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TESTIMONY OF GEORGE K. YIN 

CHIEF OF STAFF 

OF THE 

JOINT COMMITTEE ON TAXATION 

AT A HEARING OF THE SENATE COMMITTEE ON FINANCE 

RELATING TO “CHARITIES AND CHARITABLE GIVING: 

PROPOSALS FOR REFORM” 

April 5, 2005 

Mr. Chairman, Ranking Member Baucus, members of the Committee, I am pleased to 

testify today about the exempt organization proposals in the recent Joint Committee on Taxation 

staff report on “Options to Improve Tax Compliance and Reform Tax Expenditures.”1

 As you 

know, the report was in response to a request of the Chairman and Ranking Member. 

In the report, the staff offered a range of proposals to address many potential causes of 

noncompliance in the tax system. In my testimony today, I will describe only the proposals 

involving the tax-exempt sector, particularly the charitable sector. I will first discuss proposals 

dealing with charitable contributions and then turn to those concerning the operation of exempt 

organizations. 

Noncompliance in Charitable Contributions 

In the case of charitable contributions, the report focuses on the most significant area of 

potential noncompliance, namely the valuation of noncash charitable contributions. 

Under present law, taxpayers are entitled to deduct the fair market value of most 

charitable contributions of capital gain property to a public charity. When property value is 

uncertain, this rule presents compliance burdens for the taxpayer, noncompliance opportunities, 

and law enforcement difficulties. Challenging taxpayer valuations is a very resource-intensive 

task for the IRS. Even a preliminary determination that the amount of a deduction may be 

 

1

 Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax 

Expenditures (JCS-02-05), January 27, 2005. 

Joint Committee on Taxation 

April 5, 2005 

JCX-14-05 R 
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questionable requires an upfront commitment of resources. If a serious challenge is to be made, 

more resources are needed to secure alternate appraisals and expert opinions. The less likely the 

threat of enforcement, the more likely is the possibility of overvaluation and noncompliance. 

Adding to the problem is the fact that the interests of the donor and donee are generally aligned 

because each wants to see the gift completed. Thus, each party has a reason to give the value 

claimed by the donor the benefit of the doubt. 

The staff report contains several options intended to improve compliance for charitable 

contributions of property. The report does not propose changing the current law rules with 

respect to cash gifts or gifts of publicly traded securities, which do not present valuation 

concerns. 

General treatment of contributions of appreciated property

First, in general, for contributions of appreciated property, the report proposes that the 

charitable deduction be equal to the taxpayer’s basis in the property. This is the present-law rule 

for contributions to most private foundations as well as contributions of certain property to 

public charities. In most cases, basis is a more certain amount than fair market value and subject 

to easier proof by the taxpayer and verification by the IRS. Thus, this option could be expected 

to improve compliance, reduce burdens and disputes, and lessen the amount of IRS enforcement 

effort. It would also eliminate the greater tax preference under current law provided to these 

types of property gifts than to contributions of cash. 

As an alternative, the report suggests that a basis deduction might apply only to taxpayers 

contributing property unrelated to the charity’s exempt function. Under this alternative, for 

example, a taxpayer could still deduct the fair market value of an appreciated gemstone given to 

a natural history museum, but could deduct only the basis of appreciated closely held company 

stock or real estate contributed to the museum. 

Used clothing and household items

The general treatment of gifts of property just discussed would not be helpful for gifts 

that have depreciated in value, such as used clothing and household items. In such cases, the 

deduction is limited to the value of the property. Thus, a determination of value is still 

necessary. 

Congress faced this same challenge last year in adopting rules for the donation of 

vehicles. Before the new rules, vehicles, like clothing and household items, were deductible at 

their fair market value at the time of the gift. Under the new rules, a taxpayer generally is not 

allowed any deduction for a contribution of a vehicle until the item is sold by the charity, at 

which point the sales price provides an indication of the proper amount of deduction. However, 

this solution obviously would not be feasible for the many thousands of items of used clothing 

and other household goods given to charities each year. 

The relatively small value of any item of clothing or household goods makes it unlikely 

that the IRS challenges many of these deductions, leaving taxpayers with significant flexibility in 

valuing such gifts. Moreover, taxpayers may have a natural tendency to overvalue such items 

due to the attachment they have to the item. 
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Because this situation is vulnerable to error and noncompliance, the report proposes that 

at a minimum, the potential amount of error should be capped. Thus, the report suggests limiting 

the deduction for gifts of clothing and household goods to $500. This option has sometimes 

been mischaracterized as granting taxpayers an automatic $500 deduction with no questions 

asked. In fact, all of the current-law substantiation requirements would continue to apply in 

order for the deduction to be available; the proposal simply limits the deduction to no more than 

$500 each year. 

Conservation easements

Unlike clothing and household items, the value of a conservation easement generally 

exceeds the taxpayer’s basis in the easement. Yet a rule limiting the charitable deduction to the 

taxpayer’s basis in the easement is of no help in easing the potential noncompliance problem 

because in most cases, the taxpayer’s basis in the easement will depend upon a determination of 

the fair market value of the property interest. Thus, if a deduction is to be allowed for 

conservation easements, a determination of value is again necessary. 

For several reasons, determining the value of conservation easements may be even more 

difficult than in the general case. First, the value of the interest given away is a function of the 

contract terms crafted by the donor, and will vary from case to case. There may be few, if any, 

comparables to help determine value. Second, conservation easements constitute only a partial 

interest in the property rights held by the taxpayer. As difficult as it may be to determine if I 

have correctly valued the old shirt I give to a charity, at least the charity owns it and I do not. 

How much more difficult would the value determination be if I retained substantial rights to the 

shirt after contributing it to the charity? Third, in many cases, taxpayers who make these 

contributions are already subject to significant State and local restrictions on the use of their 

property. Such restrictions vary considerably from jurisdiction to jurisdiction and would have to 

be taken into account in valuing the easement. 

Because these valuation difficulties present the greatest challenge in the case of 

conservation easements placed on property used by the taxpayer as a personal residence, the 

report proposes that no deduction be allowed for such contributions. For gifts of easements 

placed on other historic structures, the report proposes a deduction equal to the lesser of 5 

percent of the fair market value of the structure or 33 percent of the value of the easement. For 

all other gifts of conservation easements, the deduction would be limited to 33 percent of the 

value of the easement. Moreover, the gift must be pursuant to some clearly articulated Federal, 

State, or local government policy in favor of the conservation objective. The report also 

proposes heightened appraisal standards and requirements in the case of these contributions. 

Noncompliance in Exempt Organization Operations 

The second broad category of noncompliance in the exempt organization area is in the 

operation of the organization. An organization that is granted exemption from Federal income 

tax warrants exemption not as a matter of right but as one of privilege. To maintain exemption 

on an ongoing basis, organizations are required always to conduct their operations in a manner 

that is consistent with the basis for exemption. To the extent an organization deviates from its 

mission, there is noncompliance. 
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Five-year review

Under present law, charitable organizations are required to obtain a determination from 

the IRS that they are tax exempt as a charitable organization, and thus eligible to receive 

deductible contributions. Typically, organizations apply for charitable status shortly after they 

are formed and the IRS generally must make its determination of such status based on statements 

of intent by the organization. However, once charitable status is granted, it rarely is revoked. 

Yet organizations may change and grow significantly over time, sometimes in ways inconsistent 

with their exemption. There is no mechanism in present law requiring a periodic review of the 

basis for an organization’s charitable status. 

The report proposes that every five years, charitable organizations (other than churches) 

file with the IRS information that would enable the IRS to determine whether the organization 

continues to be organized and operated exclusively for exempt purposes. The proposal applies to 

new organizations and organizations receiving charitable status within ten years of enactment of 

the proposal. The filing would be done electronically, perhaps as a schedule to the current 

information return, and be made publicly available to encourage improved oversight of the sector 

by both the public and by State officials. The IRS would not be required to take action or make 

any determination with respect to a five-year review filing, but would have the discretion to 

review any filing and could revoke tax-exempt status retroactively or prospectively, as warranted 

by the facts and circumstances. 

As described in more detail in the report, the information to be filed as part of a five-year 

review filing would include a narrative about the organization’s prior, current, and contemplated 

operations and practices; a description of the prior, current, and contemplated trade or business 

activities of the organization and whether and how such activities are related to the 

organization’s exempt purposes; a summary of the organization’s compensation of management 

and senior employees for the previous five-year period; a description of related party transactions 

over the previous five-year period; a description of the organization’s material changes during 

the prior five-year period; and such additional information as the IRS may require. Private 

nonoperating foundations would be required to show how much of the foundation’s required 

payout was made up of administrative expenses. 

Termination tax on public charities

Related to the issue of an organization’s ongoing basis for tax exemption is the effect of a 

public charity’s dissolution, acquisition by a for-profit company, and other change of ownership 

or control. Federal tax law requires that upon dissolution, the charitable assets of the 

organization continue to be dedicated to charitable purposes. Yet there is no Federal 

enforcement mechanism of this requirement in the case of public charities. In contrast, upon 

their termination, private foundations generally are subject to a tax equal to the amount of the 

aggregate tax benefit received by the foundation over time (not to exceed the net asset value of 

the foundation), unless their assets are dedicated to charitable purposes. 

As an example of this issue, a charitable nonprofit hospital may be acquired by a forprofit hospital, thus terminating the nonprofit hospital’s charitable status. In this case, the 

“dedication to charity” requirement of present law means that the Federal government has an 
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interest in ensuring that a fair price is paid for the nonprofit hospital, and that the proceeds from 

the transaction be dedicated to charitable purposes. 

In order to provide the Federal government with a means to enforce the “dedication to 

charity” requirement, the report proposes a termination tax on liquidations or conversions of a 

public charity. The tax would also apply to private foundation terminations, and differs from the 

present law termination tax principally in that the tax would be based on the net asset value of 

the charity and not on the aggregate tax benefit. The tax could not be recovered against assets 

held by the charity for charitable purposes. The proposal also would impose the present-law 

excess benefit transaction rules to conversions of a public charity if, after the conversion, insiders 

of the public charity are also insiders of the newly converted entity. This is intended to ensure 

that when insiders are involved in the acquisition of a charitable organization, the acquisition is 

subject to the present law rules that tax abusive insider transactions. 

Exempt organization involvement in tax shelters

One of the primary compliance concerns in tax law today is abusive tax shelters. The 

increasing involvement of exempt organizations as accommodation parties in tax shelter 

transactions is a growing concern. Such transactions contribute to the erosion of the tax base by 

improperly extending the benefit of tax exemption to nonexempt persons. Tax shelters involving 

exempt organizations also raise questions about whether the facilitation of tax avoidance by an 

exempt organization can be consistent with the basis for tax exemption. Although recent 

legislation addressed many tax shelter abuses, such legislation does not prevent certain abuses 

that might be perpetrated using exempt organizations. 

The report provides for an excise tax on the participation by any exempt organization (not 

just charitable organizations) in a transaction that the Treasury Department determines is a listed 

transaction, or a reportable transaction that is a confidential transaction or one with contractual 

protection. Under the proposal, if an exempt organization participates in such a transaction, 

knowing or with reason to know that the transaction is “prohibited,” the entity is subject to a tax 

of 100 percent of the entity’s net income attributable to the transaction. If the exempt entity is 

eligible to receive deductible contributions, the Treasury Department may suspend eligibility for 

one year. The entity-level tax does not apply to certain pension plans and similar tax-favored 

accounts. An excise tax would also apply to the entity managers that approved the entity’s 

participation in the transaction. 

The proposal also addresses the case in which an exempt organization participates in a 

transaction that is later determined by the Treasury Department to be a prohibited tax shelter 

transaction. Because the exempt entity did not know at the time it entered into the transaction 

that it would later be prohibited, taxing all of the entity’s net income attributable to the 

transaction may not be appropriate. However, the proposal would impose an excise tax at the 

UBIT rate on the exempt organization’s net income from the transaction after it has learned that 

the transaction is prohibited. There also are obligations to disclose involvement in such 

transactions. 
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Other Proposals 

I will briefly touch on the other exempt organization proposals in the report. 

Private foundation excise tax rates.-- As you know, private foundations are subject to a 

special set of restrictions and excise taxes that do not apply to public charities. The excise taxes 

apply to acts of self-dealing, failure to meet the mandated payout, excess business holdings, 

jeopardizing business investments, and taxable expenditures. The tax rates on the initial taxes 

have not been revisited since their enactment in 1969. The report proposes a doubling of the 

present law initial rates of tax. 

Intermediate sanctions.-- Public charities are subject to excise taxes on so-called “excess 

benefit transactions” between the organization and an insider of the organization. This regime 

was enacted to provide a sanction short of revocation of exemption for abusive self-dealing 

transactions by public charities. The report concludes that the sanction would be more effective 

if certain changes are made. For example, present law provides organization insiders with a 

presumption that a transaction is reasonable if certain steps are taken. The report recommends 

eliminating the presumption of reasonableness because it unnecessarily gives the taxpayer a 

procedural advantage on a matter that already is difficult to enforce. The report also suggests 

modifying the “initial contract exception” so that the sanctions apply to a contract by an 

organization with a person who is contracting for a position of substantial influence within the 

organization. 

Form 990-T.-- The report suggests that the Form 990-T, which exempt organizations file 

to report unrelated business taxable income, be made public, so as to provide the public with a 

better picture of an organization’s business activities. The report also proposes that large exempt 

organizations obtain a certification from an independent auditor or counsel regarding the 

organization’s reporting of the unrelated business income tax. 

Other proposals.-- The report contains proposals that (1) require small charitable 

organizations to file short annual returns, (2) expand the base of the tax on the net investment 

income of private foundations, (3) limit the tax-exempt status of fraternal beneficiary societies 

that provide commercial type insurance, and (4) establish additional exemption standards for 

credit counseling organizations. 

* * * 

We will continue to examine compliance issues in the exempt organizations area and give 

consideration to possible additional proposals beyond those contained in the report. 

Thank you very much for this opportunity to testify.