newsreal/Story.nsp?story_id=29593675&ID=newsreal&scategory=Internet& In M. Sklar,1 the United States Court of Appeals for the Ninth Circuit held that the taxpayers were not permitted to deduct, as a charitable contribution, any portion of the amounts they paid for their children's religious school tuition. The Sklars had sought to deduct 55 percent of the tuition payments, the portion of the payments that they allocated to religious instruction. The Sklars lost in court, largely because they failed their burden of proving the amount of the tuition payments that were allocable to "intangible religious benefits." The Ninth Circuit's analysis may invite taxpayers and religious institutions to make a more precise allocation of tuition payments to religious schools in order to facilitate a deduction. This column discusses Sklar and the possible planning opportunities suggested by the case. While the Sklar court indicated in dicta that it would not entertain similar arguments even if the taxpayers could meet their burden of proof, another circuit court or panel of the Ninth Circuit may disagree. BACKGROUND: DISALLOWANCE OF DEDUCTIONS FOR RELIGIOUS SCHOOL TUITION Code Sec. 170 generally allows taxpayers to claim a deduction for charitable contributions paid during the tax year.2 For this purpose, the term "charitable contribution" is defined to include a contribution or gift to or for the use of a corporation, trust or community chest, fund or foundation organized and operated exclusively for religious, charitable, scientific, literary or educational purposes.3 For a long time, taxpayers have sought to deduct, as charitable contributions, tuition paid to parochial schools that offer both religious and secular training to their children. A taxpayer is not permitted to claim a deduction under Code Sec. 170 if and to the extent that the taxpayer receives a financial return commensurate with the amount of money or property transferred to a charitable organization.4 Amounts paid for tuition at an educational institution are not deductible as charitable contributions because they are required payments for which the taxpayer receives benefits presumably equal in value to the amount paid.5 Courts consistently have held that tuition payments made by a taxpayer on behalf of children attending parochial or other church- sponsored schools are not deductible as charitable contributions either to the school or to the religious organization operating the school.6 For example, in M.F. Brotman,7 the Tax Court held that a taxpayer was not entitled to deduct as charitable contributions payments made for Hebrew school tuition for the taxpayer's child. While the facts in Brotman are not entirely clear, it seems that the tuition payments in that case were for religious training only. PAYMENTS FOR "INTANGIBLE RELIGIOUS BENEFITS" The taxpayers in Sklar argued that the payments for their children's religious school tuition constituted "quid pro quo contributions" within the meaning of Code Sec. 6115 and were deductible to the extent that the payments exceeded the cost of tuition for the secular training that the children received. Code Sec. 6115 defines the term cc quid pro quo contribution" as a payment made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization.8 A quid pro quo contribution does not include any payment made to an organization, organized exclusively for religious purposes, in return for which the taxpayer receives solely an intangible religious benefit that generally is not sold in a commercial transaction outside the donative intent context.9 Code Sec. 6115 imposes a disclosure requirement on charitable organizations; the statute does not authorize a deduction for a charitable contribution. Under Code Sec. 6115, a charity that receives a quid pro quo payment in excess of $75 must provide a written statement that informs the donor that the amount of the contribution for which a deduction may be claimed is limited to the excess of the amount of any money and the value of any property other than money contributed by the donor over the value of the goods or services provided by the organization.10 The statement also must provide the donor with a good faith estimate of the value of such goods or services.11 Similarly, Code Sec. 170 disallows a charitable deduction for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment by the donee organization that includes the following information: (1) the amount of cash and a description of any property other than cash contributed; (2) whether the donee organization provided any goods or services in consideration, in whole or in part, for any property that the taxpayer contributed; and (3) a description and good faith estimate of the value of any goods or services provided by the donee organization or, if such goods or services consist solely of intangible religious benefits, a statement to that effect.12 For purposes of Code Sec. 170, the term "intangible religious benefit" is defined as any intangible religious benefit that is provided by an organization organized exclusively for religious purposes and which generally is not sold in a commercial transaction outside the donative intent.13 Under Code Sec. 170, an acknowledgment is considered to be contemporaneous if the taxpayer obtains the acknowledgment on or before the earlier of (1) the date on which the taxpayer files a return for the tax year in which the contribution was made or (2) the due date (including extensions) for filing the return.15 The Sklars received letters from each of the religious schools to which they had paid tuition acknowledging receipt of the payments and stating that the amounts were applied toward the tuition for the children's religious and secular training.15 Each letter also stated that the school estimated that the total education the children received was 55 percent religious education and 45 percent secular education. In accordance with this allocation, the Sklars sought to deduct 55 percent of the tuition payments. Nothing in the Code specifically provides that payments made for intangible religious benefits are deductible. The reporting and disclosure requirements for quid pro quo payments were added to the Code in 1993.(16) All of the pre-Sklar cases and rulings denying charitable deductions for religious school tuition had been decided for tuition payments made in tax years before the effective date of the 1993 amendments.17 The legislative history of the 1993 amendments to Code Secs. 170 and 6115 indicates that Congress intended only to add substantiation and disclosure requirements for taxpayers seeking to claim deductions for charitable contributions. The Senate Report provides, "No inference is intended, however, whether or not any payment made outside the scope of the quid pro quo disclosure [requirement] is deductible (in full or in part) under the present law requirements of section 170."18 The law concerning the deductibility of payments for intangible religious benefits is uncertain. While the IRS has allowed taxpayers to deduct payments for intangible religious benefits such as pew rents, building fund assessments, periodic dues and Mass stipends paid to some churches,19 it had disallowed charitable deductions for payments made to the Church of Scientology for "auditing" sessions designed to increase a member's spiritual awareness and for training courses at which participants study the tenets of the faith and seek to attain the qualifications necessary to conduct auditing sessions.20 R.L. HERNANDEZ AND ITS AFTERMATH In RL Hernandez,21 the United States Supreme Court upheld the denial of the deduction for the Scientologists' auditing and training payments. Pursuant to a central tenet known as the "doctrine of exchange," the Church set forth schedules for mandatory fixed prices for auditing and training sessions that varied with the length and the level of sophistication of the auditing or training sessions. The Church offered a five-percent discount for advance payments and refunded unused portions of prepaid auditing and training fees, less an administrative charge. Persons who paid money to the Church received "account cards" on which they could monitor the amount of prepaid services that they had not yet claimed. The legislative history of Code Sec. 170 indicates that Congress intended to allow a deduction for a charitable contribution only for gifts made without an "expectation of any quid pro quo."22 Because the payments in Hernandez were made in exchange for specific amounts of auditing and training, the Supreme Court concluded that they were made with an expectation of a quid pro quo. The taxpayers in Hernandez did not challenge the characterization of the payments as reciprocal in nature. Instead, they argued that they were entitled to deductions because a quid pro quo analysis is inappropriate when the benefit a taxpayer receives is purely religious in nature. The Supreme Court rejected this argument. The Court found no support for such an argument in the language of Code Sec. 170. The Court also expressed concern that allowing the deduction in Hernandez might lead to an expansion of the Code Sec. 170 deduction beyond the scope that Congress intended. In this context, the Court opined that a victory for the taxpayers mightencourage other taxpayers to claim a charitable deduction for tuition paid to parochial schools.23 Finally, the Supreme Court noted that the interpretation of Code Sec. 170 that the taxpayers sought would force the IRS and the courts to differentiate between "religious" benefits and "secular" ones in applying Code Sec. 170, possibly raising problems of entanglement between church and state. The taxpayers in Hernandez also argued that in denying the deduction for auditing and training session payments, the IRS had departed from its longstanding practice of allowing taxpayers to deduct payments for religious benefits received from other religious institutions, such as pew rents, building fund assessments, periodic dues paid to a church and Mass stipends.24 The Supreme Court refused to consider this argument because it was raised only on appeal. The revenue rulings in which the IRS allowed deductions for other payments to religious institutions apparently had never been reviewed by the Tax Court of any other judicial body. Without specific facts about the nature of the transactions for which the deductible payments were made, the Court determined that it had "no way (other than the wholly illegitimate one of relying on our personal experiences and observations)" to appraise accurately whether the IRS had applied a quid pro quo analysis with respect to any or all of the religious practices in question.25 Notwithstanding the government's victory in Hernandez, the IRS issued Rev. Rul. 93-73,(26) in which it obsoleted its earlier ruling disallowing charitable deductions for Scientologists' payments auditing and training sessions. In October 1993, the IRS released favorable exemption ruling letters to at least 25 Church of Scientology-related groups.27 Shortly after Hernandez was decided, the IRS also entered into a closing agreement with the Scientologists.28 Both the IRS and the Scientologists refused to disclose the terms of their agreement. While the terms of the closing agreement never have been disclosed, it seems that the IRS does, in fact, allow the deductions claimed by the Scientologists. After the Scientologists entered into the closing agreement, a Scientology booklet entitled "Information on Taxes and Your Donations" informed Scientologists that payments made to the Church of Scientology after January 1, 1993, for auditing and processing were deductible as charitable contributions and that in general, 80 percent of such payments made before 1993 were deductible.29 DID THE IRS ABUSE ITS ADMINISTRATIVE DISCRETION IN DISALLOWING THE DEDUCTIONS IN SKLAR? The Sklars argued that in allowing the Scientologists to deduct the cost of religious instruction and denying the deduction they claimed for religious instruction, the IRS had violated the Establishment Clause of the First Amendment. The Ninth Circuit disagreed, noting that the Supreme Court had rejected a similar claim in Hernandez because adopting such a policy could require excessive government entanglement with religion. The Ninth Circuit also dismissed the Sklar's administrative inconsistency claim. A taxpayer may challenge the IRS's disparate treatment of the taxpayer if the taxpayer can show that it is similarly situated to the group being treated differently by the agency.30 The court, however, doubted that the Sklars were similarly situated to the persons who benefit from the Scientologists' closing agreement because the religious education of the Sklars' children did not seem to be similar to the auditing and training or "other qualified religious services" conducted by the Church of Scientology. The court also concluded that even if the Sklars were situated similarly to the Scientologists, it would not hold that the policy set forth in the closing agreement should be extended to all religious organizations. In the court's opinion, the treatment that the Sklars sought was of questionable statutory and constitutional validity under Hernandez. Finally, the Ninth Circuit determined that the Sklars had failed to prove that the tuition payments they made on behalf of their children constituted a quid pro quo payment. As explained above, a quid pro quo payment is a payment made in part in consideration for goods and services and in part as a charitable contribution.31 A taxpayer is permitted to deduct the portion of a quid pro quo payment that exceeds the fair market value of the goods or services received. For example, the amount paid for a ticket for admission to a symphony concert sponsored by a charitable organization is deductible only if and to the extent that the cost of the ticket exceeds the established admission charges for comparable performances by the symphony orchestra.32 If the charity charges $100 for a ticket that otherwise would be sold by a for-profit group for $75, the taxpayer who purchases the ticket may deduct $25.(33) In Sklar, the Ninth Circuit held that the taxpayers could not deduct any portion of the tuition payments because they had failed to prove that any of the tuition payments they made exceeded the fair market value of the secular education their children received.34 The court opined that the Sklars' failure to meet their burden of proof was "not simply an inadvertent evidentiary omission, but rather a reflection of the practical realities of the high costs of private education."35 WILL OTHER TAXPAYERS PREVAIL? While the Sklars lost the case in the Tax Court and in the Ninth Circuit, it is likely that other taxpayers will assert similar claims. The Ninth Circuit's opinion offers some indication of the facts that must be proved to win such a case. In future cases, taxpayers may present more facts concerning the nature of the auditing and training offered by the Church of Scientology to establish that the religious training that they or their children received was similar to the religious training received by the Scientologists. While the Sklars were unable to convince the Ninth Circuit that 55 percent of the tuition they paid was for an intangible religious benefit, other taxpayers may be more successful. In the future, taxpayers may present evidence that the tuition they pay for their children's attendance at a religious school exceeds the cost of tuition for attendance at private schools that offer only secular training. As the Ninth Circuit observed, however, it will be extremely difficult, if not impossible, in many cases to prove that the amount of tuition charged by a religious school exceeds the amount charged by secular private schools. Nevertheless, other courts may be more willing to accept a Sklar-type allocation. Allocations also may be made on the basis of salaries paid to religious teachers and other costs associated with the religious training received by the children. In a concurring opinion in Sklar, Judge Silverman opined: If the IRS does, in fact, give preferential treatment to members of the Church of Scientology-allowing them a special right to claim deductions that are contrary to law and rightly disallowed to everybody else-then the proper course of action is a lawsuit to put a stop to that policy. The remedy is not to require the IRS to let others claim the improper deduction, too.36 Thus, it seems that Judge Silverman would have denied the deduction even if the Sklars had met their burden of proving the amount of the tuition payments that were properly allocable to religious training for their children. At least one other court, however, has indicated a willingness to entertain a claim of administrative inconsistency in this context. In G.H. Powell,37 decided shortly after the Supreme Court had disallowed the deductions claimed in Hernandez, the Eleventh Circuit held that a Scientologist had stated a cause of action by claiming administrative inconsistency in the IRS's denial of a deduction for amounts he paid to the Church of Scientology for auditing and training sessions. Powell was decided on summary judgment and was remanded to the district court for further consideration of the claim. While the case was pending in the district court, the IRS entered into the closing agreement with the Scientologists. Therefore, it is uncertain whether the District Court would have ruled for the taxpayers on their administrative inconsistency claim. Some have opined, however, that the IRS entered into the settlement agreement because if it had litigated the issue in Powell and lost, "the IRS would have been left with the unfortunate choice of either denying the deductions traditionally allowed to dozens of legitimate religious organizations, or allowing the deductions disallowed in Hernandez."38 Nevertheless, in allowing the deductions to the Scientologists, the IRS may have opened the doors to other taxpayers seeking to deduct tuition payments for their children's religious education. If such taxpayers can show that the religious training furnished to their children constitutes an intangible religious benefit or is similar to the auditing and processing furnished to Scientologists, another court may allow the deductions. CONCLUSION Allowing taxpayers to claim charitable deductions for tuition paid for religious training could cause a significant drain on federal income tax revenues. Many commentators have questioned the IRS's authority to disregard the Supreme Court's Hernandez opinion.39 If taxpayers like the Sklars prevail on an administrative inconsistency claim, the IRS may reregret its concession to the Scientologists. Allowing a deduction for tuition paid for religious education, however, could enbroil the IRS in controversies concerning the definition of "religious education." For example, Jewish children read from the Torah (the Hebrew Scriptures) during their Bar or Bat Mitzvah service. Hebrew also is the official language of the modern state of Isreal. There may be a question as to whether Hebrew lessons constitute religious or secular training. Similarly, q\uestions could arise as to whether theology classes taught at traditionally secular colleges and universities constitute religious or secular training. On the other hand, disallowing any deduction for payments to religious institutions in return for intangible religious benefits could create a tremendous administrative burden, both for taxpayers and the IRS. For example, if such payments are not deductible and a taxpayer makes a payment to a church and also attends Bible study classes at the church free of charge, it might be necessary to determine the amount of the payment that is allocable to the Bible study class and therefore, nondeductible. Determining whether taxpayers who pay for religious training or other intangible religious benefits may claim charitable deductions may create an intractable problem. The closing agreement between the IRS and the Scientologists is not source of the problem. Allowing a charitable deduction for some, but not all, payments made to religious organizations inevitably requires government entanglement with religion. Indeed, determining whether an organization is organized for religious purposes requires government entanglement. Whether such entanglement is excessive enough to violate the Establishment Clause of the First Amendment is likely to be an issue in many of these cases. ALLOWING TAXPAYERS TO CLAIM CHARITABLE DEDUCTIONS FOR TUITION PAID FOR RELIGIOUS TRAINING COULD CAUSE A SIGNIFICANT DRAIN ON FEDERAL INCOME TAX REVENUES. MANY COMMENTATORS HAVE QUESTIONED THE IRS'S AUTHORITY TO DISREGARD THE SUPREME COURT'S HERNANDEZ OPINION. ENDNOTES The author would like to thank John S. Pennell and Vice Chancellor Glenn G. Morris for their comments on earlier drafts of this column. The opinions expressed herein are the views of the author and not necessarily the views of those who have commented on earlier drafts. 1 M. Sklar, CA-9, 2002-1 usTC 50,210, 279 F3d 697. 2 Code Sec. 170(a)(1). 3 Code Sec. 170(c)(2)(B). 4 S. REP. No. 83-1622, 83rd Cong., 2d Sess. 196 (1954); H.R. REP. No. 83-1337, 83rd Cong., 2d Sess. A44 (1954) (defining the term "gift" for purposes of Code Sec. 170 as payments made with no expectation of a financial return commensurate with the amount of the gift"). See also American Bar Endowment, SCt, 86-1 USTC 9482, 477 US 105, 118, 106 SCt 2426 ("[t]he sine qua non of a charitable contribution is a transfer of money or property without adequate consideration"). 5 See, e.g., K.M. Channing, DC Mass., 3 USTC 1203, 4 FSupp 33, aff'd per curiam, CA-1, 67 F2d 986 (1933), cert. denied, SCt, 291 US 686, 54 SO 563 (1934); Rev. Rul. 83-104, 19832 CB 46. 6 See, e.g., H. DeJong, CA-9, 62-2 USTC 9794, 309 F2d 373; J.A. McLaughlin, 51 TC 233, Dec. 29,222 (1968), aff'd per curiam, CA-l, 69-2 USTC 9467; M.F Brotman, 36 TCM 279, Dec. 34,297(M), TC Memo. 1977-65; J.J.L. Ryan, 28 TCM 1120, Dec. 29,782(M), TC Memo. 1969- 212. See also Rev. Rul. 54-580, 1954-2 CB 97 (payments to religious schools or religious organizations disallowed as deductible charitable contributions if the payments are earmarked for the children). Cf., Rev. Rul. 83-104, 1983-2 CB 46, superceding Rev. Rul. 7999, 1979-1 CB 108 (providing several tests for determining whether payments made as contributions to a school or a religious organization sponsoring the school are in fact earmarked for their child's tuition and therefore are not deductible as charitable contributions). 7 Brotman, id. 8 Code Sec. 6115(b). 9 Id. 10 Code Sec. 61 15(a). 11 Id. 12 Code Sec. 170(f)(8)(A), (B). Substantiation is not required if the donee organization files a return, as prescribed by regulations, which includes the information that otherwise would be required to be included in the acknowledgment. Code Sec. 170(f)(8)(D). 13 Code Sec. 170(f)(8)(B), flush language. 14 Code Sec. 170(f)(8)(C). 15 Presumably, the letters were received within the period of time required under Code Sec. 170(f)(8)(C). 16 Act Secs. 131 72(a) and 131 73(a) of the Omnibus Budget Reconciliation Act of 1993 (PL. 103-66). * The authors gratefully acknowledge the assistance and input from John A. McLees, partner in the Chicago office of Baker & McKenzie. 1 Unless otherwise noted, all Code and section references are to the Internal Revenue Code of 1986, as amended. 2 See John A. McLees and John D. McDonald, IRS Recognizes Potential for Foreign-Source Income from Maquiladora Operations, 2002 TNT 6-- 18 (Jan. 9, 2002). 3 There are actually three different methods (i.e., 50/50, independent factory price, and books and records) for determining the amount of income attributable to the production activity, but the 50/50 method is the preferred method. Reg. 11.863-3(b). 4 Not everyone has adopted this approach, however. In order to treat the maquiladora entities as disregarded entities for U.S. federal income tax purposes, they cannot be considered S.A.'s (equivalent to U.S. corporations) under Mexican corporate law. See Reg. 301.7701-2(b)(8). Therefore, if the maquiladoras have already been formed, the entities must convert from S.A.'s to S. de R.L.'s (equivalent to U.S. limited liability companies) under Mexican law. Moreover, if the maquiladoras are already formed and have historical earnings, there is a cost associated with converting the maquiladoras into disregarded entities for U.S. purposes. Specifically, the conversion will be treated as an inbound liquidation and the U.S. parent will have to recognize the "all earnings and profits amount" under Code Sec. 367(b). 5 Piedras Negras Broadcasting Co., CA5, 42-1 USTC T9384, 127 F2d 260, 261. 6 See generally, Gregg D. Lemein, International Tax Watch, Contract Manufacturing: Rev. Rul. 97-48 Revokes Rev. Rul. 75-7, TAXES, Jan. 1998, at 9; Gregg D. Lemein, International Tax Watch, Fiscally Transparent Subpart F, TAXES, May 1998, at 11; Gregg D. Lemein and John D. McDonald, International Tax Watch, Tax Court Attributes Contract Manufacturer's Activities to Principal, TAXES, Mar. 2000, at 15; and Gregg D. Lemein and John D. McDonald, International Tax Watch, Medchem (PR.) Inc.: The Confused State of Contract Manufacturing, TAXEs, July 2001, at 5. 7 U.S. shareholders are defined as U.S. persons that own 10 percent or more of the voting stock of a foreign corporation. Code Sec. 951 (b). 8 CFCs are defined as foreign corporations that are controlled by five or fewer U.S. shareholders. Control for this purpose means more than 50 percent of either the voting power or value of the foreign corporation. Code Sec. 957. 9 Code Sec. 954(d). 10 Code Sec. 954(d); Reg. 1.954-3(b). It is important to note that the branch rule can apply if the manufacturing and/ or the sales/purchase activities occur in a branch located outside of the CFC's country of incorporation. The manufacturing branch rule is referred to in the text to simplify the discussion. 11 Rev. Rul. 75-7, 1975-1 CB 244. 12 Ashland Oil, Inc., 95 TC 348, Dec. 46,899 (1990). 13 Vetco, Inc., 95 TC 579, Dec. 47,001 (1990). 14 Rev. Rul. 97-48, 1997-2 CB 89. 15 The IRS attempted to implement the position taken in Rev. Rul. 97-48 by publishing proposed regulations in Mar. 1998. These regulations would have amended the Code Sec. 954 regulations to require that a CFC itself must actually manufacture the products that it sells in order to avoid generating foreign base company sales income. The IRS subsequently announced in Notice 98-35, 1998- 2 CB 34, that the proposed regulations would be withdrawn. The IRS is expected to reissue proposed contract manufacturing regulations in the same form as the Mar. 1998 regulations, however. not tax one and not tax another without some rational basis for the difference. And so, ... it can be an independent ground of decision that the Commissioner has been inconsistent"). 31 Code Sec. 61 15(b). 32 Rev. Rul. 67-246, 1967-2 CB 104. 33 Id. 34 Sklar, supra note 1, 279 F3d, at 708. 35 Id. 36 Sklar, supra note 1, 279 F3d, at 709 (footnotes omitted; emphasis in the original). 37 G.H. Powell, CA-11, 91-2 USTC 50,514, 945 F2d 374. 38 Eaton, supra note 28, at 10 15. 39 See, e.g., Eaton, supra note 28; Paul Streckfus, Latest IRS Ruling Provides Good News for the Scientologists, 63 TAX NOTE 643, 644 (1994) (quoting former IRS Commissioners Don Alexander and Larry Gibbs as saying that in issuing Rev. Rul. 93-73, the IRS effectively disregarded the Supreme Court's opinion in Hernandez). BY SUSAN KALINKA * Susan Kalinka, JD., is the Harriet S. Daggett-Frances Leggio Landry Professor of Law at the Paul M. Herbert Law Center of Louisiana State University in Baton Rouge.