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The International Journal
of Not-for-Profit Law

Volume 10, Issue 4, August 2008

A publication of the International Center for Not-for-Profit Law

Table of Contents

Letter from the Editor

The Middle East:New Challenges

The Future of Civil Society in Iraq: A Comparison of Draft Civil Society Laws Submitted to the Iraqi Council of Representatives
Hoshyar Salam Malo

Civil Society in Egypt: A Catalyst for Democratization?
Nadine Hani Abdallah

Pushback Against NGOs in Egypt
James G. McGann

Articles

Legal and Institutional Mechanisms for NGO-Government Cooperation in Croatia, Estonia and Hungary
Katerina Hadzi-Miceva

501(c)(3) Money-Laundering Deterrents Off Target
Donald Morris

"Band of Brothers": Civil Society and the Making of a Terrorist
Scott Atran

Reflections of a Citizen Amidst Divided Lands on Reinventing Civil Society, Civil Liberties, and Governance in Post-Conflict Societies: Patterns, Potentials, and Challenges in the Globalized New Millennium
Shambhavi V. Murthy Gopalkrishna

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501(c)(3) Money Laundering Deterrents Off Target

Donald Morris1

The potential use of charitable organizations to provide cover for financial dealings of a less-than-charitable nature is a concern, whether in the context of international terrorism or domestic corruption. The IRS notes that investigative and law enforcement initiatives have identified situations in which charitable organizations have been a significant source of terrorist funding. One measure used to detect money laundering is the Internal Revenue Code reporting requirement when cash received exceeds $10,000. Two problems posed by the IRS cash reporting requirements affect 501(c)(3) organizations. First, the cash reporting rules do not apply to donations to a 501(c)(3) organization. Second, the cash reporting rules cause potential liability problems for legitimate charities that fail to recognize and understand their exposure. This is particularly true for trade or business transactions undertaken by exempt organizations, as this concept is considerably broader than that of unrelated business taxable income.

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The recent federal money laundering indictment of former U. S. Congressman Mark D. Siljander (R-Mich.) and officers of the Islamic American Relief Agency (IARA), a 501(c)(3) organization, is a reminder of the variety of fronts behind which terrorist-based activity may appear.2 The charity was accused of funneling money to Iraq in violation of the Iraqi Sanctions Regulations (Title 31, CFR, Sec. 575). This U.S. Executive Order prohibits the unauthorized transfer of funds to the Government of Iraq or to any person in Iraq. Officers of the Islamic American Relief Agency were also accused of using IARA’s tax-exempt status “to solicit donations from the public by representing that the donors’ contributions were tax deductible” (U.S. Dist. Ct. West. Dist. MO). The indictment also charges IARA with hiring Mark Siljander to advocate for the charity’s removal from the United States Senate Finance Committee’s list of §501(c)(3) organizations suspected supporting international terrorism.

The potential use of charitable organizations to provide cover for financial dealings of a less-than-charitable nature is a concern, whether in the context of international terrorism or domestic corruption. According to the IRS, “Investigative and law enforcement initiatives have identified situations in which charitable organizations have been a significant source of terrorist funding” (IRS Ann. 2003-29). In another recent Department of Justice indictment, an Alabama state senator and a former Baptist pastor allegedly conspired to employ a nonprofit corporation, the Heritage to Hope Foundation, Inc., to launder $300,000 in grant funds intended for GED training and a senior citizens home to the senator in the form of bribes (Department of Justice 2008). Of such mal-conceived exempt organizations, one observer notes, “Based on their representations of chaste and unadulterated adherence to charitable missions, the U.S. government granted them what now appear to be unwarranted income tax exemptions”(Crimm 2004). Public perception that even a few purported faith-based organizations are using their granted status of 501(c)(3) to undermine the communities they represent themselves to champion harms the hundreds of thousands of charities that remain true to their exempt missions.3

Cash Reporting Requirements

One of the tools used in the federal government’s battle against money laundering is IRC §6050I’s reporting requirement for cash received in a trade or business if the amount exceeds $10,000.4 Subject to certain exceptions and clarifications discussed below, the general rule of §6050I requires the recipient of such payments to report the amounts and payees to the IRS within 15 days using IRS Form 8300, “Report of Cash Payments Over $10,000 Received in a Trade or Business.”5

Whereas the reporting requirements apply to trade or business activities, including those of 501(c)(3) organizations, they do not apply to cash donations to charities (GCM 39840). The opportunity thus exists for 501(c)(3) organizations to avoid detection of certain money-laundering activities if the cash received takes the form of charitable donations. The exclusion from cash reporting for contributions to 501(c)(3) organizations means a rogue charity is free to accept donations of cash in any amount without the application of IRC §6050I.

Trade or Business Activity Not Equivalent to Unrelated Trade or Business Activity

Trade or business transactions in this context include certain fundraising activities typically carried on by charities, such as the sale of merchandise. But it is not limited to profit-oriented trade or business transactions subject to the unrelated business income tax (§511).6 This point may be overlooked by some charities. Thus, to the extent charitable organizations employ fundraising activities involving the receipt of cash—while failing to realize that such activities are construed as a trade or business under §6050I—the result may be inadvertent noncompliance. The records necessary for reporting cash receipts in excess of $10,000 may not be maintained and filing Form 8300 becomes impossible. This could happen, for example, in the operation of a charity auction.7 Because the items sold at auction are often donated and the auction itself is often run by volunteers, the unrelated business income tax does not apply. Even those knowledgeable about unrelated business taxable income, however, may assume that the exceptions to UBTI for sales of donated goods (§513(a)(3)) or businesses operated by volunteers (§513(a)(1)) exempts the charity’s trade or business operations from the cash reporting requirements. But the cash reporting rules (§6050I) and the unrelated business income tax (UBIT) rules (§511-§513) do not take the same approach to what constitutes a trade or business activity.

Trade or business under the §6050I cash reporting rules has the same meaning as in §162, relating to the sale of goods or the providing of services with the intention of generating income (IRS Notice 90-61). It does not require a business to be regularly carried on or compete with tax-paying businesses. With respect to 501(c)(3) organizations, the court in Professional Ins. Agents of Michigan stated “any activity constituting the sale of goods or performance of services to produce income for use in the exempt function will generally be trade or business. . . . [T]he profit motive rather than the extent of activity is relevant in determining whether an activity is a trade or business.” According to the IRS, “The provisions of sections 511 through 514 [relating to UBIT] of the Code does not control whether the activity constitutes a ‘trade or business’ within the meaning of section 162” (IRS Notice 90-61). Thus the problem for a charity extends beyond the unrelated business income question when considering its responsibility for reporting cash transactions in excess of $10,000. The fact that the activity is not “regularly carried on” (§512(a)(1)) is not relevant to cash reporting.8 The same factors may cause a charity receiving cash rental income, which is specifically excluded from UBIT, to presume the cash reporting requirements are not applicable as well. This is not the case, however. According to the IRS, a 501(c)(3) organization receiving a cash payment in excess of $10,000 for the rental of part of its building is required to file Form 8300 (IRS Notice 90-61).

Clarifying Cash Reporting

Because of the potential for assuming that UBIT rules coincide with cash reporting rules for charities, the need arises to clarify cash reporting requirements for 501(c)(3) organizations. The demand for a precise understanding of a charity’s reporting requirements for cash receipts is not limited to contexts where fundraising takes the form of a trade or business. Even the notion of what constitutes a contribution to a charity—and thus whether the payment is subject to the cash reporting rules—is a contentious issue. In challenging the IRS on the substance of what constitutes a charitable donation, for example, members of the Church of Scientology—a 501(c)(3) organization—have lost the argument that payments made to the church for personal audit sessions were donations deductible under §170. The court agreed with the IRS that these payments were directly related to specific services provided by the church rather than for intangible religious benefits.9 Quid pro quo payments to a 501(c)(3) are not charitable donations. If they are in cash, this places them under the reporting requirements of §6050I, unless construed in some other fashion.

This distinction is also important in situations where the payment to a charity is part donation and part payment for a good or service. This occurs, for example, where a donor pays $500 for a charity dinner receiving a meal worth $35. In such a situation, for purposes of §6050I, the charity needs to allocate cash received as part donation and part payment for goods or services, just as the donor bifurcates her payment (Rev. Proc. 90-12). This may result in part of the cash receipt being classified as a payment in connection with a trade or business activity, and therefore reportable if it exceeds $10,000.

Cash Reporting Ground Rules

In the Regulations and elsewhere, the IRS provides examples showing when the cash reporting requirements are applicable to any organization, taxable or tax-exempt. The following are specific ground rules and definitions for the application of the rules.

Illustrative Examples

Application of the ground rules and definitions is illustrated by the Service through questions and answers. Though the direct connection between the particular examples and the operations of charitable organizations may not obvious in some cases, the underlying principles of application may still be instructive, as they clarify when the cash reporting rules do or do not apply.

Several items are purchased at the same time and paid for in cash. Although none of the items is sold individually for more than $10,000, the total of the items is greater than $10,000. Does the cash reporting requirement apply?

Yes. Here the Regulations state that the “transaction” is the underlying event precipitating the payer’s transfer of cash to the recipient (Reg. § 1.6050I-1(c)(7)(3). “Transactions include (but are not limited to) a sale of goods or services and may not be divided into multiple transactions to avoid reporting under section 6050I of the Code (TAM 200501016).” Caution on the part of a charity (or other taxpayer) would thus dictate that when more than $10,000 in cash is received for several items of personal property purchased at the same time, the sales should be aggregated as one transaction. In the context of a charitable art auction, for example, one customer purchases two paintings for cash, one for $5,000 and the other for $6,000. The charitable organization should consider this one transaction of more than $10,000 cash and report the receipt to the IRS.

Does the same principle apply when what is essentially one cash transaction is paid for in two or more separate payments?

Yes. Multiple payments related to the same transaction are aggregated to measure whether the total exceeds $10,000 (Reg. § 1.6050I-1(b)). The question was posed to the IRS in the context of a customer purchasing several items of furniture, no one of which exceeded $10,000, but collectively the amount of cash paid was greater than $10,000 and the cash was paid at two or more times. According to the IRS, “The reporting requirements of section 6050I apply when a single customer purchases multiple items of personal property at the same time and pays for the purchase via a series of cash payments totaling in excess of $10,000” (TAM 200501016).

Here two separate issues are involved. The first is the aggregation of payments for a single transaction when the total cash received exceeds $10,000. This occurs, for example, when the customer puts $5,000 cash down on the purchase of $12,000 of furniture, paying the balance in cash upon delivery. The store’s responsibility is clear in such a case; it must aggregate and report both payments as one. In the non-profit context, a university or trade school receiving tuition of $12,000 in cash installments of $3,000 each would likewise fit the reporting requirement. The second issue is the aggregation of multiple items purchased for cash as one transaction explained above in the example of the charitable art auction. (Reg. § 1.6050I-1(c)(7)(3).

Can the cash reporting requirements be avoided if an individual who buys goods or services signs a note or purchases items on account rather than paying cash, but later liquidates the debt using cash in excess of $10,000?

The IRS says no. When a loan—made in the course of a trade or business—is repaid in cash exceeding $10,000, the recipient is required to file Form 8300. Assume that a 501(c)(3) organization is updating its office furniture and fixtures. In preparation it sells its old furnishings to a dealer in used office equipment accepting a note for $12,000. Three weeks later the note is extinguished with cash. The charity must report this receipt. This applies to the payment of a “preexisting debt, a contribution to a custodial account, trust or escrow arrangements or the reimbursement of expenses” (Reg. § 1.6050I-1(c)(7).

Is cash in excess of $10,000 received by one person, including an agent, for the account of a second, considered a reportable transaction by the first person? For example, when a collection agency collects cash which is applied to the accounts receivable of another trade or business, is the collection agency required to report the cash?

The Regulations say yes (Reg. § 1.6050I-1(a)(2) and (3). A 501(c)(3) credit counseling agency acts as an intermediary for a client, for example. It accepts $15,000 in cash from the client and applies the payment to satisfy the client’s creditor. Though the agency is acting only as an agent, it is still responsible for reporting the cash receipt.

What about delivery companies that collect COD payments at the point of delivery? Are they required to report cash receipts in excess of $10,000, even though the delivery company is simply the conduit for the underlying transaction between the customer and the business where the item was purchased?

According to the IRS, the answer is again yes. The service states, “If a driver receives more than $10,000 in currency (and coin), the receipt is clearly reportable under section 1.6050I-1 without regard to whether it was received in a designated reporting transaction (TAM 9718003).” The guidance goes on to clarify that if the payment received is composed partly of cash of less than $10,000 and the balance in money orders (or other financial instruments) of less than $10,000 each, the delivery company must combine the cash with the money orders (as explained earlier) and report the total on Form 8300, if the total is greater than $10,000. A charitable art gallery selling paintings on consignment is analogous.

How is the distinction between a retail business and a wholesale business drawn for purposes of determining whether a money order (or other financial instrument) less than $10,000 constitutes cash?

As noted, money orders or other financial instruments of less than $10,000, are considered cash if received in a designated reporting transaction—defined as a retail sale—involving (1) consumer durables, (2) collectibles, or (3) travel and entertainment activities. The IRS illustrates the difference with examples of retail and wholesale automobile auctions. The distinction between cash reporting requirements for retail as opposed to wholesale customers using money orders turns on whether the money order is considered cash. The Service uses the example of a sale by a retail auto auction to a customer who pays a total of $25,000 in the form of 50 $500 money orders. This is a transaction requiring reporting (Chief Counsel Advice 200211046). On the other hand, when the same transaction occurs in the context of a wholesale auto auction, the result is different. Since the basis for the reporting requirement—a designated reporting transaction—is a retail sale, the fact that this is a wholesale transaction removes the money orders from the category of cash. However, the wholesale auto auction would still report the receipt of cash (currency or coin) in excess of $10,000. In applying this provision, 501(c)(3)s must clarify for themselves whether any sales of consumer durables, collectibles, or travel and entertainment are being made to the ultimate consumer and therefore qualify as retail transactions.

In addition, reporting is required, even by the wholesale auto auction, if the recipient believes the payment of more than $10,000 in money orders (or other financial instruments), each with a face value of less than $10,000, constitutes a suspicious transaction (Chief Counsel Advice 200211046). This could occur, for example, where the customer initially tells the auto action that he intends to pay in cash in excess of $10,000. Since the auction house is required to file Form 8300 in such an instance, the auctioneer requests the customer’s Social Security number. As a result of this turn of events, the customer informs the auto auction that he has changed his mind and will pay with money orders. The customer then produces a series of $500 money orders totaling the purchase price of the car. Since this change in the form of payment could reasonably be construed as an attempt to avoid the cash reporting requirements of §6050I, it constitutes a suspicious transaction (Chief Counsel Advice 200152047). The result would be the same if the initial offer of cash was replaced with an offer to pay with a check or by some other means. Even though the payment by check is not a reportable cash transaction, a suspicious transaction is one “in which it appears that a person is attempting to cause Form 8300 not to be filed, or to file a false or incomplete form or there is an indication of illegal activity” (Chief Counsel Advice 200152047).

In analyzing the meaning of cash receipt, what is the locus of receipt? What is meant by recipient? (Reg. § 1.6050I-1(c)(8)). A department store has many cashiers, for example, and a customer makes purchases from several different cashiers during a day, where the total cash tendered exceeds $10,000 but no individual cashier receives more than $10,000. Is the cashier or the store the recipient?

In answering the question, the IRS says it depends on the facts of the case. The Regulations state that “each store, division, branch, department, headquarters, or office (‘branch’) (regardless of physical location) comprising a portion of a person’s trade or business shall for purposes of this section be deemed a separate recipient” (Reg. § 1.6050I-1(c)(8)(i)). In an analogous situation, where an individual places pari-mutuel wagers at separate racetrack betting windows, the separate cash wagers—in spite of the fact that they collectively exceed $10,000 in cash—are not assumed to be received by the racetrack but rather by each betting window (Reg. § 1.6050I-1(c)(8)(iii)(2); TAM 200501016, 1/7/2005). Each window is a separate recipient as the racetrack does not maintain an account for each patron.

On the other hand, a branch (or individual cashier) that receives cash payments is not a separate recipient if the branch has reason to know the identity of the payer making cash payments to other branches (Reg. § 1.6050I-1(c)(8)(ii). Thus if the customer is specifically identified by the store as she makes her purchases from several cashiers, and as a result the purchases are reflected in her account with the store, the IRS holds the store responsible to aggregate the individual cash payments though paid to separate cashiers (or branches) (TAM 200501016). Must a company’s right hand know what its left hand is doing? It depends. A charitable business such as a museum gift shop with multiple sales registers or conducted both at the museum and on-line should therefore examine its particular circumstances in this light.

Does payment to a racetrack in the form of a winning ticket plus cash totaling more than $10,000 constitute a reportable transaction?

The Service says no. The winning ticket is not cash, nor is it a financial instrument like a money order. The ticket may only be used at the racetrack and has no general standing as currency (Chief Counsel Advice 200012047). This fact may be important for charitable fundraising activities involving prizes or other winnings, where a winning ticket or voucher which the recipient may “reinvest” in the same activity offers an alternative to cash payments.

Conclusion

The foregoing outlines two potential problems posed by the cash reporting requirements of IRC §6050I for §501(c)(3) organizations. In the first place, as the opening discussion of Mark Siljander and the Senate Finance Committee’s list of 501(c)(3) organizations suspected of supporting terrorism indicates, money laundering by charitable organizations is not restricted to the Islamic American Relief Agency or Senator McClain. The fact that donations of cash in excess of $10,000 to a 501(c)(3) organization is not a reportable transaction under §6050I demonstrates a weakness in the legal structure intended to thwart money laundering.

Second, §6050I causes potential liability problems for legitimate charities which fail to recognize and understand their exposure to its cash reporting requirements. This is particularly true for trade or business transactions, such as charitable auctions, where the concept of trade or business, understood in the context of §162, is considerably broader than the concept of unrelated business taxable income as set forth in §511-§513. As a result, an activity which would not normally generate unrelated business taxable income—because it is not regularly carried on or is manned by volunteers or sells only donated merchandise—may yet fall within the requirements for reporting cash receipts in excess of $10,000.

References

Anderson, Alice M. and Wexler, Robert A. 2000. “Making Use of the Internet—Issues for Tax-Exempt Organizations,” Journal of Taxation, vol. 92, no. 5 (May).

Crimm, Nina J. 2004 “High Alert: The Government’s War on the Financing of Terrorism and its Implications for Donors, Domestic Charitable Organizations, and Global Philanthropy,” 45 William and Mary Law Review 1341.

Department of Justice. 2008. “State Senator Edward B. McClain and former head of nonprofit corporation charged with carrying out corrupt scheme involving over $305,000 in bribe payments.” News release, May 29, www.usdoj.gov/usao/ain.

Internal Revenue Service. Announcement 2003-29, 2003-1 C.B. 928.

---. Chief Counsel Advice 200152047.

---. Chief Counsel Advice 200211046.

---. General Council Memorandum 39840, 3/19/91.

---. Notice 90-61, 1990-2 CB 347.

---. Rev. Proc. 90-12, 1990-1 CB 471.

---. TAM 9718003, 5/2/1997.

---. TAM 200501016, 1/7/2005.

Knight, Ray A. and Knight, Lee G. 1995 “Reporting Cash Transactions,” Management Accounting, Vol. 77 (July).

Olson, Carol Duane. 1986. “Toward a Neutral Definition of ‘Trade or Business’ in the Internal Revenue Code,” 54 U. Cin. L. Rev. 1199.

Professional Ins. Agents of Michigan, 726 F. 2d 1097, 1102 (6th Cir. 1984).

United States District Court for the Western District of Missouri. Case No. 07-00087-01/07-CR-W-NKL.

1 Donald Morris CPA, CFE, PhD, teaches in the Department of Accountancy at the University of Illinois at Springfield. He holds an MS in taxation from DePaul University. Before his teaching career, he was the owner-manager of an accounting practice in the Chicago area. He is the author of Opportunity: Optimizing Life’s Chances (Prometheus Books, 2006). His article “Establishing Basis for Gambling Losses” appeared in The Tax Adviser, June 2007.

2 In addition to charges of money laundering and conspiracy to commit money laundering, the grand jury indictment includes conspiracy to violate the International Economic Powers Act and the Iraqi Sanctions Regulations, theft of public money, obstruction of justice and obstructing or impeding administration of Internal Revenue Laws. Case No. 07-00087-01/07-CR-W-NKL, United States District Court for the Western District of Missouri.

3 To promote the non-profit sector and help 501(c)(3) organizations perform their missions more effectively, the White House, though Executive Order 13199, “Establishment of White House Office of Faith-Based and Community Initiatives,” offers specific assistance such as grant writing and other administrative training for non-profits. Executive Order 13397 outlined the responsibilities of the Department of Homeland Security with respect to faith-based and community initiatives. On the harm done to the non-profit community by the actions of ill-intentioned 501(c)(3)s, one observer notes, “Some well-intentioned donors reportedly now are reticent to make charitable contributions to domestic charitable organizations. Law-abiding Muslim charities have documented a decline in contributions received, and charitable organizations are struggling to maintain their pre-September 11 levels of commitment to global philanthropy” (Crimm 2004).

4 Title 31 U.S.C. §5331 requires the same reporting and employs the same form, except that Form 8300 is filed with the Financial Crimes Enforcement Network (Fin CEN). For a thorough discussion and analysis of the federal government’s legal resources for combating international terrorism, including money laundering activities, see Crimm (2004). For a discussion of cash reporting from the accountant’s perspective, see Knight and Knight (1995).

5 Organizations exempt from federal income tax under section 501(a) of the Code are “persons” as defined in section 7701(a). Notice 90-61, 1990-2 CB 347.

6 References are to the Internal Revenue Code of 1986 as amended.

7 Charity auctions employing the Internet may add new potential for money laundering. For an article discussing the Internet’s impact on charities (though not specifically mentioning money laundering) see Anderson and Wexler (2005).

8 “‘Trade or business’ is one of the most frequently used phrases in the Internal Revenue Code (the ‘Code’), appearing in over two hundred sections and nearly three hundred and fifty subsections.” Olson (1986).

9 See for example, Graham, 83 TC 575 (1984).

10 This is the case since if the money order (or others) exceeds $10,000 and was paid for in cash, the financial institution that issued it would already have filed a report on FinCEN Form 104.

 

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