Vincent J. Fumo (D), a former Pennsylvania state senator who was convicted on federal criminal charges in 2009 for defrauding a public charity, is also subject to excise tax under Section 4958 on the charity’s funds he misused.
In 2009, Fumo was convicted in federal court of conspiring with the executive director of Citizens Alliance for Better Neighborhoods (Citizens Alliance), a tax code Section 501(c)(3) tax-exempt organization and public charity under Section 509, to use the charity’s funds to purchase vehicles, farm equipment, tools, and consumer goods for his personal use and make other expenditures on his behalf, including for foreign travel, the services of a private investigator, and cell phone service for his chauffeurs and daughter. Fumo was sentenced to 55 months in federal prison and was ultimately required to pay Citizens Alliance restitution of $1.165 million, the amount of the loss Fumo caused to the charity as determined by the federal trial court.
In May 2013, shortly before his release from prison, the IRS determined that Fumo was liable for excise tax under Section 4958(a)(1) on his ill-gotten gains, which applies whether or not the funds are subsequently returned to the charity. Generally, that section imposes a first-tier excise tax equal to 25% of any “excess benefit” received from a charity and provides that such tax “shall be paid by any disqualified person … with respect to such transaction.” A potential second-tier 200% excise tax is imposed on the disqualified person under Section 4958(b) where the excess benefit is not “corrected” within a specified “taxable period,” although the IRS apparently considered Fumo’s repayment of $1.165 million to Citizens Alliance to constitute a “correction” of the excess benefit so that Section 4958(b) was not applicable.
Subsequently, in Fumo v. Commissioner, T.C. Memo. 2021-61 (May 17, 2021), the IRS filed a motion for summary judgment with the Tax Court contending that there was no genuine dispute of fact as to Fumo’s status as a “disqualified person” with respect to Citizens Alliance and, as a matter of law, Fumo was a disqualified person subject to excise tax under excess benefit transaction rules of Section 4958. As discussed below, the U.S. Tax Court in its May 17 opinion was clearly in agreement with the IRS on this issue, rejecting Fumo’s primary argument that he could not be a disqualified person, because he was not an officer, employee, or director of Citizens Alliance and otherwise had no formal affiliation with the organization.
The Tax Court first noted that the statutory definition of a “disqualified person” under Section 4958(f)(1)(A) includes “any person who was, at any time during the five-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization,” and then carefully reviewed the “comprehensive regulations” under Section 4958 addressing this issue, including the persons holding specified powers and responsibilities with respect to a charity that are deemed to be “in a position to exercise substantial influence over its affairs.”
With respect to persons holding certain formal positions with a charity, the court noted that under Treasury Regulation Section 53.4958-3(c), voting members of the governing body, presidents, chief executive officers, chief operating officers, treasurers, and chief financial officers are, by virtue of their powers or responsibilities, automatically deemed to be “in a position to exercise substantial influence over … its affairs” and, therefore, are per se “disqualified persons” under Section 4958.
Apart from these enumerated officials who are deemed to be disqualified persons, the court, citing Treas. Reg. Section 53.4958-3(a)(1), stated that the question of whether an individual is a disqualified person generally “depends upon all relevant facts and circumstances.” Treas. Reg. Section 53.4958-3(e)(1), the court noted, specifies a nonexclusive listing of factors “tending to show that a person has substantial influence over the affairs of an organization” which the court stated include limited to:
- founding the organization,
- being a substantial contributor to the organization,
- having or sharing authority to determine a substantial portion of its capital expenditures or operating budget, or
- managing a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization.
With respect to the first factor, the court pointed out a number of facts indicating that Fumo was the founder of the charity. Fumo admitted during his criminal trial that he “created” Citizens Alliance, “gave it birth,” and “nursed it along.” He regarded it as a “constituent service” designed to curry favor with voters in his district. The organization was incorporated at his direction by three members of his senatorial staff, two of whom listed his first district office as their address. He also testified that, "[i]f it weren’t for me, … [Citizens Alliance] wouldn’t exist.” While noting that Citizens Alliance did not bear his name, that court stated that it seems clear that Fumo in substance “founded the organization.”
The court then turned to the second factor listed in regulations, which looks to whether a person is a substantial contributor to the organization, defined as a person who contributes as little as 2% of its total contributions. Section 507(d)(2)(A). Although the court stated that Fumo does not appear to have donated money to Citizens Alliance directly, he admitted during his criminal trial that he “raised money for it.” Indeed, during 1991-2004, the court noted that he was instrumental in securing at least $15 million in public grants for Citizens Alliance and a comparable volume of funding from private sources.
Although the court determined that Fumo was not technically a substantial contributor, because he did not actually make any direct contributions to the charity, the court emphasized that the regulations provide that the facts and circumstances tending to show that a person has substantial influence “include, but are not limited to,” the factors listed therein and, as such, are non-exclusive. Treas. Reg. Section 53.4958-3(e)(2).
The court found that Fumo’s role as the “chief fundraiser” for Citizens Alliance is an unlisted factor that strongly supports, by analogy with the second listed factor, his status as a “disqualified person.” In this regard, the court indicated that the regulations providing that a 2% contributor will tend to have “substantial influence” over a charity is presumably because a threat by such a donor to terminate his current level of funding would give them meaningful leverage over the charity’s decision making. Relatively speaking, the court stated, the “petitioner had much greater leverage over the affairs of Citizens Alliance because he was responsible for virtually all of its funding, albeit indirectly rather than directly.”
With respect to the factor regarding a person having or sharing authority to determine a substantial portion of its capital expenditures or operating budget, the court found that Fumo had such authority. While recognizing that Fumo was not an officer, trustee, or employee of Citizens Alliance and, therefore, lacked such authority in a formal sense, the court noted that he testified during his criminal trial that, while he did not have “a title or a job,” he “did make a lot of decisions on important topics.”
Apart from petitioner’s direct role in making important decisions, the officers of Citizens Alliance who had day-to-day authority over budget and capital expenditures were subject to petitioner’s control, because they were his employees. Accordingly, the court found that Fumo “ha[d] or share[d] authority to control or determine”—directly or indirectly—a substantial portion of Citizens Alliance’s capital expenditures and operating budget.
Finally, the clearest indication according to the Tax Court that Fumo was “in a position to exercise substantial influence over the affairs of the organization” was “that he in fact exercised such influence, and did so repeatedly over a period of many years. In this regard, the Tax Court noted that the trial court in the criminal case determined that the benefits petitioner extracted from Citizens Alliance caused it to suffer a cumulative loss of $1.165 million, and that he could not have achieved this feat without possessing “substantial influence” over the organization and its personnel.
Fumo’s principal argument for non-disqualified person treatment was that he “was neither an officer, employee, nor director” of Citizens Alliance and “held no formal position,” and that a person can only be a disqualified person if they are “formally affiliated with a charitable organization.” According to Fumo, the test under Section 4958 is not whether the individual “in fact … manipulated substantial influence” over a charity, but whether he held a position that would enable him to wield substantial influence, thereby construing the word “position” under Section 4958 to mean “office” or “job title.”
In rejecting Fumo’s argument, the Tax Court stated that the regulations make it clear that a person need not be an officer, director, or high-level employee of a charity to be a “disqualified person.” While persons holding official positions, such as chief executive officers or chief financial officers, are automatically deemed “disqualified persons” under Treas. Reg. Section 53.4958-3(c), the court stated that the status of most other individuals is governed by the “facts and circumstances” test whereby an individual can be a “disqualified person” even though they have no formal job title or formal affiliation with the charity.
Finally, the court found Fumo’s arguments for not classifying him as a disqualified person based on the fact that his staff members, not him, were the literal incorporators and that he was not technically the founder of the charity as unconvincing and constituting hypertechnical arguments that ignore the substance of what occurred.
This case serves as an important reminder that “disqualified person” status for purposes of the excess benefit transaction rules under Section 4958 can arise where a person has no formal position with a charity. The case also highlights that attempts to apply the meaning of “disqualified person” narrowly and to apply hypertechnical arguments in order to avoid such status are not likely to succeed where, regardless of whether a person lacks any formal affiliation with a charity, the facts and circumstances demonstrate, as was clearly the case in Fumo v. Commissioner, that the person is in a position to exercise substantial influence over the affairs of the charity.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Richard L. Fox is a shareholder and attorney in the Philadelphia office of Buchanan Ingersoll & Rooney, PC, where he writes and speaks frequently on issues pertaining to philanthropic planning. Richard can be reached at (215) 665-3811 and firstname.lastname@example.org.
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