IRS Issues Final Regulations Providing Relief for Certain Tax-Exempt Organizations

On May 26, 2020, the Treasury Department and the IRS issued final rules (T.D. 9898) stating that certain tax-exempt groups will no longer be required to provide the names and addresses of major donors on annual returns filed with the IRS. These regulations specify that only organizations described in section 501(c)(3) and section 527 organizations are required to continue to provide names and addresses of contributors on their Forms 990 (Return of Organization Exempt From Income Tax), Forms 990- EZ (Short Form Return of Organization Exempt From Income Tax), and Forms 990-PF (Return of Private Foundation). Most of the information filled out on these annual returns in available for public inspection.

Charitable Organizations (501(c)(3))’s and Political Organizations (Section 527)

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes and none of its earnings may inure to any private shareholder or individual. Organizations descried in 501(c)(3) are referred to as charitable organizations and such charitable organizations are barred from taking any action in an attempt to influence legislation as a substantial part of its activities, and this cannot participate in any campaign activity for or against political candidates.

This Treasury Decision revises §1.6033-2(a)(2)(ii)(F) to provide that organizations described in section 501(c)(3) generally are required to provide names and addresses of contributors of more than $5,000.  Similarly, §1.6033-2(a)(2)(iii)(D) is revised to remove the requirement to provide the names of contributors who contribute over $1,000 for a specific charitable purpose to the following organizations:

  • Social and recreation clubs per 501(c)(7)
  • Fraternity Beneficiary Societies and Associations per 501(c)(8), and
  • Domestic Fraternal Societies and Associations per 501(c)(10).

Political organizations that are tax-exempt under section 527 of the code will also still have to report contributor names and addresses. A 527 group is created primarily to influence the selection, nomination, election, appointment, or defeat of candidates to federal, state, and local office. These final regulations also clarify that section 527 organizations with gross receipts greater than $25,000 generally are subject to the reporting requirements under section 6033(a)(1) as if they were exempt from taxes under section 501(a).

Social welfare organizations (501(c)(4)) and Business Leagues (501(c)(6))

Under the final regulations, social welfare organizations and business leagues are not required to provide donor names and addresses. The following organizations qualify as social welfare organizations under 501(c)(4):

  • Civil leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare;
  • Local associations of employees, where membership is limited to the employees of a designated person in a particular municipality, and the net earnings are used exclusively tor charitable, educational, or recreational purposes; and
  • Certain organizations that engage in substantial lobbying activities (i.e. the National Rifle Association, the American Civil Liberties Union, and Citizens United).

Additionally, the Code provides for the exemption of business leagues, chambers of commerce, real estate boards, boards of trade and professional football leagues, under 501(c)(6), so long as they are not organized for profit and no part of the net earnings are used for the benefit of any private shareholder or individual. Organizations that qualify under 501(c)(6) are also allowed to engage in some political activity.

Commentators in favor of the IRS’s decision not to collect names and addresses of substantial donors to some tax-exempt organizations discussed the concern that supporters of certain organizations would face harassment if their status as contributors was publicly revealed. This would produce a “chilling effect,” discouraging potential contributors from giving to certain tax-exempt organizations and rise to a violation of a first amendment violation with regards to freedom of speech and freedom of association. On the other hand, critics asserted that the new rules will lead to an increase in the flow of money into U.S. elections through organizations described in section 501(c)(4) and (6). The IRS quashed this criticism and underscored section 6103 of the Code generally prohibits the IRS from disclosing any names and addresses of organizations’ substantial contributors to federal agencies for non-tax investigations, including campaign finance matters, except in narrowly prescribed circumstances.

As a final note, all tax-exempt organizations are required to maintain records regarding their substantial contributions, irrespective if they have to follow the annual reporting requirement. Still, states have the authority to impose their own reporting requirements as both the Treasury Department and the IRS expect each state to “determine the appropriateness of the burdens it may impose in light of its own tax administration needs.”

VW Contributor: Skylar Young
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8th Circuit Holds Reasonable Basis Defense to Negligence Penalty Requires Taxpayers to Prove Actual Reliance on Authorities

On April 24, 2020 the Eighth Circuit Court of Appeals upheld the district court’s determination that Wells Fargo was not entitled to a tax credit on its 2003 tax return arising from a transaction the company entered into with a British bank. In Wells Fargo v. United States, No. 17-3578, the court determined that Wells Fargo was liable for a negligence penalty after claiming that credit. And, perhaps the most important takeaway from this holding was the Eighth Circuit’s conclusion that the reasonable basis defense to the negligence penalty, which Wells Fargo raised, requires a taxpayer to prove that they actually relied on relevant legal authority rather than prove objectively the authority supported the taxpayer’s position.

In 2002, Wells Fargo entered into a structured trust advantaged repackaged securities transaction (STARS) with Barclays Bank, a corporate citizen of the United Kingdom. The government argued that STARS was an unlawful tax avoidance scheme in which Wells Fargo exploited the differences between the tax laws of the U.S. and the U.K.. In 2003, Wells Fargo claimed foreign-tax credits on its federal tax return arising from STARS, but the Internal Revenue Service (IRS) disallowed those credits and found that Wells Fargo owed additional taxes. After paying the resulting tax deficiency, Wells Fargo filed a lawsuit to challenge the IRS’s decision and to obtain a refund. The government responded by imposing a “negligence penalty” on Wells Fargo as an offset defense because Wells Fargo underpaid its 2003 taxes after claiming this credit.

Under 26 U.S.C. § 61(a), the U.S. government taxes the income of its citizens, which includes corporations, “from whatever source derived.” To offset the problem of double taxation on income that is also taxed by a foreign jurisdiction, the Internal Revenue Code created the foreign-tax credit, in which the taxpayer can claim a dollar-for-dollar tax credit against its federal tax liability for taxes it paid to another country. However, this tax credit is granted only if there is a valid transaction. This article will not discuss the granular aspects of the complicated structure of the STARS transaction between Wells Fargo and Barclays besides the fact that the STARS comprised both a loan component and a trust component. The trust structure produced disputed foreign tax credits and the loan structure generated disputed interest deductions. The Eight Circuit found that the STARS’s trust component was a sham transaction, but not the loan component. A transaction is illegitimate if it is structured solely to obtain a tax benefit- meaning that it lacked economic substance outside of its tax considerations. Because the court found that the trust component of the transaction was a sham, Wells Fargo was not entitled to claim credits for any foreign taxes that it paid which arose from that transaction.

The Eighth Circuit also rejected Wells Fargo’s appeal that the district court erred in applying a negligence penalty. The district court imposed the negligence penalty on Wells Fargo because it found that the entity did not display prudence when preparing its tax return, warranting an $11.8 million penalty. Note, the Eighth Circuit upheld the district court’s determination requiring the government to refund to Wells Fargo a net amount of $13.65 million. Under 26 U.S.C. § 6662(b)(1) of the Internal Revenue Code, a taxpayer is liable for a “negligence penalty” of twenty percent of an underpayment of its taxes attributable to its “negligence.” The Code of Federal Regulations, the applicable regulation 26 C.F.R. § 1.6662-4(d)(3)(iii) creates a defense to the negligence penalty if the taxpayer’s “return position” was reasonably based on one or more of the authorities set forth in the regulation. The regulation defines a “return position” as the particular position a taxpayer adopts when the taxpayer determines its tax liability with respect to a particular item of income, deduction, or credit. The dispute between Wells Fargo and the government was whether a reasonable-basis defense requires evidence that the taxpayer actually relied on relevant legal authority to support its return position. Wells Fargo argued the standard need only be objectively reasonable. The government, on the other hand, argued the reasonable-basis defense required Wells Fargo to prove, through evidence, that they subjectively relied on the relevant authority.

The Eighth Circuit agreed with the government’s argument. The court looked to the plain meaning of the phrase “reasonably based” and found that in order to ‘base’ a return position on particular legal authority, a taxpayer may show that it actually relied upon those authorities in forming its position. And, citing previous cases, the court highlighted that in determining whether the negligence penalty applies, the focus is on the taxpayer’s conduct. Thus, the Eighth Circuit interpreted 26 C.F.R. § 1.662-3(b)(1) and (b)(3) to include a reliance requirement, even though the word “reliance” or similar language does not appear in the regulation.

Wells Fargo also argued that a subjective standard would result in the taxpayer waiving attorney-client privilege in order to prove that it actually relied on the relevant legal authority. The court noted this argument had “some appeal” but gave it short shrift. As a policy matter, the court noted that the actual reliance requirement “incentives taxpayers to actually conform to the requisite standard of care rather than simply taking the chance that there may be a reasonable basis for their underpayment of tax.”

While Judge Grasz did join the majority opinion in finding the transaction to be a sham, he provided a fiery dissent on the imposition of the negligence penalty. Judge Grasz argued the 26 C.F.R. § 1.6662-3(b)(3) does not necessitate a taxpayer show actual reliance on certain authorities to qualify for the reasonable-basis defense because such language is absent in the regulation. On the other hand, he points to a different regulation, 26 C.F.R. § 1.662-4, which is cross-referenced with the  § 1.6662-3(b)(3) which explicitly includes the language that the taxpayer “analyzes the pertinent authorities in the manner described in this section and in reliance upon that analysis.” Citing to the Supreme Court’s reasoning regarding the canon of statutory construction, when Congress includes specific language in one section of a statute but omits it from another section of that same statute, it is presumed that Congress intended to omit such language. Thus, he concluded the fact that the regulation at issue does not specify actual reliance reveals there is no such requirement and an objective standard should govern.

Normally under a negligence standard, the conduct at issue is analyzed by asking what a reasonably prudent person would do under the same circumstances. That is to say, an objective test is applied. After this decision, a taxpayer could face penalties for adopting a return position even if it has plausible legal support. Wells Fargo is the first appellate opinion to hold that the reasonable basis for penalty defense purposes is based on a subjective rather than objective standard.

VW Contributor: Skylar Young
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The Green Jacket of the Masters Golf Tournament is Finally a Registered Trademark

The golf season is almost here for most individuals in the United States and, for golf enthusiasts, that means the Masters golf tournament. Last year, Tiger Woods won the iconic tournament in a dramatic return to the winners circle. However, while Tiger was putting on the green jacket as the winner of the Masters, a fight over that jacket was occurring with the United States Patent and Trademark Office (“USPTO”).

On February 21, 2019, Augusta National, Inc., applied to register the green jacket as a trademark. Initially, the USPTO denied registration of the green jacket with gold buttons because they deemed it a non-distinctive product design with functional elements, thus not eligible for registration. The USPTO subsequently denied registration because the jacket was deemed a decoration and ornamentation, not an inherently distinctive service mark, thus not eligible for registration. Regardless of the reasons, the green jacket that has been awarded to the winner of the Masters since 1949, when Sam Snead won the tournament, was initially deemed ineligible for trademark registration. Ultimately, the inherently distinctive green jacket prevailed in arguments with the USPTO and it received registration almost a year later.

For businesses, this illustrates a couple important points. First, that trademark law is used for trade dress, sounds, designs, and possible even smell, not just your standard logo or words. The second is that regardless of how distinctive and historical a trademark, the registration process requires expertise and knowledge of the overall prosecution process. Of course, the attorneys are Vandenack Weaver LLC are here to help with that prosecution, even if the trademark isn’t as famous as the green jacket. As for Tiger, we will have to wait and see if he can defend his title at the Masters.


VW Contributor: Alex Rainville
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Federal Trade Commission To Evaluate Endorsements and Testimonials in Advertising

On February 12, 2020, the Federal Trade Commission (“FTC”) announced that it is seeking public comment regarding endorsements and testimonials in advertising, including those on consumer review websites. The FTC is interested in learning about the connections between the endorser, reviewer, the underlying business, and the medium in which the endorsement is posted.

The FTC is charged with enforcing the Endorsement Guides, as enacted in 1980 and amended in 2009. The Guides provide rules for businesses and other organizations to follow when using endorsement and testimonial advertising, including a requirement to disclose material connections of the endorser. The intent is to ensure that the consumer understands the connections in order to properly evaluate the credibility of the endorsement and testimonial. Based on the evolution of technology, the FTC is particularly concerned with the use of consumer review websites and whether they properly disclose the various connections and incentives.

The FTC is accepting comment from the public regarding these rules and, based on statements from commissioners on the rise of influencers and fake reviews, this could be an area that the FTC decides to revise rules and have stricter enforcement. For businesses and organizations that use consumer reviews and endorsements as a form of advertising, this is the time to ensure that the advertising and marketing efforts comply with the Guides.

VW Contributor: Alex Rainville
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Separating Claim Recovery and Lawsuit Fees: 2nd Circuit Paves Way for Better Negotiations in FLSA Claims

In Fair Labor and Standards Act (FLSA) lawsuits, recovering damages for claims is typically only one part of the discussion when negotiating settlements. Employers engaged in FLSA lawsuits and settlement negotiations with employees and their representative counsel, can quickly become aware that lawsuit costs and plaintiff’s attorney fees are a factor in the overall bargaining process. On February 4, 2020, the Second Circuit, in Fisher v. SD Protection Inc., 2020 WL 550470 (2d Cir. 2020) held that attorneys’ fee awards in FLSA claim settlements are not limited by the principle of “proportionality” in that such fees are not limited or subject to a 1/3 cap based on the amount of the overall settlement.

In the Second Circuit, settlements in FLSA lawsuits were typically subject to strict court scrutiny court review to ensure that the agreed upon terms, including the amount of attorneys’ fees, were fair and reasonable. Thus, many of the district courts within the Second Circuit applied the rule of “proportionality” and refused to approve fee amounts greater than an amount 1/3 of the total settlement.

In Fisher, however, the Second Circuit held that such a rule is at odds with the purpose of the FLSA and has the potential to discourage competent lawyers from taking on cases for low-wage workers due to such limitations on collecting attorneys’ fees. The issue in Fisher arose from a wage dispute brought by an hourly employee, which is a normal cause of action under FLSA lawsuits. The employee sued under the FLSA based on the employer’s alleged failure to pay overtime and provide mandatory accurate wage statements.

The parties reached a settlement before a class was certified, with the total settlement amount at $25,000, including fees and costs. In submitting approval for the settlement from the district court, the parties disclosed that the plaintiff would be paid only $2,000 of that amount, with the remaining $23,000 going to the employee’s attorney. The district court judge disagreed with the terms and reduced the attorneys’ fee to only $8,250, or 1/3 of the total settlement amount as a matter of general policy.

The plaintiff appealed the district judge’s actions to the Second Circuit, and in a detailed decision, the Court reversed and remanded, disapproving of the district court’s requirement of “proportionality” between the amount of the settlement and the size of the fee award. The Second Circuit held that such a rule is not mandated by either the text or the purpose of the FLSA statute. While acknowledging that the proposed split of $23,000 to the plaintiff’s attorney and $2,000 to the plaintiff “understandably gave the district court pause,” the Court rejected an “explicit percentage cap” on fee awards. The Second Circuit justified this decision as in most FLSA wage dispute cases, the plaintiffs are generally hourly workers, and favorable settlement outcomes result in limited recovery. Limiting attorney fees can dissuade competent attorneys from taking on FLSA cases when fee recovery would be proportional to only 1/3 of total recovery. The Second Circuit also criticized the district court judge for rewriting the settlement agreement instead of just simply rejecting the agreement and having the parties revise it. The Second Circuit concluded that in rewriting the agreement, the district court judge exceeded his authority.

The ruling in Fisher is good news for employers in the negotiation process of FLSA lawsuits. In practice it should allow for more free negotiating of settlements, without limitations imposed on fee awards. This ruling will hopefully foster settlements and drive down costs for all parties involved.

VW Contributor: Ryan J. Coufal
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New Rules at the Trademark Office

Effective February 15, 2020, the United States Patent and Trademark Office (“USPTO”) implemented several new rules for applicants and registrants. While these rule changes are not substantive in nature, the procedural and administrative updates are likely to cause substantive disruption for certain trademark owners and applicants. Although it is arguable what will have the largest impact, the update to the specimen requirements are likely to create new challenges.

The USPTO revised the items that are deemed an acceptable specimen. The change is designed to ensure that the specimen submitted clearly depicts the trademark in use with the specific good or service provided. By way of example, mock-ups, designs on their own, and labels without clear association with the good or service are no longer accepted. Another change includes the USPTO designating email as the only method for formal correspondence. This procedural change includes a new requirement that all registration applications must be submitted electronically, with limited exception. For attorney’s filing on behalf of a client, the attorney will also need to provide the email address for the client, as opposed to just the attorney. This requirement applies to proceedings in front of the trademark trial and appeal board as well as registration applications.

These procedural changes are the latest updates to take effect as the USPTO attempts to modernize and combat fraudulent registrations and applications. For those with a registered trademark, these changes will apply to the next required filing or, if the USPTO so elects, to an audit of the registered mark. This means that trademark owners should ensure that they continuously use their trademarks in commerce in the manner described in the trademark registration.

VW Contributor: Alex Rainville
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Seventh Circuit Follows Fifth Circuit in Holding FLSA Collective Action Opt-In Notices Should Not be Sent to Employees with Valid Arbitration Agreements

On January 24, 2020 in the case of Bigger v. Facebook, Inc., the Seventh Circuit held that a federal district trial court should not authorize notice of a Fair Labor and Standards Act (FLSA) collective action suit to employees of the defendant company who are ineligible to join the suit because they entered into agreements to resolve disputes exclusively via arbitration. The Seventh Circuit warned that without such limitations, FLSA collective actions run the risk of abuse for being too broad to opt-in and cause unfair harm to employers.

The appellate decision stems from FLSA collective action claims. Typically, early on in these types of litigation cases, plaintiffs will request that courts authorize written notice to potential plaintiffs of the opportunity to join in the collective action suit, in order to certify the collective class. These notices are generally sent to current or previous employees of a defendant employer, allowing them the opportunity to “opt-in” as another plaintiff in the suit.

In Bigger v. Facebook, Inc., a former Client Solutions Manager claimed that Facebook misclassified her as an overtime-exempt employee in violation of the FLSA. Plaintiff Bigger asked the United States District Court for the Northern District of Illinois to conditionally certify a collective action class and to authorize opt-in notice to a national collective of fellow Facebook Client Solutions Managers. In opposition to the request for notice, Facebook argued that most of the employees Bigger proposed to notify had previously entered into arbitration agreements. Facebook asserted these employees should not be classified as potential opt-in plaintiffs due to being limited to resolving disputes with Facebook through arbitration. Thus, Facebook asserted these employees should not receive any notice. The District Court held it was too early to make merits determinations at the conditional certification stage of an FLSA collective action and therefore authorized notice to the entire group plaintiff proposed, regardless of whether they had signed arbitration agreements or not.

Upon appeal, the Seventh Circuit held that the District Court should have allowed Facebook to prove that a large number of its employees had entered into arbitration agreements. The Seventh Circuit noted that the ruling is to protect employers from unfair or “dangerous” harm by stating, “notice giving, in certain circumstances, may become indistinguishable from the solicitation of claims . . . .” The Seventh Circuit thus concluded that district courts must give employers a chance to show that potential notice recipients have valid arbitration agreements.

The Seventh Circuit’s decision in Bigger followed the similar Fifth Circuit ruling last year of In re JPMorgan Chase and Company, 916 F.3d 494 (5th Cir. 2019). The rulings in these cases present a number of considerations for employers. On one hand, these rulings can make it harder for plaintiff’s counsel to use opt-in notices to identify potential plaintiffs for FLSA claims. While on the other hand, employers could run the risk of bearing the cost of arbitration for hundreds of potential FLSA claims upfront if such an issue were to arise, but be limited to arbitration.

VW Contributor: Ryan Coufal
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