IRS Reps Explain Rules on Charities, Terrorist Activity by J. Christine Harris In a discussion on terrorism and grantmaking at the Western Conference on Tax Exempt Organizations in Los Angeles November 18, officials from the IRS and Treasury examined the interplay between the tax- and non-tax-related rules designed to prevent charities from supporting terrorist activities. Date: Nov. 22, 2004 In a November 18 discussion on terrorism and grantmaking at the Western Conference on Tax Exempt Organizations, sponsored by the IRS and Loyola Law School in Los Angeles, officials from the IRS and Treasury examined the interplay between the tax- and non-tax-related rules designed to prevent charities from supporting terrorist activities. Speaking on his own behalf, Leonard Henzke Jr., a tax law specialist in the IRS's Exempt Organizations Division (Office of Rulings and Agreements), said the IRS has a "fine line to dance" because it must ensure that charitable funds are not diverted to terrorist activity, but, "at the same time, we must avoid taking actions that will inadvertently hurt the charitable communities' ability to provide funds and services in places . . . that have a great need for charitable giving." Henzke said the IRS's regulation of exempt organizations that are involved or potentially involved in terrorist activity or funding includes: (1) existing guidance on foreign grantmaking, (2) enforcement initiatives to monitor the compliance of organizations that make foreign grants or engage in foreign operations, and (3) rigid procedures under new code section 501(p) that arise from other federal laws or executive orders. He said the IRS is also interested in learning which of the "best practices" in Treasury's "Anti- Terrorist Financing Guidelines: Voluntary Best Practices for U.S.- Based Charities" are being used by charities. Although the IRS has issued guidance on domestic organizations that conduct some or all of their activities abroad (Rev. Rul. 71- 460, 1971-2 C.B. 231); EOs that distribute funds to non-501(c)(3) organizations (Rev. Rul. 86-489, 1968-2 C.B. 210); and the deductibility of donations to domestic charities that end up as gifts to foreign organizations (Rev. Rul. 63-252, 1963-2 C.B. 101), the agency is studying those rulings to see if they adequately inform charities of what measures to take to avoid financing terrorists, Henzke said. Henzke said the IRS is also developing teams to monitor charities' compliance with current guidance and to examine returns of organizations making foreign grants or having foreign operations. The compliance team "will focus on current practices, that is, the existence and effectiveness of controls put in place to monitor the distribution of overseas grants and other assistance," he said. A foreign grants team, which is expected to begin examining returns in late November, will use information obtained in the exams to determine what further guidance or enforcement action is necessary, Henzke said. Henzke said section 501(p) -- added to the code by the Military Family Tax Relief Act of 2003 (P.L. 108-121) -- requires the IRS to disallow any deductions that have been claimed for contributions to an organization that has had its exemption suspended by operation of section 501(p)(1), Henzke said. (For the Military Family Tax Relief Act of 2003, see Doc 2003-24578 or 2003 TNT 220-13 .) Interagency Jurisdiction Elaborating on section 501(p), Eric San Juan, an attorney- adviser in Treasury's Office of Tax Legislative Counsel in the Office of Tax Policy, said the suspension of an organization's exemption under section 501(p) is not considered an action of the IRS. Section 501(p) "suspends by operation of law," and the criteria used to determine which organizations have engaged in or supported terrorist activity for purposes of suspension under section 501(p) are based on non-tax-related pronouncements and information that the IRS may not have, he said. San Juan also said the "recourse for review of a [section 501(p)] designation would not be to the IRS but would be to the federal agency making the designation." If an organization is successful in having a section 501(p) designation removed or if the designation is later found to be erroneous, the organization may be entitled to a refund of any overpayment of income tax, he said. "This is all a way of saying that the tax consequences of a nontax designation are by operation of law and not by operation of the Internal Revenue Code," San Juan said, noting that the IRS and Treasury would continue to work on any necessary guidance that is within the IRS's jurisdiction. Some Advice to Practitioners Betsy Buchalter Adler, of Silk, Adler & Colvin, San Francisco, and the American Bar Association's Exempt Organization Committee chair, gave practitioners some advice on "philanthropy in a counterterrorist legal environment." She said international grantmakers should: regularly check the Specially Designated Nationals list that is maintained by Treasury's Office of Foreign Assets Control; assess the risk of diversion, based on the grantee and the circumstances; manage the risk by taking steps that are most likely to prevent diversion; and keep good records of the organization's grant procedures and risk assessments. Adler said keeping records of the grantor organization's grantmaking procedures and risk management is particularly helpful for purposes of subsequent audits or investigations of the grantor or the grantee. Citing provisions in the Uniting and Strengthening America by Providing Appropriate Tools to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001 (P.L. 107-56), she said good recordkeeping could also help an organization defend against penalties that the legislation authorizes for providing material resources or financial support for terrorism or listed persons. Under the antiterrorist funding provisions of the USA PATRIOT Act, the government must prove that the defendant organization knew or intended that the support would be used in terrorist acts or by foreign terrorist groups, Adler said. If the government prevails, those who were injured by the terrorist act may sue the funders of the group, she said.