Other Items of Interest

March 2, 2012

Legislative

IRS

Summary

In recent days:

In Fort Properties, Inc. v. American Master Lease, LLC, the Court of Appeals for the Federal Circuit ("Court of Appeals") denied patent protection to a method of aggregating encumbered properties into a portfolio of "deedshares" to facilitate Section 1031 exchanges.
Citing reports that IRS has been singling out "Tea Party groups" for special scrutiny, the chair of the Oversight Subcommittee of the House Ways and Means Committee, Rep. Charles Boustany (R-LA), wrote a second letter to IRS Commissioner, Douglas H. Shulman, supplementing his earlier request for detailed information on the agency's oversight of exemption applications.

Extended Summary

1. Fort Properties Decision

The patent described a method of aggregating properties into a portfolio of "deedshares," each encumbered by its own mortgage debt, which could be exchanged in transactions that would qualify for nonrecognition of gain or loss under Section 1031.

The plaintiff, Fort Properties, described as "a real estate company specializing in the sponsorship of tenancy-in-common tax-deferred ownership offerings," sought a declaratory judgment that it was not infringing the patent. American Master Lease, the holder of the patent, counterclaimed for infringement.

The trial court granted summary judgment to Fort Properties, citing the 2008 Court of Appeals decision in In re Bilski. There, the court denied patent protection for a method of hedging risks in commodities trading because the method did not meet the so-called "machine or transformation" test. The Bilski decision was later affirmed by the Supreme Court, but on different grounds (see our earlier commentary), with a plurality of justices rejecting the "machine or transformation" test.

The Court of Appeals reviewed the legal question de novo, affirming the result and agreeing with the plaintiff that the claimed method "consists entirely of mental processes and abstract intellectual concepts."

With the enactment of the Patent Reform Act, Pub. L. 112-29, effective September 16, 2011, tax planning strategies are explicitly no longer patentable (see our earlier commentary).

2. Boustany Letter to Shulman

In a letter dated October 6, 2011, Rep. Boustany sought information concerning audit and compliance activities, with particular emphasis on enforcement efforts directed toward organizations that "more closely resemble for-profit enterprises" than social welfare groups or charities (see our earlier commentary).

In the follow-up letter, dated March 1, 2012, Rep. Boustany sought data on the review process for applicants for exempt status under Section 501(c)(3) and 501(c)(4), including:

how many applications for exempt status were reviewed in each of the past four years;
how many were granted;
a detailed description of the review process;
how the agency determines that an application is "substantially complete," or whether additional information is needed;
whether the agency has standard forms for seeking additional information from applicants;
whether the agency has formal guidelines for determining that additional information is required; and
how many applications selected for follow-up questioning were ultimately granted.

In the opening paragraph of the letter, Rep. Boustany said his inquiry was prompted in part by reports that "IRS has been questioning new tax-exempt applicants, including grassroots political entities such as Tea Party groups, about their operations and donors."

This would appear to be a reference to, among others, the Richmond Tea Party, which recently issued a press release decrying the "outrageous demands" made upon it in the course of its still pending application for Section 501(c)(4) status. The release stated that:

the organization had filed its application more than two years ago;
it took IRS nearly nine months to send out its initial list of 17 questions;
Richmond Tea Party responded timely, "providing over 500 pages of documentation"; and
more than a year later, IRS sent another list of 12 questions in 53 subparts, including "the totally inappropriate request for a full list of our donors and volunteers."

Copies of both IRS letters were linked to the press release.

On February 21, Jamie Radtke, a Republican candidate for Senate from Virginia and a former president of the Richmond Tea Party, issued a press release saying she had written Rep. Darrell Issa (R-CA), chair of the House Committee on Oversight and Government Reform, urging him to initiate a formal investigation into the matter.

CPC Commentary

We have encountered similar questioning by IRS in applications, as in the case of the Richmond Tea Party. Our experience did not have political overtones; the Service simply did not like (and still does not like) supporting organizations and donor advised funds, no matter how charitable in nature.

It is clear the IRS does not approve of 501(c)(4) organizations that are created primarily for political lobbying for specific candidates. However, in this case, the IRS is not creating new law, but is merely enforcing existing law.

It remains to be seen whether the IRS' actions are directed at a particular group, or it is "all" 501(c)(4)s that are being heavily scrutinized. We assume it is the latter, given the Service's nonpolitical nature in recent decades, and would give them the benefit of the doubt. To a large extent, IRS employees are fair and reasonable, trying to do their job.