Family Trust of Massachusetts, Inc. v. United States , 722 F.3d 355 ( 2013 )

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued May 15, 2013 Decided June 28, 2013
No. 12-5360
FAMILY TRUST OF MASSACHUSETTS, INC.,
APPELLANT
v.
UNITED STATES OF AMERICA,
APPELLEE
Appeal from the United States District Court
for the District of Columbia
(No. 1:11-cv-00680)
Christopher S. Rizek argued the cause for the appellant.
Matthew C. Hicks was on brief.
Jennifer M. Rubin, Attorney, United States Department of
Justice, argued the cause for the appellee. Ronald C. Machen
Jr., United States Attorney, and Kenneth L. Greene, Attorney,
were on brief.
Before: HENDERSON, TATEL and GRIFFITH, Circuit Judges.
KAREN LECRAFT HENDERSON, Circuit Judge: The Family
Trust of Massachusetts, Inc. (FTM) manages a pooled trust
established pursuant to 42 U.S.C. § 1396p(d) to provide
supplemental services and benefits to disabled individuals
receiving Medicaid, Supplemental Security Income (SSI) or
other public benefits. FTM applied to the United States Internal
2
Revenue Service (IRS) for a charitable tax exemption under
I.R.C. § 501(a) and (c)(3) based on its trustee services. After the
IRS preliminarily denied FTM’s application, FTM filed this
action seeking a declaration that it is a tax exempt charitable
organization. The district court granted summary judgment to
the government, concluding that FTM failed to satisfy two of the
statutory requirements to constitute a charitable organization: (1)
that it be “operated exclusively for . . . charitable . . . purposes”
and (2) that “no part of [its] net earnings . . . inure[] to the
benefit of any private shareholder or individual.” I.R.C.
§ 501(c)(3); see Family Trust of Mass., Inc. v. United States, 892
F. Supp. 2d 149 (D.D.C. 2012). We agree with the district court
that FTM is not operated exclusively for charitable purposes
and, accordingly, affirm the grant of summary judgment on that
ground.
I.
Eligibility for some government benefit programs, including
Medicaid and SSI, is limited by a claimant’s income and assets,
which affect whether and to what extent the claimant may
receive benefits. See Sai Kwan Wong v. Doar, 571 F.3d 247,
251 (2d Cir. 2009); Lewis v. Alexander, 685 F.3d 325, 333 (3d
Cir. 2012). Under statutory “trust-counting” rules, a trust corpus
generally is counted as an asset for the purpose of the eligibility
limits. Lewis, 685 F.3d at 333 (citing Omnibus Budget
Reconciliation Act of 1993, Pub. L. No. 103–66, Title XIII
§ 13611(d(1)(C), 107 Stat. 312 (codified at 42 U.S.C.
§ 1396p(d)(1)(C)). The Congress made an exception, however,
for a qualifying “special needs” or “supplemental needs”
trust—that is, “ ‘a discretionary trust established for the benefit
of a person with a severe and chronic or persistent disability and
[] intended to provide for expenses that assistance programs
3
such as Medicaid do not cover.’ ”1 Id. (quoting Sullivan v.
Cnty. of Suffolk, 174 F.3d 282, 284 (2d Cir. 1999)); see 42
U.S.C. § 1396p(d)(4). One form of such a trust is the “pooled”
special needs trust, which “ ‘is a special arrangement with a
non-profit organization that serves as trustee to manage assets
belonging to many disabled individuals, with investments being
pooled, but with separate trust “accounts” being maintained for
each disabled individual.’ ” Id. (quoting Jan P. Myskowski,
Special Needs Trusts in the Era of the Uniform Trust Code, 46
N.H. Bar J., Spring 2005, at 16); see 42 U.S.C.
§1396p(d)(4)(C)(iii).2 FTM was organized in March 2003, inter
alia, to manage such pooled account trusts. See Articles of
Organization, Family Trust of Mass., art. II (filed July 31, 2002)
(JA 256). FTM’s Articles of Organization identify four
individuals as directors, including Peter M. Macy. Macy is also
identified as President and Treasurer and his law office address
is listed as FTM’s “principal office.” Id. art. VII (JA 259).
In March 2004, FTM executed a trust agreement
establishing the “Family Trust for Supplemental Needs II”
(Trust)—with FTM as its trustee—“to provide for the collective
management and distribution of the Trust Estate on behalf of
persons who are disabled, as defined in 42 U.S.C. §1382c(a)(3),
for whom trust accounts are established.” Trust Agreement,
Family Trust for Supplemental Needs II § 2.020 (Mar. 23,
2004) (JA 116) (Trust Agreement). The Trust Agreement sets
the minimum contribution level for a trust account at $25,000,
payable over three years, and provides that, upon the death of a
1
Expenses the trust account covers include “books, television,
Internet, travel, and even such necessities as clothing and toiletries.”
Lewis, 685 F.3d at 333.
2
Each pooled account must have been established solely for the
benefit of a disabled individual by himself, his parent, grandparent or
legal guardian or a court. 42 U.S.C. § 1396p(d)(4)(C).
4
beneficiary, the Trust retains a portion of the residual corpus
equal to $1,000 plus five to twenty per cent of the remaining
funds, depending on the length of the account’s life. Each
account is assessed a minimum annual trustee fee of $750. The
number of pooled trust accounts grew from about 20 in 2005 to
300 by 2010, largely through referrals from “elder law”
professionals, including Macy himself. See Letter from FTM to
IRS at 4 (Mar. 2, 2009) (JA 456) (“Macy refers his own disabled
clients to the pooled trust if they meet the criteria of FTM’s
charitable class.”); Mem. from FTM to IRS ¶ 3 (Dec. 26, 2006)
(JA 313) (“Information about the benefits of or through [FTM]
is disseminated primarily through word-of-mouth in the Elder
Law legal community, but it also is presented in various treatises
and other source books for Medicaid law in Massachusetts.”).
In November 2005, FTM applied to the IRS for a tax
exemption as a “charitable” organization under I.R.C. § 501(a)
and (c)(3).3 There followed substantial correspondence between
FTM and the IRS. On February 12, 2008, the IRS sent FTM a
proposed denial of the application, stating that FTM’s trust
management services lacked the “donative element necessary”
to establish a charitable purpose. Letter from IRS to FTM at 6-7
(Feb. 12, 2008) (JA 400-01) (Proposed Exemption Denial). The
IRS explained:
You state that you charge the Trust fees that are
reasonable, consistent with the laws of Massachusetts.
Thus, you have not established that the services you
provide to the Trust are charitable within the meaning
of section 501(c)(3).
3
Section 501(a) exempts from taxation “[a]n organization
described in subsection (c),” which includes “[c]orporations . . .
organized and operated exclusively for . . . charitable . . . purposes, . . .
no part of the net earnings of which inures to the benefit of any private
shareholder or individual.” I.R.C. § 501(a), (c)(3).
5
In addition, although you state that the fees you
charge the Trust are below commercial trustee rates for
administration of trusts of the size and nature of the
assets you manage, you have not established that these
fees are substantially below your cost . . . . Therefore,
your services to the Trust are not charitable within the
meaning of section 501(c)(3) of the Code.
Id. at 7 (JA 401). The IRS also reasoned that FTM is not
“operated exclusively for the relief of the poor and distressed”
because it is the Trust—for which FTM provides “trustee
services and trust management and investment services”—that
provides such relief. Id.
Additional correspondence followed, culminating in an
August 3, 2010 conference, after which the IRS sought
additional information, including tax returns for “tax years 2007
to the present.” Letter from IRS to FTM at 3 (Aug. 18, 2010)
(JA 519). FTM responded with copies of its 2007 and 2008
returns, advising that its 2009 return would “be filed by October
15, 2010.” Letter from FTM to IRS at 11 (Oct. 8, 2010) (JA
554). FTM filed the 2009 return with the IRS on November 11,
2010.
On April 6, 2011, FTM filed a complaint in district court,
pursuant to I.R.C. § 7428(a),4 seeking a declaration that FTM “is
exempt from federal income taxation under Section 501(a) of
the Internal Revenue Code as an organization described in
Section 50l(c)(3) of the Internal Revenue Code.” Compl. at 3,
FTM v. United States, C.A. No. 11–680 (D.D.C. Apr. 6, 2011)
(JA 9). The government moved to supplement the stipulated
4
Section 7428 allows an organization that requests a section
501(c)(3) exemption but does not receive a final determination of
exemption eligibility within 270 days to seek a declaration of
exemption from the United States Tax Court, Court of Federal Claims
or District Court for the District of Columbia. I.R.C. § 7428(a), (b).
6
administrative record with FTM’s 2003 and 2009 tax returns,5
which motion FTM opposed. The district court granted the
motion, concluding that the tax returns were “pertinent returns”
within the meaning of Tax Court Rule 210(b)(12)
(“ ‘Administrative record’ includes, where applicable, . . . all
pertinent returns . . . .”). Family Trust of Mass., Inc. v. United
States, 2012 WL 3194421 (D.D.C. June 7, 2012). In September
2012, on cross-motions for summary judgment on the merits, the
district court granted summary judgment in the government’s
favor. Family Trust of Mass., 892 F. Supp. 2d at 161. FTM
timely appealed.
II.
The district court granted summary judgment on the
alternative grounds that FTM failed to meet two requirements
for a section 501(c)(3) exemption: (1) “that it is operated solely
for exempt purposes” and (2) “that its net earnings do not
provide a private benefit to any individual.” Family Trust of
Mass., 892 F. Supp. 2d at 161. “[T]he determination of whether
an organization is organized and operated exclusively for
exempt purposes is a factual determination reviewed only for
clear error.” Fund for the Study of Econ. Growth & Tax Reform
v. IRS, 161 F.3d 755, 758 (D.C. Cir. 1998); see also ASA
Investerings P’ship v. Comm’r, 201 F.3d 505, 511 (D.C. Cir.
2003) (“[I]n tax cases mixed questions of law and fact are to be
treated like questions of fact” (citing Fund, 161 F.3d at 759)).
5
The IRS sought to include the 2003 and 2009 returns in order to
emphasize the substantial increase in FTM’s “profitability” from
2003—its first year of operation when it had no revenue or
expenses—to 2009, its most recently documented tax year when it had
revenues of $667,679 and expenses of $305,155. See U.S. Separate
Filing re: Admin. R. and/or Mot. to Supplement Agreed Admin. R.,
FTM v. United States, C.A. No. 11–680, at 3-4 (Sept. 21, 2011) (JA
64-65); id. Ex. A, at 1 (JA 68).
7
Because the district court did not clearly err in determining that
FTM is not operated exclusively for a charitable purpose, we
affirm the district court on the first ground without reaching the
second.6
To qualify for the section 501(c)(3) charitable exemption,
FTM must, inter alia, be “operated exclusively for . . . charitable
. . . purposes.” I.R.C. § 501(c)(3). See IHC Health Plans, Inc.
v. Comm’r, 325 F.3d 1188, 1194 (10th Cir. 2003) (“Under
section 501(c)(3), an organization must meet three requirements
to qualify for tax exemption: (1) the corporation must be
organized and operated exclusively for exempt purposes; (2) no
part of the corporation’s net earnings may inure to the benefit of
any shareholder or individual; and (3) the corporation must not
engage in political campaigns or, to a substantial extent, in
lobbying activities.”) (footnote and quotation marks omitted);
accord Church of the Visible Intelligence that Governs the
Universe v. United States, 4 Cl. Ct. 55, 61 (1983). Under the
IRS’s test, “[a]n organization will be regarded as operated
exclusively for one or more exempt purposes only if it engages
primarily in activities which accomplish one or more of such
exempt purposes specified in section 501(c)(3)”; conversely,
“[a]n organization will not be so regarded if more than an
insubstantial part of its activities is not in furtherance of an
exempt purpose.” 26 C.F.R. § 1.501(c)(3)-1(c)(1) (emphases
added). The administrative record establishes that “more than
an insubstantial part” of FTM’s activities has been in
furtherance of a commercial rather than a charitable purpose.
In determining whether an organization “operates for a
substantial commercial purpose” we consider “various objective
6
Moreover, the parties agree regarding the operational purpose
prong that we need not decide who bore the burden of proof in district
court. See Appellee’s Br. 64; Tr. of Oral Argument at 26 (May 15,
2013).
8
indicia[, e.g., t]he particular manner in which an organization’s
activities are conducted, the commercial hue of those activities,
competition with commercial firms, and the existence and
amount of annual or accumulated profits.” Living Faith, Inc. v.
Comm’r, 950 F.2d 365, 372 (7th Cir. 1991). The objective
indicia here point to a commercial purpose underlying FTM’s
activities which are, as the district court described them,
“shrouded with a ‘commercial hue.’ ” 892 F. Supp. 2d at 159;
cf. Better Bus. Bureau of Wash., D.C. v. United States, 326 U.S.
279, 283-84, (1945) (“commercial hue permeating . . .
organization” disqualified organization from “exclusively for
. . . educational purposes” exemption from social security tax).
To all appearances, FTM operates as a commercial, for-
profit trustee. It charges fees to establish and manage the pooled
trusts and retains residual funds—the “residuals”—from the
accounts of deceased beneficiaries. As the following data show,
FTM’s operations have consistently produced revenue in excess
of expense:
Tax Year Revenue Expenses
2003 $ 0 $ 0
2004 $ 5,825 $ 628
2005 $ 53,125 $ 34,054
2006 $ 54,790 $ 53,927
2007 $194,235 $ 95,443
2008 $303,083 $182,230
2009 $667,679 $305,155
Pl.’s Reply Mem. in Supp. of its Cross-Mot. for Summ. J. at 8,
FTM v. United States, C.A. No. 11–680 (D.D.C. Dec. 21, 2011)
(JA 993); Ex. A , U.S. Separate Filing re: Admin. R. and/or Mot.
to Supplement Agreed Admin. R., FTM v. United States, C.A.
No. 11–680, at 1 (D.D.C. Sept. 21, 2011) (JA 68); id. Ex. B, at
9
1, 10 (JA 71, 79).7 Notwithstanding FTM’s profitability, its
operations manifest no countervailing “donative element” to
mark them as charitable. There is no evidence that the fees
FTM charges are below market rate, much less below cost—at
least if the residuals are taken into account. Moreover, FTM
dismissed as “not appropriate for trust administration” the
solicitation of charitable donations to defray trust costs. Letter
from FTM to IRS at 11 (Oct. 8, 2010) (JA 554); see Living
Faith, Inc., 950 F.2d at 373-74 (“lack of below-cost pricing
militates against granting an exemption,” while “lack of plans to
solicit contributions” is “relevant factor” in determining
commercial nature vel non) (citing Fed’n Pharmacy Servs., Inc.
v. Comm’r, 625 F.2d 804, 807 (6th Cir. 1980)); B.S.W. Grp., Inc.
v. Comm’r, 70 T.C. 352, 356 (1978) (furnishing services even
“at cost lacks the donative element necessary to establish . . .
activity as charitable”); id. at 359 (noting among “factors
7
FTM opposes consideration of its 2009 return, asserting the
district court erred in including it in the Administrative Record
“[d]espite the complete absence of the[] return[] at the administrative
level.” Appellant’s Br. 27. In November 2010 (when FTM filed the
return), however, the parties were still at “the administrative
level”—the IRS had not filed a final determination (and in fact never
did so) and this action was not filed in district court until April 6,
2011—some six months thence. See Family Trust of Mass., 2012 WL
3194421, at 5*. Moreover, FTM acquiesced in the IRS’s request for
the returns and, in any event, cannot claim unfair surprise at the
contents. Under the circumstances, the district court did not abuse its
discretion in including the 2009 return in the administrative record as
a “pertinent return[]” under Tax Court Rule 210(b)(12). See Cape
Cod Hosp. v. Sebelius, 630 F.3d 203, 211 (D.C. Cir. 2011) (district
court did not abuse discretion in supplementing administrative record
with comment letter agency “accepted . . . without objection”
notwithstanding party failed to comply with requirement that
commenter planning hand-delivery of comments telephone agency to
schedule same).
10
weigh[ing] against” charitable tax exemption that petitioner
“ha[d] not solicited, nor ha[d] it received, voluntary
contributions from the public” and its income came from “fees
for services . . . set high enough to recoup all projected costs . . .
and indeed, to produce a net profit”). Nor has FTM used its
burgeoning residuals revenue to offset or waive trust
management fees. Reply Br. 23; cf. Lewis, 685 F.3d at 348-49
(“Retaining the residual enables the trust to cover administrative
fees and other overhead without increasing charges on accounts
of living beneficiaries.”).8
The charitable purpose of FTM’s operations is further
undercut by the commercial trappings of its operations. The
interrelationship between FTM and Macy’s law firm—FTM’s
headquarters are in Macy’s law offices, he refers clients to FTM
and he has performed legal services for it as well—cast FTM’s
operations as a commercial offshoot of Macy’s elder law
practice. Moreover, FTM has actively marketed its services
through “word-of-mouth in the Elder Law legal community,”
Mem. from FTM to IRS ¶ 3 (Dec. 26, 2006) (JA 313)—Macy’s
professional milieu—where it is likely to find affluent and
disabled elder law clients eager to obtain FTM’s services and
able to afford the minimum $25,000 deposit and $750 annual
fee. See http://www.familytrustofmass.org/ right_for_you.html
(promoting “Family Trust” as “right for you . . . if you . . . [a]re
an Elder Law attorney or financial professional assisting clients
8
Regarding retained residuals, FTM asserted to the IRS that “all
such amounts received since the inception of FTM in fact have been
earmarked for FTM’s charitable guardianship program.” Letter from
FTM to IRS at 11 (Mar. 12, 2008) (JA 415). No guardianship
program has been established. See Tr. of Oral Argument at 6 (May
15, 2013); see also Proposed Exemption Denial at 7 (JA 401)
(“Whether the guardianship services you expect to perform in the
future will constitute a charitable activity remains to be seen. At the
present time, these services are remote and speculative.”).
11
to preserve assets against the cost of long-term care through
estate planning”) (JA 522); Living Faith Inc., 950 F.2d at 373(noting “use of promotional materials and commercial catch
phrases to enhance sales are relevant factors in determining
whether an organization operate[s] in the same manner as that
of any profitable commercial enterprise” and concluding
materials promoting organization’s restaurants, bible classes and
cooking classes had “strong commercial hue, and thus
provide[d] an indicia of a forbidden commercial purpose”)
(brackets in original; quotation marks omitted). FTM’s
marketing practices highlight its already-pervasive commercial
hue.
For the foregoing reasons, we conclude FTM is not operated
exclusively for a charitable purpose and accordingly affirm the
district court’s grant of summary judgment to the government.
So ordered.