Sending a mixed signal to the Internal Revenue Service and healthcare providers, the U.S. Tax Court issued a long-awaited decision in the first-ever test case of the use of intermediate sanctions for tax-exempt organizations.
In its ruling, the court assessed about $23 million in taxes and penalties for a so-called “excess benefit transaction” involving a Mississippi home health agency and related companies. However, it rejected the IRS’ demand for income-tax payment and the revocation of the organizations’ tax-exempt status. The court also left open the possibility that the agency’s owners could correct the illegal transaction--which involved the transfer of tax-exempt assets to for-profit organizations--and seek an abatement of the taxes and penalties.
The case involved Sta-Home Home Health Agency and five branch offices in Mississippi, owned by the Caracci family. Three of the organizations--the parent company and its branches in Forest and Grenada--had tax-exempt status.
The others--Sta-Home’s branches in Greenwood, Jackson and Forest--were created as for-profit corporations in 1995, with the Caracci family owning all resulting stock. Assets of the tax-exempt organizations were transferred to the for-profit corporations.
All six organizations, however, operated essentially as one. Sta-Home employed six members of the Caracci family--three siblings who founded the firm in 1976 and three of their children--as consultants or executives.
The IRS charged that the family undervalued the tax-exempt assets in transferring them to the for-profit corporations and demanded payment of excise taxes as a punishment for the “excess benefit transaction” under Section 4958 of the Internal Revenue Code. The section was enacted to create an “intermediate” sanction for misusing charitable funds that would be less drastic than revocation of tax-exempt status.
The agency also said the three Caracci children who benefited from the stock receipt were liable for income taxes, and it revoked the tax-exempt status of the three nonprofits. All told, it sought $256.1 million in payment and penalties.
The tax court accepted the IRS’ first contention and assessed sanctions of double the $5.16 million in excess benefits on both the family and the for-profit organizations involved, as well as a 25% excise tax.
However, the court rejected the IRS’ demand for income taxes from the Caracci children, saying the stock should be categorized as a gift and thus is not taxable. And it deemed the revocation of the tax exemptions as “inappropriate” because the organizations had not operated contrary to their charitable mission since the asset transfer and had already been assessed intermediate sanctions.
Elizabeth Mills, a tax attorney with the Chicago office of McDermott, Will & Emery, said, “This case shows that the tax court will be tough, but fair, on intermediate sanctions cases. The service went after these people with everything they could under this law.”