Watchdog Group Seeks IRS Investigation Into Church's Alleged Tax Law Violations
Watchdog Group Seeks IRS Investigation Into Church's Alleged Tax Law Violations
- AuthorsSloan, Melanie
- Institutional AuthorsCitizens for Responsibility and Ethics in Washington
- Cross-Reference
- Code Sections
- Subject Area/Tax Topics
- Industry GroupsNonprofit sector
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2007-3432
- Tax Analysts Electronic Citation2007 TNT 28-25
February 8, 2007
The Honorable Mark W. Everson
Commissioner
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20004
Dear Commissioner Everson:
Citizens for Responsibility and Ethics in Washington ("CREW") respectfully requests an immediate Internal Revenue Service ("IRS") investigation into the activities of Living Word Christian Center ("LWCC"), located in Brooklyn Park, Minnesota. Based on recently released financial documents, it appears that LWCC has illegally provided President and Senior Pastor James "Mac" Hammond with benefits that violate federal tax law. Although the subject matter of this complaint is unrelated to CREW's October 18, 2006 complaint against LWCC for illegal electioneering, the pattern of potentially illegal conduct by the church is troubling and merits investigation. Pursuant to IRS procedures, CREW is submitting a copy of this complaint to the IRS field office in Dallas.
IRC Section 501(c)(3) Requirements
Public charities, including churches, are granted special privileges under federal tax law. Among these are exemption from most income tax and the ability to confer tax-deductibility to donor's contributions. A public charity must be organized and operate exclusively to engage in charitable activities, demonstrate a minimum level of public support, and may not pass on any portion of its net earnings in a manner that inures to the benefit of private individuals. 26 C.F.R. § 1.501(c)(3)-1(c). This restricts a public charity from engaging in certain acts of self-dealing with insiders and from creating excessive compensation schemes that are not in the interest of the organization or the public benefit it is mandated to serve. Id. See also Tax Guide for Churches and Religious Organizations, I.R.S. Pub. 1828 ("Pub. 1828") (September 2003) at 4. The IRS is solely responsible for enforcing the provisions of IRC § 501(c)(3). See IRC § 7801(a)(2). See also Pub. 1828.
Background
LWCC is a church located in Brooklyn Park, Minnesota that is exempt from taxation pursuant to IRC § 501(c)(3). In the 26 years since its founding, the church has grown dramatically, expanding its worship center, purchasing several tracts of land, and making other capital expenditures. LWCC accomplished this largely through private financing. In 2004, LWCC sought a mortgage to continue its expansion. The Marshall Group, LWCC's mortgage broker, prepared a confidential information memorandum as part of the due diligence process for a loan from its affiliate, Marshall Investments Corporation. The Marshall Group, Living Word Christian Center $25,000,000 First Mortgage Loan, October 2004 ("The Marshall Group memorandum")(attached as Exhibit A) at 7. The Marshall Group memorandum detailed terms for a $25 million loan that would be used by LWCC to retire debt from a prior bank loan and return equity to private investors. Id. CREW does not know whether The Marshall Group ultimately loaned the money to LWCC.
Based on the information in The Marshall Group memorandum, it appears that LWCC may have violated tax law prohibitions on inurement and self-dealing through a series of financial transactions involving its founder, Senior Pastor and member of the Board of Trustees, James "Mac" Hammond. These transactions include a financially questionable leaseback scheme involving Mr. Hammond's planes and several personal loans made to Mr. Hammond by LWCC that appear to be disguised distributions of LWCC's earnings. Both the leaseback scheme and the private loans may well violate established inurement rules. See Founding Church of Scientology v. U.S., 412 F.2d 1197, (Ct. Cl. 1969), cert, denied, 397 U.S. 1009 (1970). Given the nature of these transactions, CREW believes that the IRS should open an immediate investigation into LWCC's financial activities pursuant to IRC § 7611.
Airplane leaseback
In 1999, LWCC sold Mr. Hammond an airplane for $1,063,000. Exhibit A at 90. The terms of the deal included $700,000 cash and a note for $363,000 payable to LWCC at 8.7% interest. Id. at 90. The loan was secured by "an airplane" according to the information in The Marshall Group memorandum, however it is unclear whether it was the plane LWCC sold to Mr. Hammond, or a second plane he owned at the time. Id. The terms of the loan dictated that Mr. Hammond pay $8,981 per month to LWCC.1 In April 2002, the balance of the airplane loan was rolled into an additional loan for $30,500, and the note was restated for $159,514 payable to LWCC at the prime rate plus 1.5%. Exhibit A at 90. Mr. Hammond paid LWCC $10,199 monthly from April 2002 until the note was paid in full in April 2003. Id. at 69.
Mr. Hammond leased two planes to LWCC under a non-cancellable operating lease that required LWCC to cover operational expenses including maintenance, fuel and staff costs. Exhibit A at 28. Based on the information in The Marshall Group memorandum, the monthly charge to LWCC under this agreement ranged from $17,008 per month to $39,422 per month, per plane. Id. at 54, 75 and 95.
Mr. Hammond enjoyed favorable financial treatment in his transactions with LWCC. Mr. Hammond paid an average of $9,590 per month to LWCC through April 2003 for the balance of the debt on the plane LWCC sold him. Exhibit A at 90. LWCC paid Mr. Hammond, at a minimum, nearly twice that amount monthly to lease the plane back from him.2 Despite the fact that LWCC had an option to purchase the plane it leased from Mr. Hammond, the church never exercised that right. Had it done so, or had the church maintained ownership of the plane it sold to Mr. Hammond, it would have incurred fewer expenses. Based on the information in these documents, it appears that LWCC made a decision to financially benefit Mr. Hammond, a member of LWCC's board of trustees. Id. at 30. LWCC also rented hangar space owned by Mr. Hammond for $3,650 per month with an option to purchase. Id. at 95. LWCC did not exercise the option to purchase the hangar, but instead allowed Mr. Hammond to borrow $155,000 from the church in 2002, using the hangar as collateral. Id. at 91. Essentially, LWCC paid Mr. Hammond to use, operate and store his own planes at his own hangar facility.
The airplane leaseback scheme appears to have violated federal tax law because it potentially inured charitable resources to the benefit of Mr. Hammond. Inurement occurs when an insider, such as a director or founder, derives a benefit from an organization's assets or resources because of his or her position. 26 C.F.R. § 1.501(c)(3)-1(c); Jean Wright and Jay H. Rotz, Reasonable Compensation, IRS Exempt Organizations Continuing Professional Education Text (1993) at 4. There is little question that Mr. Hammond was an insider of LWCC for inurement purposes. He sat on the board of trustees along with his wife Lynn Hammond, where they comprised two of the seven votes. See Exhibit A at 30. Mr. Hammond was, and continues to be, the spiritual leader and founder of LWCC and exerted significant influence over the organization. See Joe Bodell, Give 10% Or Else: Church Employees Ordered to Tithe, Minnesota Monitor (December 18, 2006) (attached as Exhibit C).
Tax law prohibits transferring property to insiders for less than fair market value. Pub. 1828 at 4. See also Founding Church of Scientology v. U.S., 412 F.2d 1197, 1202 (Ct. Cl. 1969), cert. den., 397 U.S. 1009 (1970) (disguised distribution or benefit from the net earnings constituted inurement). Mr. Hammond received favorable financial terms that allowed him to purchase a plane from LWCC and lease it back to the church. The terms of the post-sale arrangement appear to be financially worse for LWCC than they would have been had LWCC maintained ownership of the plane. The IRS has stated:
The general rule is that if the arrangements are indistinguishable from ordinary prudent business practices in comparable circumstances, a fair exchange of benefits is presumed and inurement will not be found. If the transactions depart from that standard to the benefit of an individual, a finding of inurement should be made.
Overview of Inurement/Private Benefit Issues in IRC 501(c)(3), IRS Exempt Organizations Continuing Professional Education Text (1990) at 3. Although the information available does not prove that the leaseback transaction between LWCC and Mr. Hammond fell outside of ordinary prudent business practices, there is ample evidence to warrant an IRS investigation into whether LWCC engaged in prohibited private inurement.
A related issue regarding the leaseback transaction is whether LWCC's payments to Mr. Hammond for the use of his planes sufficiently furthered its exempt purpose as a ministry. A charitable organization may spend its net earnings on ordinary and necessary expenses related to its exempt purpose, including reasonable compensation for the work done by insiders. Founding Church of Scientology, 412 F.2d at 1200. If, however, a charity compensates an insider in a manner that is not ordinary and necessary to its operations, the charity risks loss of its tax status. John Marshall Law School and John Marshall University v. United States, 228 Ct. Cl. 902, 903 (1981).
The Marshall Group memorandum notes:
[LWCC] believes that these lease arrangements are no more expensive than if secured from an independent provider. [LWCC] believes the aircraft are important to the efficient management of its ministry at the present time, and it continually reviews and assesses the economic advantages of their deployment. [LWCC] uses the airplanes to transport the Senior Pastor and/or staff to national events and speaking engagements, and to transport guests, speakers, educators, and others to and from [LWCC]'s Main Campus in the Minneapolis/St. Paul area.
Exhibit A at 28. The Marshall Group memorandum did not compare alternative airline travel options that might have saved the organization money without sacrificing its travel needs. Living Word Christian Center is located 23.9 miles from Minneapolis/St. Paul International airport, which serves 131 nonstop markets. MSPAirport.com, Statistics, http://www.mspairport.com/msp/stats/default.aspx (last visited February 7, 2007). It is unclear whether LWCC's leases for the two planes represented ordinary and necessary expenditures to further its exempt purpose, but it is clear that the ultimate beneficiary of these payments was Mr. Hammond. This warrants further investigation by the IRS.
Personal Loans
According to The Marshall Group memorandum, Mr. Hammond received eight personal loans from LWCC between 1999 and 2004:
$363,000 (July 1999)
$478,428 (December 1999)
$562,874 (June 2000)
$ 15,000 (December 2001)
$159,514 (April 2002)
$155,000 (May 2002)
$225,000 (March 2003)
$117,133 (December 2003)
LWCC potentially violated tax law because the loans may have inured to the benefit of Mr. Hammond, an insider. See John Marshall, 228 Ct. Cl. at 903 (revocation of exemptions upheld where insiders received a series of interest-free, unsecured loans). There is no evidence that Mr. Hammond mitigated his insider status by recusing himself from the board votes regarding the loans, and given his status as the spiritual leader and founder of LWCC and the significant influence he exerted over the organization, asking the church to justify the loans would be within the IRS's authority. See Founding Church of Scientology, 412 F.2d at 1201 (church should justify loans, reimbursements and other payments made to "dominant figure" in the church).
In Lowry Hospital Association v. Commissioner, 66 T.C. 850 (1976), the court upheld the revocation of tax-exempt status of a hospital that made a series of unsecured loans to its doctor's privately-owned nursing home and to a trust for his children. In supporting its holding, the court noted that the nature of the loans, and the financially questionable position taken by the hospital suggested that the loans constituted illegal inurement:
Moreover, it cannot be said that being the principal source of financing for Dr. Lowry's nursing home was in petitioner's best interest. While the interest rate received by petitioner on the unsecured loans was roughly equivalent to the interest rate it was receiving or could have received on passbook deposits from the local bank at the time the loan was made, the nursing home loans represented a substantially greater risk. An equivalent risk, incurred for a similar duration, could be expected to produce higher earnings elsewhere. Petitioner could also have used these funds to improve the hospital service to the community. Petitioner made loans which were not in its own best interest, that we do not believe would have been made by parties on an arm's-length basis, and that resulted in a financial benefit to Dr. Lowry and the trust for his children.
Id. at 858-859 (footnote omitted). Mr. Hammond's loans may have been charged at prevailing interest rates, however the terms of the payback included a lengthy period of interest-only payments, plus three separate unsecured loans. Exhibit A at 50 and 91. This suggests, as it did in Lowry Hospital Association, that LWCC's loans to Mr. Hammond were not negotiated on an arm's-length basis and, therefore, may have been illegal inurement.
Conclusion
Based on the totality of the available facts and circumstances, it appears that LWCC illegally extended private benefits to Senior Pastor Mac Hammond in violation of IRC § 501(c)(3). Because there is sufficient information pointing towards illegal activity in The Marshall Group memorandum, CREW respectfully requests that the IRS conduct a full-scale investigation into the financial transactions and internal processes that led to the airplane leaseback as well as the loans between Mr. Hammond and LWCC. The burden is on LWCC to prove it has not operated in any way for the benefit of Mr. Hammond because it is in the best position to offer details regarding its internal financial dealings and obligations. 26 C.F.R. § 1.501(c)(3)-1(d)(1)(ii). See Overview of Inurement/Private Benefit Issues in IRC 501(c)(3), IRS Exempt Organizations Continuing Professional Education Text (1990) at 28. If, as it appears, LWCC has violated the law, the IRS should seek all appropriate fines and penalties, including the revocation of LWCC's tax exempt status.
Thank you for your consideration of this important matter. Please contact me if I can provide additional information or be of further assistance.
Melanie Sloan
Executive Director
Citizens for Responsibility
and Ethics in Washington
cc: IRS -- EO Classification, Dallas
1 The Marshall Group memorandum does not contain the monthly payment information for this loan. CREW calculated the likely monthly payment based on the principle, the interest rate and the length of the loan.
2 The Marshall Group memorandum notes that Mr. Hammond leased two planes to LWCC during this period, but does not specify the rate Mr. Hammond charged for a specific plane. Based on Federal Aviation Administration registration records available to CREW, it appears that Mr. Hammond upgraded his planes periodically since 1999, but owned no more than two planes at any given time. Federal Aviation Administration Aircraft Report of James M. Hammond (January 1, 1999-present) (attached as Exhibit B). It also appears that Mr. Hammond may have sold the plane he purchased from LWCC in and used the proceeds to upgrade to a different model. Id.
3 This accounts for the April 2002 loan that rolled the unpaid balance of the July 1999 loan together with an additional $30,500 loan. Exhibit A at 90. A summary of the loan terms detailed in The Marshall Group memorandum is attached as Exhibit D.
END OF FOOTNOTES
- AuthorsSloan, Melanie
- Institutional AuthorsCitizens for Responsibility and Ethics in Washington
- Cross-Reference
- Code Sections
- Subject Area/Tax Topics
- Industry GroupsNonprofit sector
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 2007-3432
- Tax Analysts Electronic Citation2007 TNT 28-25