Michael Cohen’s accusations against President Trump in his statement before the House Committee on Oversight and Reform yesterday include arranging for a straw bidder to purchase a portrait of President Trump at an auction, using Trump Foundation funds to repay the fake bidder, and keeping the art for himself. As part of the New York Attorney General’s stipulation agreement with The Trump Foundation, the foundation must sell two other Trump portraits it currently owns.
This stipulation agreement with the New York Attorney General has saved the Trump Foundation from a burdensome penalty tax in connection with the involuntary termination. As had been widely reported at the end of last year, the New York Attorney General announced on December 18 that its investigation had found “a shocking pattern of illegality involving the Trump Foundation – including unlawful coordination with the Trump presidential campaign, repeated and willful self-dealing, and much more.” Under the stipulation agreement, the Trump Foundation will dissolve and submit to the court a list of non-for-profit organizations to receive the Foundation’s remaining assets. The Attorney General and the state court will need to approve the organizations that receive the Trump Foundation’s funds.
Under the provision of the Internal Revenue Code governing voluntary termination of private foundation status, a dissolving foundation can distribute its assets to established charities. Voluntary terminations are not uncommon. They occur, for example, if family members disagree about the direction of a family foundation, if the costs of complying with private foundation rules become burdensome, or if the foundation decides to change its legal form from a trust to a corporation. The New York Community Trust has described in detail how dozens of New York private foundations have terminated and transferred their assets to it for such reasons. These voluntary terminations, however, do not involve private foundations that have run afoul of the many excise taxes that apply to private foundations
If a private foundation has engaged in “willful repeated acts” or “a willful and flagrant act” resulting in application of private foundation excise taxes, it can become liable for the dreaded and confiscatory termination tax. This tax equals the lesser of (1) the total tax benefits from exemption to the foundation and its major contributors or (2) the value of the net assets of the foundation.
Calculating the precise amount of the termination tax is complicated and technical. A press report from the Washington Post’s indefatigable David Fahrenthold gives a sense of the potential size of any termination tax. The first option includes the value to substantial contributors donors of the charitable contribution deduction. According to a lawyer for the Trump Foundation, President Trump has donated $8,250,000 and the McMahons donated $5,000,000 million to the Trump Foundation. If we assume that they and no others were substantial contributors, that the amount donated consisted entirely of cash contributions, and that the donors’ marginal rate was an unrealistically low 25%, then the termination tax under the first options would come to $3,300,00. For the second option, the New York Attorney General has represented to the court that $1.75 million of assets remain in the foundation. The value of the remaining assets is likely to be the lower of the two options and thus gives some sense of the size of any federal termination tax.
Despite referrals from the New York Attorney General and others, the IRS has not to date investigated the Trump Foundation. It may never do so. If it did, however, the pattern of illegality alleged by the New York Attorney General would constitute impermissible violations of the tax provisions applicable to private foundations. Major donors and board members who engage in self-dealing with the private foundation become liable for a private foundation excise tax. Such transactions between insiders and the Trump Foundation have occurred repeatedly. If Cohen’s accusation regarding this third portrait are substantiated, it would be another instance of self-dealing. Further, a private foundation cannot engage in campaign intervention without being subject to another private foundation excise tax. The Trump Foundation has in fact paid excise tax for intervening in an election, and the New York Attorney General has alleged other similar violations.
In turn, such violations of the private foundation excise tax rules would give rise to the foundation termination tax. Under applicable regulations, a private foundation becomes liable for the foundation termination tax if it or its managers commit “voluntarily, consciously, and knowingly” at least two acts or failures to act that violate the private foundation excise tax provisions.
However, even if the agency had audited the foundation and found flagrant and willful violations of the private foundation excise tax rules that call for impositions of the private foundation termination tax, the IRS has discretion to abate the foundation termination tax in certain circumstances. These circumstances include corrective action under state law.
Regulations require that any state corrective action involves “vigorous enforcement of State laws” ensuring that the private foundations assets are used for charitable purposes. Thus, even had the IRS audited the Trump Foundation, the action of the New York Attorney General would have protected it from imposition of the termination tax.
Despite the grand language in the applicable regulations, the authors of a leading textbook observe that there is “no indication as to how liberally the Service may exercise its authority” to abate the termination tax. Some may think that a tax paid to the federal government would better make taxpayers whole for abuses of the tax system. Others may agree that the assets of a dissolving private foundation should benefit other charities.
At the least, we might well want to define further the kind of state corrective action permitting abatement of the foundation termination tax. I suggest that the regulations be amended to permit the IRS to exercise this abatement authority only when state corrective action include provisions like that of New York law. IRS abatement should be permitted only when state action required that state regulators and courts can exercise a veto power over any distribution proposed by a foundation being required to dissolve because of violations of applicable law. Bad actors should not be able to direct the destination of charitable assets without government oversight.