Mr. Soros Goes to Washington:

The Case for Reform of the Estate and Gift Tax Treatment of Political Contributions

Eric G. Reis

Partner Thompson & Knight L.L.P. 1700 Pacific Avenue, Suite 3300 Dallas, Texas 75201 214/969-1118 214/880-3183 (fax) [email protected]

Mr. Soros Goes to Washington: The Case for Reform of the Estate and Gift Tax Treatment of Political Contributions

∗ Eric Reis

I. Introduction

Politics is a billion-dollar growth industry.1 Despite Congressional efforts to restrain political spending, individual donors continue to make multi-million-dollar contributions.2 These contributions are often made through lightly-regulated “527” organizations, named for the section of the Internal Revenue Code that governs their operations.3 Like any surging business, 527 organizations and more conventional campaign funds attract contributors who have a keen interest in short-term success.4 But long-term political movements have also developed, soliciting funds for projects that will continue long after the rise or fall of a particular politician. The National Rifle Association actively solicits very long-term gifts and bequests to its sister charity, the NRA Foundation,5 with significant success.6 The political purpose of these bequests is only thinly veiled.7 More conventional political

∗ Partner, Thompson & Knight LLP, Dallas, Texas. A.B. 1992, Harvard University; J.D. 1996, The University of Texas School of Law, Austin. 1 See Center for Responsive Politics, 2004 Election-Overview: Stats at a Glance, at http://www.opensecrets.org/overview/stats.asp?cycle=2004 (reporting total campaign contributions of $1.35 billion to all candidates for federal office in the 2004 election cycle); Institute on Money in State Politics, Follow the Money, at http://www.followthemoney.org/database/power_search.phtml?sl=10 (select “All States” and “2004”) (reporting total campaign contributions in excess of $1.6 billion to candidates for state office in the 2004 election cycle). 2 See, e.g., Center for Responsive Politics, George Soros Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001147458&Cycle=2004 (reporting contributions by Mr. Soros of over $12 million to Joint Victory Campaign 2004, $7.5 million to America Coming Together, $2.5 million to MoveOn.org, and smaller amounts to other organizations); Center for Responsive Politics, T. Boone Pickens Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001162782&Cycle=2004 (reporting contributions by Mr. Pickens of $2.5 million to Progress for America, $2 million to Swift Boat Veterans for Truth, and $100,000 to the Club for Growth). 3 I.R.C. § 527. 4 Rick Klein & Charlie Savage, Some Democrats Decry Kerry’s Unspent $16M, BOSTON GLOBE, Nov. 19, 2004, at A2 (reporting criticism of Senator John Kerry for retaining campaign funds past election day in 2004). 5 The NRA Foundation, Estate Planning/Heritage Society, at http://www.nrafoundation.org/giving/ planned_giving.asp. 6 See National Rifle Association, NRA Foundation Receives Record-Breaking $1 Million Bequest, at http://www.nra.org/Article.aspx?id=2345 (“Longtime NRA member Andrew Burns of Wysox, PA has left a record-breaking bequest of $1 million to The NRA Foundation, helping to preserve America’s legacy of freedom for future generations.”). 7 See id. (“Many individuals are concerned that the freedom they have enjoyed under the Second Amendment may not last for their children or grandchildren to experience and cherish. That’s why they have provided a legacy of freedom in their estate planning by contributing to the programs and activities of The NRA Foundation.”).

- 1 - organizations, such as Senator John Kerry’s 2004 presidential campaign, also now appear to solicit and retain contributions with an eye toward more than one election cycle.8 This growing interest in long-term political giving mimics an older trend in charitable giving. Nearly every large charity (including such well-known institutions as the United Way, American Red Cross, Boy Scouts of America, and Harvard University) has a “planned giving” program to encourage donors to make long-term and testamentary gifts in the most tax-favored manner.9 Charities with strong political interests (including Planned Parenthood and the libertarian Cato Institute) have also established such programs.10 It seems only a matter of time before purely political organizations develop similar programs. Curiously, however, the current estate and gift tax treatment of political contributions is based on the premise that donors do not have long-term political interests and will not attempt to make deferred gifts and bequests for political causes.11 Bequests to political organizations are subject to estate tax, for no apparent policy reason.12 On the other hand, lifetime gifts to a political organization are wholly exempt from gift tax, without regard to when the contribution may actually be used.13 Once one accepts that some taxpayers do have an interest in long-term or deferred political giving on a large scale, serious weaknesses in the current estate and gift tax regime for political contributions become apparent. In this article, I argue that the current regime is both too strict and too lenient in its approach to such contributions. The regime is too strict, in that it flatly denies any estate tax deduction for bequests to a political organization.14 This is contrary to good public policy, as a bequest at death is less likely to have a corrupting influence on public officials than a gift made during lifetime. Conversely, the regime is too liberal, in that it allows an unlimited gift tax exclusion for contributions made during lifetime.15 This unlimited exclusion could be used to facilitate very large nonpolitical transfers to a donor’s family, much as other gift tax exclusions and deductions were used prior to the adoption of restrictive rules.16

8 BOSTON GLOBE, Nov. 19, 2004, at A2. 9 See United Way, Welcome to the United Way Planned Giving, at http://www.uwgift.org/ plgive_main.jsp?WebID=GL2002-0020; American Red Cross, Planned Giving, at http://www.redcross.org/donate/plngiv; Boy Scouts of America, Welcome to the Boy Scouts of America Planned Giving, at http://www.bsagiftplan.org; Harvard University, Harvard University Planned Giving, at http://post.harvard.edu/harvard/pgo/html/index.htm. 10 See Planned Parenthood Federation of America, Inc., Bequests and Planned Gifts, at http:// www.plannedparenthood.org/pp2/portal/files/portal/getinvolved/donate/learn_pp_gifts.xml; Cato Institute, Welcome to Planned Giving at Cato, at http://www.cato.gift-planning.org/index.php. 11 See Carson v. Comm’r, 71 T.C. 252, 261-62 (1978) (“The vicissitudes of politics make political candidates an unlikely object for a decedent to “settle” his estate on, and an aspiring politician planning to finance his political ascendancy on testamentary campaign contributions may not rise far or fast.”), aff’d, 641 F.2d 864 (10th Cir. 1981). 12 Carson, 71 T.C. at 262 (“[I]t is quite clear that a legacy to a campaign fund would form part of the taxable estate.”); see generally I.R.C. §§ 2051-2058 (specifying the particular items that may be deducted in computing a decedent’s taxable estate, which items do not include political contributions). 13 I.R.C. § 2501(a)(4). 14 Carson, 71 T.C. at 262. 15 I.R.C. § 2501(a)(4). 16 See, e.g., Hipp v. United States, 215 F. Supp. 222, 223, 228 (W.D.S.C. 1962) (allowing a large gift tax charitable deduction for a gift in trust, where the trust was required to pay only an uncertain amount of

- 2 - In Part II of this article, I explore the planning techniques that were used to exploit the gift tax charitable deduction prior to the adoption of restrictive rules in the Tax Reform Act of 1969, and to exploit the exclusion for “retained interests” prior to the enactment of Chapter 14 of the Internal Revenue Code in 1990. I also note that these techniques may still be used to exploit the gift tax annual exclusion under present law. In Parts III and IV of this article, I analyze the structure of the gift tax exclusion for political contributions and consider how this exclusion might likewise be used to facilitate tax-free transfers to members of the donor’s family. In Part V, I examine the estate tax treatment of bequests to political organizations, and describe how taxpayers can effectively avoid tax on such bequests even under existing law (making this tax little more than a trap for the unwary). Finally, in Part VI, I argue for several significant reforms. These reforms include the adoption of rules limiting the gift tax exclusion for political contributions, and the enactment of an estate tax deduction for bequests to political organizations.17

II. A History of Artificial Valuation

To understand how the gift tax exclusion for political contributions might be used, it is helpful to consider how similar deductions and exclusions were manipulated under prior law.18

A. The Gift Tax Charitable Deduction

Before enactment of the Tax Reform Act of 1969, charitable contributions of “partial interests” in property were generally deductible for federal gift tax purposes.19 (A “partial interest” consists of some, but not all, of the bundle of rights constituting ownership of property.20) Taxpayers soon found ways to exploit this deduction. income to charity, for a limited period of time, and then distribute the principal to the taxpayer’s children); Saltzman v. Comm’r, 68 T.C.M. (CCH) 1544, 1556, 1567-68 (excluding over half the value of the taxpayer’s contribution to a trust from gift tax, where the trust paid very little income to the taxpayer for a limited period of time and then distributed the principal to the taxpayer’s son), rev’d on other grounds, 131 F.3d 87 (2d Cir. 1997). 17 This article does not consider the broader debate on whether the federal estate tax should be repealed. See Ed Feulner, Keep the Death Tax Dead, WASH. TIMES, Sept. 19, 2005 (supporting repeal of the estate tax); Bill Gates Sr. & Chuck Collins, Don’t End Estate Tax at Time of War, Disaster, CHARLOTTE OBSERVER, Sept. 15, 2005 (opposing repeal of the estate tax). Rather, I work from a premise both sides may support: that if we are to have an estate and gift tax system, it should operate as efficiently, fairly, and consistently as possible. 18 Throughout this article, I use terms such as “manipulate” and “exploit” to describe strategies that take full advantage of flaws or inconsistencies in the tax system. By using such terms, I do not criticize taxpayers who use the planning techniques permitted under applicable law, even where that law seems flawed. Cf. Helvering v. Gregory, 69 F. 2d 809, 810 (2d Cir. 1934) (Hand, J.) (“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”), aff’d, 293 U.S. 465 (1935). 19 See S. REP. NO. 91-552, 91st Cong., 1st Sess. (1969), reprinted in INTERNAL REVENUE ACTS 1966-1970, at 1639, 1728, 1733 (West 1971) (describing then-current law on charitable contributions of partial interests in trust). 20 See Treas. Reg. § 25.2522(c)-3(c)(1)(i) (as amended in 2001) (disallowing the gift tax charitable deduction for most transfers of partial interests after July 31, 1969).

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1. Donation of Income Interests in Trust

In Hipp v. United States, the taxpayers (a married couple) contributed stock in a closely held corporation to a trust.21 The trust agreement directed the trustees to pay the trust’s income to unspecified charities for a period of ten years, and then deliver the trust corpus to the taxpayers’ children.22 The stock had a current income yield of 0.62% at the time of the gift, though the taxpayers argued (and the court agreed) that the expected yield would be higher based on the corporation’s past history of dividend increases and stock splits.23 However, the taxpayers’ family controlled more than 50% of the voting stock of the corporation and could therefore determine its future dividend policy.24 The taxpayers computed the value of the gift to their children by deducting the value of the charities’ income interest from the total value of their contributions to the trust.25 Importantly, the taxpayers determined the value of the charities’ income interest by referring to standard actuarial tables promulgated by the Treasury.26 These tables assumed that the property would generate an income yield of 3.5% – over five times as much as the stock’s actual income yield at the time of the gift.27 Thus, using these tables arguably overstated the value of the charities’ interest by a factor of five or more, greatly depressing the purported value of the grantors’ gift to their children. Nevertheless, the court upheld the use of the tables as a reasonable method for valuing the gift.28 The court noted “how difficult it is to determine income from [the corporation’s] common stock during the period of the trust” by any other means.29 While acknowledging that “the tables may seldom accurately predict the value in a particular situation,” the court asserted that “they do prove to be accurate when used in a great number of circumstances.”30 The court also cited with approval a prior court’s observation that “‘the United States is in business with enough taxpayers so that the law of averages has ample opportunity to work.’”31 With the benefit of forty years’ hindsight, we can see that this conclusion was somewhat naïve. Like a person who signs up for health insurance only after becoming sick, taxpayers will engage in transactions of this type only when the inaccuracies work to their advantage. The Hipp case was particularly favorable to the taxpayers, and it should be noted that other cases gave the Internal Revenue Service some defenses against the most artificial applications of the rules. For example, in Hamm v. Commissioner, the taxpayer contributed common stock in a corporation to a trust that was to pay its income to charity

21 Hipp v. United States, 215 F. Supp. 222, 223 (W.D.S.C. 1962). 22 Id. 23 Id. at 225-26. 24 Id. at 224. 25 See I.R.C. § 2522(a) (“In computing taxable gifts for the calendar year, there shall be allowed as a deduction . . . the amount of all gifts made during such year to or for the use of” certain charities, governmental entities, and other organizations.). 26 215 F. Supp. at 224; Treas. Reg. § 25.2512-5A(b) (as amended in 2000). 27 Treas. Reg. § 25.2512-5A(b). 28 215 F. Supp. at 228. 29 Id. at 227. 30 Id. at 226. 31 Id. (quoting Gelb v. Comm’r, 298 F.2d 544, 552 (2d Cir. 1962)).

- 4 - for a period of years, and then distribute its corpus to the taxpayer’s children.32 The common stock in question had never paid a dividend since the corporation’s inception 16 years earlier, and could not pay a dividend in the future until the corporation first satisfied $3.7 million of delinquent dividends payable with respect to outstanding preferred stock.33 Under these extraordinary circumstances, the court determined that the charity was unlikely to receive any benefit from the trust and disallowed any gift tax deduction for the value of the charity’s income interest.34 Notwithstanding occasional victories such as Hamm, the Internal Revenue Service came to recognize that it was losing the overall war against taxpayers who made gifts of partial interests in property. In Revenue Ruling 77-195, the Service effectively conceded the issue except in the most extreme cases.35 In this ruling, a taxpayer contributed stock in a corporation to a trust that was to pay income to a particular beneficiary for a term of years. The stock had historically paid only a 3% annual dividend, but actuarial tables then in effect assumed an annual yield of 6%. Nevertheless, the Service held that it would be appropriate to use the tables to determine the value of the income interest for gift tax purposes.

2. A Hammer Falls: TRA 1969 Obliterates Common Uses of the Charitable Deduction

The Service’s concession in Revenue Ruling 77-195 may have been hastened by legislative developments. The Tax Reform Act of 1969 (“TRA 1969”) solved the valuation problem in a drastic and highly effective manner, by simply disallowing any gift tax, estate tax, or income tax charitable deduction for most gifts of partial interests in property to charity.36 This made the valuation issue moot for most charitable gifts. After TRA 1969, a taxpayer could obtain a gift tax charitable deduction for a term interest or remainder interest only if the interest was structured in a form prescribed by statute and designed to be easy to value. A taxpayer could deduct the value of a term interest in trust only if the trust provided for payment of a fixed dollar amount (an “annuity” interest) or a fixed percentage of the trust assets (a “unitrust” interest) to charity each year.37 A taxpayer could deduct the value of a remainder interest in trust only if it followed an annuity or unitrust interest.38 Most other gifts of partial interests in property to charity, whether in trust or otherwise, were nondeductible.39 This provision, known as the “partial interest rule,” made it all but impossible for taxpayers to manipulate the gift tax charitable deduction by carving up their interests in creative ways.

32 Hamm v. Comm’r, 20 T.C.M. (CCH) 1814, 1816 (1961), affd, 325 F.2d 934 (8th Cir. 1963), cert. den., 377 U.S. 993 (1964). 33 Id. at 1837. 34 Id. at 1837, 1839. 35 Rev. Rul. 77-195, 1977-1 C.B. 295. The ruling does not specifically refer to the gift tax charitable deduction, but states its holding in general terms applicable to valuation of any income interest. 36 See I.R.C. §§ 2522(c)(2) (disallowing the gift tax charitable deduction), 2055(e)(2) (disallowing the estate tax charitable deduction), and 170(f)(2)(B) (disallowing the income tax charitable deduction). 37 Id. § 2522(c)(2)(B). 38 Id. §§ 2522(c)(2)(A), 664, 642(c)(5). 39 Id. § 2522(c)(2).

- 5 - TRA 1969 imposed other restrictions (known as the “self-dealing rules”) that also made it difficult for taxpayers to manipulate their gifts to charity. Prior to 1969, a taxpayer might give a partial interest in property to a family charity (now known as a “private foundation”) that could be expected to cooperate fully in the transaction.40 The foundation’s directors, typically comprised of family members or their designees, would not complain when the property in question was managed or invested in a manner that generated little immediate benefit for the foundation. Similarly, if the gift were made in trust, the trustees could be expected to cooperate with the plan. These strategies were restrained by the enactment of excise taxes that harshly penalize “self-dealing” transactions between private foundations and certain “disqualified persons,” including substantial contributors and members of their family.41 These excise taxes also penalize self-dealing transactions between a split-interest trust (essentially, any trust that has received a contribution for which a person obtained a gift tax, estate tax, or income tax charitable deduction) and disqualified persons.42 More recently, Congress reinforced these rules by establishing new excise taxes penalizing “excess benefit transactions” between disqualified persons and charities other than private foundations.43 “Excess benefit transaction” is defined to include certain transactions in which a charity “directly or indirectly” provides an economic benefit to a disqualified person.44 While this excise tax regime is not as onerous and restrictive as the regime applicable to private foundations, it provides another useful check on use of the gift tax charitable deduction. Thus, a taxpayer who wishes to manipulate the gift tax charitable deduction must somehow comply with the new partial interest rule; must not make the contribution in trust; and must find a charity willing to cooperate with the taxpayer’s plan that is not controlled by the taxpayer or the taxpayer’s family. Even then, the taxpayer risks being penalized if the plan is found to be an “excess benefit transaction.” This regime is not airtight, but severely limits planning opportunities. As discussed in Part III of this article, infra, political organizations are not subject to the self-dealing rules or the excess benefit transaction tax regime. Furthermore, the gift tax exclusion for contributions to political organizations is not subject to the partial interest rule, though other (less restrictive) rules apply.

B. Manipulation of Retained Interests

Even before TRA 1969, taxpayers’ ability to exploit the gift tax charitable deduction was subject to certain natural limits. A taxpayer with no charitable inclinations would find it difficult to exploit the gift tax charitable deduction, as even the most aggressive strategies would normally require the payment of some amount to charity.

40 See, e.g., Hamm v. Comm’r, 20 T.C.M. (CCH) 1814, 1816, 1837 (1961) (describing the taxpayer’s contribution of an income interest in property to a foundation bearing the taxpayer’s name, and noting that the property did not in fact generate any income). 41 I.R.C. §§ 4941, 4946(a). 42 Id. § 4947(a)(2). 43 See id. § 4958 (imposing excise taxes on “excess benefit transactions” between charities and disqualified persons). 44 Id. § 4958(c)(1)(A).

- 6 - Soon, however, savvy taxpayers discovered another exclusion that was effectively unlimited. These taxpayers found that they could carve up their property rights in creative ways, transfer some of these rights to their descendants, and retain other rights that depressed the value of their gift for tax purposes.

1. Retention of Preferred or Lapsing Rights in Business Entities

Snyder v. Commissioner is perhaps the most celebrated example of these strategies.45 In Snyder, the taxpayer owned stock in W. L. Gore & Associates (“Gore”), a publicly traded company best known for its development of Gore-Tex®, a fabric used in raincoats.46 The company was phenomenally successful, increasing in value from $48.50 per share on March 31, 1977 to $8,640 per share on March 30, 1981, and appeared poised for further growth.47 The taxpayer sought to transfer this growth to her great- grandchildren at only a nominal gift tax cost.48 To accomplish her objective, the taxpayer incorporated a new company (“Libbyfam”) with three classes of stock: common stock, Class A preferred, and Class B preferred.49 The Class A preferred shareholders were entitled to a noncumulative annual dividend of 7% and could convert their shares to Class B preferred shares at any time.50 The Class B preferred shareholders were entitled to a cumulative annual dividend of 7%, payable only after dividends had been paid to the Class A preferred shareholders, and could compel the company to redeem their shares at par upon 14 days’ notice.51 The common shareholders held the remaining interest in Libbyfam. The taxpayer contributed 300 shares of stock in Gore to Libbyfam in exchange for all of the Class A preferred shares, and caused all of the common shares to be issued to a trust for her great- grandchildren.52 No Class B preferred shares were issued.53 Less than $11,000 in dividends were paid to Class A preferred stockholders over the next several years.54 Based on the then-current price of $8,640 per share for Gore stock, the market value of the taxpayer’s contribution to Libbyfam was nearly $2.6 million. Strikingly, however, the Tax Court concluded that the value of the Libbyfam common stock that she transferred in trust was only $1,000.55 In effect, the taxpayer’s preferred interest in Libbyfam “crowded out” the value of the common shares. The actual value of the common shareholders’ interest was ultimately much greater, however. By June 30, 1985,

45 Snyder v. Comm’r, 93 T.C. 529 (1989). 46 Id. at 535; Gore-Tex® and Windstopper® Fabrics | Technology, http://www.gore-tex.com (follow link to “Technology”). 47 93 T.C. at 535 & n.1. 48 Id. at 536-37. 49 Id. at 536. 50 Id. A shareholder’s right to receive noncumulative dividends lapses at the end of each year; if the corporation does not pay all or part of the dividend in any given year, the balance is not carried forward to future years. 51 Id. A shareholder’s right to receive cumulative dividends is more definite. If the corporation does not pay all or part of the dividend in any given year, the balance is carried forward. 52 Id. 53 Id. at 537. 54 Id. 55 Id. at 545.

- 7 - Gore stock had increased in value to $17,800 per share, causing Libbyfam to be worth over $5.3 million.56 Nearly the entire increase in value (less only modest dividends paid to the taxpayer as the Class A preferred stockholder) inured to the benefit of the taxpayer’s great-grandchildren. The taxpayer’s strategy in Snyder was not a total success. The Tax Court held that she made an additional gift to her great-grandchildren by failing to exercise her right to convert her Class A noncumulative preferred stock to Class B cumulative preferred stock (thereby foregoing the larger dividends she could have received as a Class B stockholder).57 Importantly, however, the Tax Court also held that the taxpayer’s failure to redeem her preferred stock did not constitute a gift.58 Thus, it appears that with only modest changes in the Libbyfam structure (e.g., by establishing only one class of preferred interest, with noncumulative dividend rights), the taxpayer could have transferred over $2.7 million of appreciation in Gore stock to her great-grandchildren at a gift tax value of little more than $1,000.59 Certainly, Congress worried that this could be accomplished under the gift tax laws then in effect.60 Taxpayers found other ways to manipulate retained interests for the benefit of their descendants. In Estate of Harrison v. Commissioner, the decedent and his two sons had contributed assets to a newly formed limited partnership, in exchange for interests proportionate to their contributions.61 The decedent received a 1% general partnership interest and a 77.8% limited partnership interest, while each son received a 10.6% limited partnership interest.62 As general partner, the decedent had the right to dissolve the partnership at any time, but this right lapsed upon his death.63 The partnership agreement also gave the sons the option to purchase the decedent’s general partnership interest at his death, which they exercised.64 The estate and Internal Revenue Service agreed that the decedent’s limited partnership interest was worth approximately $59.5 million immediately prior to his death, that being the value of the decedent’s pro rata share of the partnership assets.65 The estate and Internal Revenue Service also agreed that the decedent’s limited partnership interest was worth only $33 million immediately after his death, when his right to liquidate the partnership lapsed.66 This discrepancy reflected the fact that an

56 Id. at 537. 57 Id. at 547. 58 See id. at 546-47 (distinguishing between debt and equity investments, and observing that a taxpayer’s decision to retain an equity investment that generates a low current return does not necessarily constitute a gift). 59 In determining that the Gore common stock had a gift tax value of only $1,000, the court took into account the potential impact of the taxpayer’s redemption right on the value of the common stock. Id. at 545. Therefore, the gift tax value of the common stock may have been moderately higher absent the redemption right. 60 See COM. REP. ¶ 27,011.11, PUB. L. NO. 101-508 (1990). 61 Estate of Harrison v. Comm’r, 52 T.C.M. (CCH) 1306, 1307 (1987). 62 Id. 63 Id. 64 Id. 65 Id. at 1308. 66 Id.

- 8 - illiquid, unmarketable limited partnership interest without voting rights is worth substantially less than its pro rata share of the underlying partnership assets.67 The Tax Court held that the lower value should be used for federal estate tax purposes, because that value reflected the property interest that actually passed from the decedent at the moment of death.68 Thus, Harrison took the result in Snyder one step further: Not only could a taxpayer’s retained interests be taken into account to avoid application of gift tax, as in Snyder, but they could be structured in such a way as to “disappear” upon the decedent’s death, avoiding estate tax. Snyder and Harrison, taken together, opened a gaping hole in the estate and gift tax system through which value could simply vanish.

2. Retention of Interests in Trust

Taxpayers’ manipulation of retained interests was not limited to corporations and partnerships. Taxpayers also found that they could retain interests in trusts that artificially depressed the value of a gift to their descendants. In some ways, these trusts, known as “grantor retained income trusts” or GRITs, resembled the charitable income trusts described in Part II.A of this article, supra. However, the grantor would retain an interest in the trust rather than give this interest to charity. For example, in Saltzman v. Commissioner, the taxpayer contributed an undivided 80% interest in 40.2 acres of land to a newly formed trust. 69 The trustees were directed to pay all of the trust’s income to the taxpayer for 10 years, and then distribute the principal to the taxpayer’s son.70 If the taxpayer died within the 10-year term, he would have the general power to appoint the trust principal to anyone by will.71 In computing the value of the taxpayer’s gift to his son, the Tax Court took into account both of his retained interests. First, the court deducted the value of the taxpayer’s retained income interest, determined using standard tables published by the Internal Revenue Service.72 At the time, these tables assumed that an income interest would pay 10% each year.73 In reality, the trust paid no income.74 Nevertheless, the court held that it was appropriate to use the standard tables because the trustees had discretion to sell the trust property and reinvest in income-producing assets.75 Second, the court deducted the value of the taxpayer’s retained reversionary interest, i.e., his right to designate who would receive the trust assets if he died during the 10-year term.76 This greatly depressed the value of the taxpayer’s gift, as the taxpayer

67 See id. (“The difference between the two values is attributable entirely to the right which decedent had as a general partner up until his death to force a dissolution of the partnership.”). 68 Id. at 1308-09. 69 Saltzman v. Comm’r, 68 T.C.M. (CCH) 1544, 1556 (1994), rev’d on other grounds, 131 F.3d 87 (2d Cir. 1997). 70 Id. 71 Id. at 1556, 1568. 72 Id. at 1567-68 73 Treas. Reg. §§ 25.2512-5A(d)(1)(ii), (d)(6)(i) (as amended in 2000). 74 Saltzman, 68 C.C.H (TCM) at 1556, 1568. 75 Id. at 1568. 76 Id.

- 9 - had a 43.08% chance of dying during the term based on standard actuarial tables.77 From a tax perspective, this created a no-lose proposition for the taxpayer. If he died during the trust term, the trust assets would be included in his gross estate and, when computing the estate tax due, his estate would be credited with any gift tax payable with respect to the gift to his son.78 Thus, the taxpayer would be put in essentially the same position as if he had never created the trust. On the other hand, if he survived the 10-year term, the trust assets would pass to his son at the original gift tax value, which reflected a contingency that did not occur. The Saltzman court seemed unconcerned by the troubling policy implications of this result, perhaps because by the time its opinion was issued, Congress had enacted new rules to curb such strategies.79

3. The Hammer Falls Again: RRA 1990 Obliterates Common Abuses of Retained Interests in Property

Congress was alarmed by the results in Snyder and Harrison, and concerned about the strategy later used in Saltzman.80 The Revenue Reconciliation Act of 1990 (“RRA 1990”) established new Chapter 14 of the Internal Revenue Code, which curbed manipulation of retained interests in much the same manner that the Tax Reform Act of 1969 ended many uses of the gift tax charitable deduction.81 First, Chapter 14 establishes a harsh rule for valuing gifts of stock or partnership interests to members of one’s family: For such purposes, all interests retained by the taxpayer are valued at zero unless the interests are structured in a form prescribed by statute and designed to be easy to value.82 Further, any special rights or powers of the taxpayer will be deemed to be exercised, or not exercised, in whatever manner would maximize the value of the taxpayer’s gift.83 If these provisions had been in effect at the time of the transfers in Snyder, the taxpayer would have been treated as having made a gift of $2.6 million rather than $1,000 to her children. (Her noncumulative preferred stock would have been valued at zero, and the common stock would have been valued based on the assumption that she would never exercise her rights to convert and redeem the preferred stock.) Second, if the taxpayer retains a right in a corporation or partnership that lapses, Chapter 14 may treat that lapse as an additional gift or bequest to the other owners of the business.84 If this provision had been in effect at the time of the decedent’s death in Harrison, the decedent would have been deemed to make an additional $29.5 million bequest, generating an additional $16.2 million of estate tax. Third, if the taxpayer transfers property in trust for the benefit of a member of his family, all interests retained by the taxpayer are valued at zero unless the interests are

77 Id. at 1556. 78 I.R.C. §§ 2033, 2001(b)(2). 79 See id. §§ 2701-2704 (establishing special valuation rules for transfers of interests in trusts and other entities to members of the donor’s family). 80 COM. REP. ¶ 27,011.11, PUB. L. NO. 101-508 (1990). 81 I.R.C. §§ 2701-2704. 82 Id. § 2701(a)(1), (a)(3). 83 Id. § 2701(a)(3)(B). 84 Id. § 2704(a)(1).

- 10 - structured in a form prescribed by statute and designed to be easy to value.85 If this provision had been in effect at the time of the gift in Saltzman, the taxpayer would have been treated as having made a gift of the entire amount he transferred in trust. Importantly, none of these provisions apply unless the taxpayer (or certain members of the taxpayer’s family) retains an interest in the property or company at issue.86 As discussed in Part IV of this article, infra, a taxpayer can simply and easily avoid the Chapter 14 special valuation rules by disposing of what would otherwise be a retained interest. A political organization could serve as a convenient repository for such interests.

C. The Gift Tax Annual Exclusion

Notwithstanding the 1969 and 1990 reforms, taxpayers may still use similar strategies to manipulate the gift tax annual exclusion under present law. The federal gift tax has long excluded gifts of property to any recipient, up to a specified dollar amount (currently, $12,000 per year).87 However, the exclusion is not available for gifts of “future interests” (as opposed to “present interests”) in property.88 Generally, a gift of an income interest in trust is treated as a gift of a present interest and is eligible for this exclusion, while a gift of a remainder interest in trust is treated as a future interest and is not eligible for the exclusion.89 In Rosen v. Commissioner, the taxpayers (two brothers and their wives) contributed stock in a closely held corporation to trusts for the benefit of their children.90 The trusts’ income was to be paid to the children annually, and the principal distributed to them when they reached specified ages.91 However, the stock did not in fact pay any dividends.92 In computing the value of their gifts, the taxpayers claimed an annual exclusion for the value of each child’s income interest.93 The taxpayers determined the value of the income interests using standard actuarial tables published by the Internal Revenue Service, which assumed an income yield of 3.5%.94 Not surprisingly, the government found this abusive.95 The Fourth Circuit Court of Appeals disagreed, noting that use of the tables is prohibited “only in cases where such usage would result in an ‘unrealistic and unreasonable’ valuation.”96 Like the district court in Hipp, the Fourth Circuit relied on the questionable assumption that “‘the United States is in business with enough taxpayers so that the law of averages has ample opportunity to work.’”97

85 Id. § 2702(a)(1), (a)(2). 86 Id. §§ 2701(a)(1)(B), 2702(a)(1), 2704(a)(1)(B). 87 Id. § 2503(b); Rev. Proc. 2005-70, 2005-47 I.R.B. 979. 88 I.R.C. § 2503(b)(1). 89 Treas. Reg. § 25.2503-3(a), (b) (as amended in 1983). 90 Rosen v. Comm’r, 397 F.2d 245, 246 (4th Cir. 1968). 91 Id. 92 Id. at 247. 93 Id. at 246-47. 94 Id. at 247; Treas. Reg. §§ 25.2512-5A(b). 95 397 F.2d at 247. 96 Id. (quoting Weller v. Comm’r, 38 T.C. 790, 803 (1962)). 97 Id. at 248 (quoting Gelb v. Comm’r, 298 F.2d 544, 551 (2d Cir. 1962)).

- 11 - The Rosen case is of limited direct importance, as the dollar limit on the gift tax annual exclusion constrains planning opportunities. However, Rosen is nevertheless significant in that it demonstrates how a gift tax deduction or exclusion may be manipulated. Importantly, the gift tax exclusion for contributions to political organizations is not subject to any dollar limit.98 Campaign finance rules do impose dollar limits on certain political contributions, but (as discussed in Part III.A.2 of this article, infra) these rules are sufficiently porous to allow wealthy individuals to make multi-million-dollar contributions.99

III. Structure of the Gift Tax Exclusion for Political Contributions

Given this history of manipulation of gift tax deductions and exclusions, Congress was surprisingly careless in its drafting of the gift tax exclusion for political contributions. As outlined below, section 2501(a)(4) of the Internal Revenue Code imposes few limitations on the use of this exclusion, and other statutes do a poor job of bridging the gap. Section 2501(a)(1) of the Internal Revenue Code imposes the federal gift tax on most gratuitous transfers. With striking brevity, section 2501(a)(4) excludes political contributions:

Paragraph (1) shall not apply to the transfer of money or other property to a political organization (within the meaning of section 527(e)(1)) for the use of such organization.100

Treasury regulations issued under this provision do little more than restate the statutory text.101 From these meager words, we can identify only two limitations on use of the exclusion: The donee must be an organization described in section 527(e)(1) of the Internal Revenue Code, and the gift must be made both “to” and “for the use of” such organization. Campaign finance laws (notably the Bipartisan Campaign Reform Act of 2001, also known as the “McCain-Feingold” legislation) impose additional limitations,

98 I.R.C. § 2501(a)(4) (West Supp. 2005) (exempting from gift tax any “transfer of money or other property to a political organization . . . for the use of such organization,” in any amount). 99 See Center for Responsive Politics, George Soros Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001147458&Cycle=2004 (reporting contributions by Mr. Soros of over $12 million to Joint Victory Campaign 2004, $7.5 million to America Coming Together, $2.5 million to MoveOn.org, and smaller amounts to other organizations); Center for Responsive Politics, T. Boone Pickens Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001162782&Cycle=2004 (reporting contributions by Mr. Pickens of $2.5 million to Progress for America, $2 million to Swift Boat Veterans for Truth, and $100,000 to the Club for Growth). 100 I.R.C. § 2501(a)(4). 101 See Treas. Reg. § 25.2501-1(a)(5) (as amended in 1983) (providing that the federal gift tax “shall not apply to a transfer after May 7, 1974, of money or other property to a political organization for the use of that organization”).

- 12 - but do not prevent a determined donor from making very large contributions in support of his or her favorite political causes.102

A. Limitations on Identity of Donee

1. Limitations Imposed by Tax Law

To understand these limitations on the section 2501(a)(4) exclusion, it is helpful first to consider the types of organizations to which a donor may wish to contribute. First, a donor may wish to contribute to a charity described in section 501(c)(3) of the Internal Revenue Code.103 Charities are subject to stringent limits on their political activities.104 Even so, charities such as the Christian Broadcasting Network and Planned Parenthood have significant political influence.105 Contributions to such organizations do not qualify for the section 2501(a)(4) exclusion, because these organizations do not meet the requirements of section 527(e)(1) (as described below). Nevertheless, most such contributions are wholly deductible for federal gift tax purposes as charitable contributions,106 subject to the restrictive rules discussed in Part II.A.2 of this article, supra. Second, a donor may wish to contribute to a “civic league” or other “social welfare” organization described in section 501(c)(4) of the Internal Revenue Code.107 Such organizations include the Sierra Club and the National Rifle Association.108 These organizations are permitted to engage in a broader range of political activities than their charitable counterparts.109 However, contributions to these organizations do not qualify

102 See Center for Responsive Politics, George Soros Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001147458&Cycle=2004 (reporting contributions by Mr. Soros of over $12 million to Joint Victory Campaign 2004, $7.5 million to America Coming Together, $2.5 million to MoveOn.org, and smaller amounts to other organizations); Center for Responsive Politics, T. Boone Pickens Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001162782&Cycle=2004 (reporting contributions by Mr. Pickens of $2.5 million to Progress for America, $2 million to Swift Boat Veterans for Truth, and $100,000 to the Club for Growth). 103 I.R.C. § 501(c)(3). 104 See id. (providing, in relevant part, that a charity is an organization “no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation”); I.R.C. § 501(h) (setting dollar limits on a charity’s “lobbying expenditures”). 105 See D. W. Miller, Striving to Understand the Christian Right, CHRON. HIGHER EDUC., June 30, 2000, at A17 (considering the political influence of organizations such as the Christian Broadcasting Network); ROBERT G. MARSHALL & CHARLES A. DONOVAN, BLESSED ARE THE BARREN: THE SOCIAL POLICY OF PLANNED PARENTHOOD (Ignatius Press 1991) (analyzing the political impact of Planned Parenthood’s activities). 106 I.R.C. § 2522(a). 107 Id. § 501(c)(4). 108 See Sierra Club v. Comm’r, 86 F.3d 1526, 1527 (9th Cir. 1996) (identifying “Sierra Club, Inc.,” as “a tax-exempt organization under I.R.C. section 501(c)(4)”); Gregory L. Colvin, Looking for the Lessons of the Gingrich Affair, JOURNAL OF TAXATION OF EXEMPT ORGANIZATIONS, Sept./Oct. 1999, at 82 (identifying the Sierra Club, Common Cause, the National Rifle Association, and the NAACP as organizations described in section 501(c)(4) of the Internal Revenue Code). 109 Rev. Rul. 2004-6, 2004-1 C.B. 328 (acknowledging that section 501(c)(4) organizations “may, consistent with their exempt purpose, publicly advocate positions on public policy issues,” and noting that

- 13 - for the gift tax charitable deduction and do not qualify for the section 2501(a)(4) gift tax exclusion.110 Thus, contributions to a section 501(c)(4) organization in excess of the annual exclusion available for gifts generally (currently $12,000 per donee) are subject to gift tax.111 This limitation is not widely understood, and presents a trap for the unwary. A donor who makes a $2 million gift to the National Rifle Association, for example, will have a very nasty surprise. Finally, a donor may make a contribution to a political organization described in section 527(e)(1) of the Internal Revenue Code.112 These contributions are wholly exempt from gift tax under section 2501(a)(4) of the Code.113 Section 527(e)(1) defines a “political organization” as “a party, committee, association, fund, or other organization (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.”114 The term “exempt function” includes “the function of influencing or attempting to influence the selection, nomination, election, or appointment of any individual to any Federal, State, or local public office . . . .”115 Thus, the Democratic and Republican parties, the campaign committees of individual candidates, and independent political groups such as Americans Coming Together and Swift Boat Veterans for Truth are all properly classified as “section 527 organizations” under these definitions, because they operate primarily for political purposes. By contrast, general purpose organizations that have significant political interests (such as the Sierra Club or the National Rifle Association) do not satisfy these requirements and are not properly classified as section 527 organizations. A donor who wishes to make use of the section 2501(a)(4) gift tax exclusion must contribute to an organization that operates primarily for political purposes. While the phrase “section 527 organization” has broad application, it is commonly used in the popular press to refer only to a particular subset of such organizations: those that are independent of any party or candidate.116 These independent organizations are of particular interest because, as discussed below, they receive more favorable treatment under campaign finance law.

2. Limitations Imposed by Campaign Finance Law

The Bipartisan Campaign Reform Act of 2002 (“BCRA”), popularly known as the McCain-Feingold legislation, imposes further limitations on the types of organizations to

“public policy advocacy may involve discussion of the positions of public officials who are also candidates for public office.”). 110 Treas. Reg. § 25.2501-1(a)(5) (as amended in 1983). 111 I.R.C. § 2503(b); Rev. Proc. 2005-70, 2005-47 I.R.B. 979. 112 I.R.C. § 527(e)(1). 113 I.R.C. § 2501(a)(4). 114 I.R.C. § 527(e)(1) (emphasis added). 115 Id. § 527(e)(2). 116 See, e.g., Larry O’Dell, Democrats Cry Foul over McDonnell Ad, DAILY PRESS, Oct. 14, 2005 (reporting that section 527 organizations “are required to disclose individual donors only to the Internal Revenue Service,” which is true only if the organization is independent of any party or candidate); Adam C. Smith & Steve Bousquet, New Radio Ad Out the Gate in 2006 Race for Governor, ST. PETERSBURG TIMES, Oct. 6, 2005 (using the term “527 groups” to refer to independent political organizations).

- 14 - which unlimited political contributions may be made.117 Contributions made expressly to promote a particular candidate have been subject to strict dollar limits since the 1970s, but before BCRA donors avoided these limitations by making so-called “soft money” contributions to political parties to promote get-out-the-vote efforts, issue advertising, and other political activity.118 The “issue advertising” loophole was particularly important, as only minor changes in wording were needed to transform a campaign message into an issue ad.119 BCRA curtailed this loophole by limiting the amount of any contribution to a national political party or congressional campaign committee.120 Under the new regime, a donor may not contribute more than a specified dollar amount (currently $25,000 per election) to a political party for any purpose.121 Accordingly, the section 2501(a)(4) gift tax exclusion is of limited benefit for donors to national political parties. However, BCRA still allows donors to make unlimited “soft money” contributions to independent political organizations.122 BCRA also allows these independent organizations to spend unlimited amounts on issue advertising, though communications within 60 days of a general election and 30 days of a primary election are more strictly regulated.123

3. Significance of Limitations on Identity of Donee

Taking these various restrictions into account, an individual who wishes to make unlimited use of the section 2501(a)(4) gift tax exclusion need only direct his or her contributions to a nominally independent political group that makes soft-money expenditures. There is no shortage of such groups, as the panoply of “section 527”

117 Bipartisan Campaign Reform Act of 2002, Pub. Law No. 107-155, 116 Stat. 81 (2002) (amending Federal Election Campaign Act of 1971, 2 U.S.C. § 431). 118 McConnell v. Fed. Elec. Comm’n, 540 U.S. 93, 93-94 (2003). 119 See Buckley v. Valeo, 424 U.S. 1, 44 & n.52 (1976) (holding that the campaign finance rules then in effect applied only to “communications containing express words of advocacy of election or defeat, such as ‘vote for,’ ‘elect,’ ‘support,’ ‘cast your ballot for,’ ‘Smith for Congress,’ ‘vote against,’ ‘defeat,’ ‘reject.’”). 120 See 2 U.S.C.A § 441i(a)(1) (2005) (“A national committee of a political party (including a national congressional campaign committee of a political party) may not solicit, receive, or direct to another person a contribution, donation, or transfer of funds or any other thing of value, or spend any funds, that are not subject to the limitations, prohibitions, and reporting requirements of this Act.”) 121 Id. § 441a(a)(1)(B), (c)(1). 122 See id. § 441i(d)(2) (prohibiting political parties from soliciting contributions for section 527 organizations, but not limiting independent contributions to such organizations); McConnell, 424 U.S. at 177 (“[T]he restriction does nothing more than subject contributions [to section 527 organizations and nonprofit organizations] solicited by parties to FECA’s regulatory regime, leaving open substantial opportunities for solicitation and other expressive activity in support of these organizations.”) (emphasis added). 123 2 U.S.C.A. § 441a(a)(7)(C) (2005) (treating certain “electioneering communications” as contributions to a candidate that are subject to the statutory contribution limits); id. § 434(f)(3) (defining “electioneering communication” as a broadcast, cable, or satellite communication that refers to a clearly identified candidate for federal office, is made within 60 or 30 days of certain elections, and is targeted to the relevant electorate). See also Federal Election Comm’n v. Club For Growth, No. 1:05-cv-01851-RMU (D. D.C. filed Sept. 19, 2005) (considering claims by the Federal Election Commission that a section 527 organization violated federal campaign laws by, inter alia, using unlimited soft-money contributions to engage in express political advocacy).

- 15 - organizations participating in the 2004 election cycle demonstrates.124 Further, there are few limits on an individual donor’s ability to support such organizations, as George Soros and T. Boone Pickens vividly demonstrated by making eye-catching contributions to liberal and conservative causes in 2004.125

B. Possible Limitations on Contributions in Trust

Section 2501(a)(4) of the Internal Revenue Code imposes one other restriction: to qualify for the unlimited gift tax exclusion, a contribution must be made both “to” and “for the use of” a political organization.126 No published cases or rulings interpret the meaning of these words in this context, and the legislative history of section 2501(a)(4) is also silent on this issue.127 However, similar language in other tax statutes has been construed to limit the availability of a tax benefit for gifts made indirectly or in trust (“for the use of” the recipient) rather than outright (“to” the recipient). Congress has allowed an income tax deduction for charitable contributions since the earliest days of the federal income tax.128 The War Revenue Act of 1917 first established a deduction for “contributions or gifts made within the taxable year to” certain nonprofit corporations and associations.129 The Internal Revenue Service construed this provision to apply only to outright rights, and not to gifts made in trust.130 That prompted objections from donors, so Congress amended the provision in 1921 to allow a deduction for “contributions or gifts made within the taxable year to or for the use of” a broader list of permitted donees.131 The Service then relented, acknowledging that the phrase “for the use of” is “intended to convey a similar meaning as ‘in trust for.’”132 The U.S. Supreme Court approved this construction in 1990, declaring that “[t]he Commissioner’s interpretation of ‘for the use of’ thus appears to be entirely faithful to Congress’ understanding and intent in using that phrase” in its income tax statutes.133 The current version of this income tax provision still defines the term “charitable contribution” as “a contribution or gift to or for the use of” certain charitable

124 See Center for Responsive Politics, 527 Committee Activity, Top 50 Federally Focused Organizations, at http://opensecrets.org/527s/527cmtes.asp?level=C&format=&cycle=2004 (identifying the 50 largest section 527 organizations participating in the 2004 federal election cycle). 125 Center for Responsive Politics, George Soros Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001147458&Cycle=2004; Center for Responsive Politics, T. Boone Pickens Contributions to 527 Committees, 2004 Election Cycle, at http://www.opensecrets.org/527s/527indivsdetail.asp?ID=11001162782&Cycle=2004. 126 I.R.C. § 2501(a)(4). 127 See S. REP. NO. 1357, 93d Cong., 2d Sess. (1974) (setting forth the reasons for enactment of section 2501(a)(4)), reprinted in 1974 U.S.C.C.A.N. 7508. 128 See Bowman v. Comm’r, 16 B.T.A. 1157, 1162-63 (1929) (analyzing the early history of the deduction). 129 War Revenue Act of 1917, ch. 63, § 1201(2), 40 Stat. 330 (emphasis added). 130 O. D. 669, 3 C.B. 187 (1920). 131 Revenue Act of 1921, ch. 186, § 214(a)(11), 42 Stat. 241; Hearings on Proposed Revenue Act of 1921 before the Senate Committee on Finance, 67th Cong., 1st Sess., 521 (1921), as cited in Davis v. Comm’r, 495 U.S. 472, 480 (1990). 132 I. T. 1867, II-2 C.B. 155 (1923); see also Rev. Rul. 55-275, 1955-1 C.B. 295; Rev. Rul. 194, 1953-2 C.B. 128; I. T. 3707, 1945 C.B. 114. 133 Davis v. Comm’r, 495 U.S. 472, 482 (1990).

- 16 - organizations and other entities.134 Generally, a gift “to” a charity is deductible for federal income tax purposes, up to a specified percentage of the donor’s income (with certain adjustments).135 Most gifts “for the use of” a charity are also deductible for federal income tax purposes, but the deduction may be limited to a lower percentage of the donor’s income depending on the type of gift and the classification of the donee.136 Thus, the Internal Revenue Service and the courts are sometimes called upon to distinguish between the two types of contributions, and to determine whether an indirect gift may be classified as a gift “for the use of” a charity. In Davis v. Commissioner, the U.S. Supreme Court considered whether the taxpayers, a married couple, could deduct expenses they paid for their sons, who were Mormon missionaries.137 The Court readily determined that payment of these expenses was not a gift “to” the Mormon Church, under the plain language of the statute and the regulations issued thereunder.138 The Court also determined that payment of these expenses was not made “for the use of” the Mormon Church, as the Church did not have enforceable legal rights with respect to these payments, as a beneficiary would have with respect to donations made in trust.139 Accordingly, the taxpayers’ income tax deduction was disallowed.140 The Internal Revenue Service has further refined the distinction between gifts made “to” or “for the use of” a charity for income tax purposes. A “contribution of an income interest in property . . . shall be considered as made ‘for the use of’ rather than ‘to’ the charitable organization.”141 On the other hand, “the contribution of a remainder interest in property” – i.e., the right to receive principal following the termination of an income interest – “shall be considered as made ‘to’ the charitable organization.”142 This is true even if the gift is made in trust, provided the principal is distributed outright to the charitable organization upon termination of the income interest.143 With respect to the gift tax exclusion for political contributions, it is unclear what Congress intended when it required that such contributions be made “to a political organization . . . for the use of such organization.”144 When using similar wording in the income tax statutes described above, Congress contemplated that a gift would be made either to a charity or for the use of the charity. Congress’ use of this language in section 2501(a)(4) might indicate that the gift tax exclusion is available only for gifts made outright to a political organization. A gift in trust would typically be made “to” a third party trustee (not the political organization) “for the use of” the political organization as beneficiary, and therefore may not satisfy both requirements of the statute. That interpretation seems consistent with the Internal

134 I.R.C. § 170(c) (emphasis added). 135 Id. § 170(b)(1)(A). 136 Id. § 170(b)(1)(B). 137 Davis v. Comm’r, 495 U.S. 472, 473-74 (1990). 138 Id. at 486-87. 139 Id. at 484-86. 140 Id. at 488-89. 141 Treas. Reg. § 1.170A-8(a)(2) (1972). 142 Id. 143 Id. 144 I.R.C. § 2501(a)(4).

- 17 - Revenue Service’s and U.S. Supreme Court’s construction of the terms “to” and “for the use of.” However, the language of section 2501(a)(4) might also be construed less restrictively, to require that any gifts to a political organization in fact be made for political purposes (and not for the private benefit of an individual). Under this more liberal reading, the curious language of section 2501(a)(4) is intended solely to prevent donors from laundering what are in fact private expenditures through a political organization. In any event, it would appear difficult for the Internal Revenue Service to argue that gifts of remainder interests in property, whether or not in trust, do not qualify for the section 2501(a)(4) gift tax exclusion. As noted above, the Treasury has determined by regulation that charitable donations of remainder interests in property, outright or in trust, are considered to have been made “to” a charity.145 For consistency’s sake, it seems likely that a court would hold the Service to this interpretation for purposes of section 2501(a)(4). Further, it seems clear that a gift of a remainder interest in property to a political organization is also made “for the use of” such organization, as it is of no obvious benefit to anyone else. Thus, a court would likely hold that (i) most gifts in trust do not qualify for the section 2501(a)(4) gift tax exclusion, but (ii) gifts of remainder interests in property (even if made in trust) do qualify for this exclusion. As explained in the next Part of this article, these modest limitations do not significantly impede taxpayers’ use of the exclusion for private (non-political) purposes.

C. Enforcement of Limitations on Gift Tax Exclusion

Section 2501(a)(4) of the Internal Revenue Code provides that the gift tax simply “shall not apply” to political contributions described therein.146 Thus, such contributions need not even be reported for gift tax purposes. The official instructions for the federal gift tax return, IRS Form 709, confirm that “[t]hese transfers are not ‘gifts’ as that term is used on Form 709 and its instructions. You need not file a Form 709 to report these transfers and should not list them . . . if you do file Form 709.”147 Accordingly, the IRS has little opportunity to enforce the few limitations that do exist on taxpayers’ use of this gift tax exclusion.

IV. Back to the Future: Using Old Tricks to Manipulate a (Relatively) New Exclusion

With Congress having left the barn door open, it seems only a matter of time before taxpayers and their advisors come charging through. The gift tax exclusion for political contributions breathes new life into tax strategies forgotten since before the Tax Reform Act of 1969 and the Revenue Reconciliation Act of 1990. I explore below several ways a canny taxpayer might use this exclusion to benefit his or her own family.

145 Treas. Reg. § 1.170A-8(a)(2). 146 I.R.C. § 2501(a)(4). 147 Internal Revenue Service, 2004 Instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, at 2.

- 18 - A. Snyder Revisited: Use of Preferred Interests

In Snyder v. Commissioner (described in Part II.C.1 of this article, supra), the taxpayer transferred common stock in a corporation to a trust for her great-grandchildren, and retained noncumulative preferred stock.148 The existence of the noncumulative preferred stock greatly depressed the value of the common stock for gift tax purposes. This strategy could easily be adapted to make use of the gift tax exclusion for political contributions:

• First, the taxpayer would form an entity in which he or she owns all of the interests. For purposes of this example, assume the entity is a corporation, though it could also be a limited liability company or partnership. Assume also, as in Snyder, that the initial value of the entity’s assets is $2.6 million.

• The corporation would have two classes of stock: 10 shares of voting common stock and 990 shares of nonvoting preferred stock.

• The preferred stock would be entitled to receive a 10% noncumulative annual dividend. However, the directors of the corporation would have discretion to declare or not declare a dividend in any particular year, based on their assessment of the corporation’s current and future capital needs. The common stock would be entitled to receive dividends in a particular year only if the preferred dividend for that year had been made in full. Upon liquidation of the corporation, the preferred stockholders would receive back their share of the original capital of the corporation, but no more, while the common stockholders would receive the balance of the corporation’s assets. Under applicable state law, the corporation would be perpetual; no single stockholder could force its liquidation.149

• The taxpayer would transfer the preferred stock to an independent political organization (not affiliated with any party or candidate) that is described in section 527(e)(1) of the Internal Revenue Code. This gift would be exempt from gift tax, and need not be reported on a federal gift tax return.150

• Thereafter, the taxpayer would transfer the common stock to the taxpayer’s children, dividing the stock among them so that no one child receives a controlling interest in the corporation. The taxpayer would retain no interests and the corporation would not be subject to any restrictions on liquidation other than

148 Snyder v. Comm’r, 93 T.C. 529, 536 (1989). 149 See, e.g., DEL. CODE ANN. tit. 8, § 275(a), (b) (providing for the dissolution of a corporation upon the vote of a majority of the directors and a majority of the outstanding stock that is entitled to vote); Id. § 275(c) (providing for the dissolution of a corporation without action of the directors, if all of the stockholders who are entitled to vote consent in writing). 150 I.R.C. §2501(a)(4); Internal Revenue Service, 2006 Instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, at 2.

- 19 - those imposed by state law. Thus, the Chapter 14 special valuation rules would not apply to this transfer.151

• Each child’s common stock would be valued under normal gift tax principles, at the price a disinterested third party would pay for it.152 Realistically, a third party would pay very little for this interest, considering that it may receive little or nothing if the directors choose to make distributions to the preferred stockholder. In that regard, it is important to recognize that each child’s interest is valued separately for gift tax purposes (i.e., one may not assume that the children will act in concert in voting their interests).153

• Taking this into account, the taxpayer may place a very low value on the common stock for gift tax purposes. If this value is less than the annual exclusion amount under section 2503(b) of the Internal Revenue Code (currently $12,000 per recipient per year), the taxpayer may not be required to file a federal gift tax return reporting these transfers.154 This assumption is not unrealistic; under similar facts in Snyder, the Tax Court valued the common stock at only $1,000.155

• The directors of the corporation may cause substantially all of the future appreciation of the corporation to pass to the taxpayer’s children by choosing not to declare any dividend on the preferred stock. For example, if the corporation enjoys a 10% annual return on its assets, the corporation might accumulate and reinvest the entire $260,000 annual return for distribution to the common stockholders upon liquidation of the corporation. This would be easiest to justify during the initial “growth” phase of the corporation’s operations.

• If the directors are too aggressive in withholding distributions from the political organization, it might complain. However, under the business judgment rule, courts are reluctant to interfere with the distribution decisions of a corporation’s directors.156 Furthermore, in the interest of donor relations and to encourage

151 See I.R.C. § 2701(a)(1) (applying special valuation rules only where the transferor keeps an “applicable retained interest”); id. § 2704(b) (disregarding restrictions on liquidation of an entity in some cases, but not where the restrictions are imposed by state law). 152 See Treas. Reg. 25.2512-1 (as amended in 1992) (explaining that the value of property for gift tax purposes is “the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts”). 153 Rev. Rul. 93-12, 1993-1 C.B. 202; Tech. Adv. Mem. 9449001 (Mar. 11, 1994). 154 I.R.C. § 2503(b); Rev. Proc. 2006-53, 2006-48 I.R.B. 996; Internal Revenue Service, 2006 Instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, at 1. 155 Snyder v. Comm’r, 93 T.C. 529, 537 (1989). 156 See United States v. Byrum, 408 U.S. 125 (1972) (“‘The cases in which courts have refused to require declaration of dividends or larger dividends despite the existence of current earnings or a substantial surplus or both are numerous; plaintiffs have won only a small minority of the cases. The labels are ‘business judgment’; ‘business purpose’; ‘non-interference in internal affairs.’ The courts have accepted the general defense of discretion, supplemented by one or more of a number of grounds put forward as reasons

- 20 - future gifts, the political organization may be quiescent. Therefore, the directors of the corporation may feel obligated to declare only a modest dividend on the preferred stock in future years, even after the corporation matures beyond its initial growth phase. As a result, substantial value may continue to pass to the taxpayer’s children free of gift tax.

• At some future date (perhaps during an election season, when the political organization’s needs are greatest), the taxpayer’s children might buy out the political organization’s interest at a discounted price. Alternatively, the corporation could offer to redeem the political organization’s interest, again at a discounted price. Either way, this purchase would result in a further gift-tax-free transfer of value to the taxpayer’s children. For example, if the taxpayer’s children purchased the preferred stock at a 40% discount to its face value, then over $1 million of additional value would pass to the taxpayer’s children free of gift tax. (Recall that the corporation was capitalized with $2.6 million in assets. 40% of $2.6 million is slightly more than $1 million.)

• The children’s purchase of the political organization’s interest need not be reported as a separate political contribution, as the political organization would merely be converting an existing asset to cash. This would make it difficult for political opponents and disinterested observers to track the timing and amount of the family’s political contributions.

• In summary, up to $260,000 is accumulated each year for the children while the preferred stock is outstanding, and over $1 million more passes to the children when the preferred stock is repurchased, all free of gift tax. Surely, this is a result of which the taxpayer in Snyder would be proud. Unlike the taxpayer in Snyder, the taxpayer here would be required to make a significant political contribution as part of the plan. In this example, the contribution would amount to slightly more than $1.5 million (i.e., 60% of $2.6 million). However, the taxpayer may not see that as a disadvantage, particularly if he or she is politically active and already makes large political contributions.

Under present law, the Internal Revenue Service has relatively few tools to identify and fight this strategy. As noted above, the initial transfer of preferred stock need not be reported on a gift tax return.157 The subsequent transfer of the common interest may not need to be reported either, and if reported, will not be flagged as a transfer subject to the Chapter 14 of the Internal Revenue Code.158 More importantly, the

for not paying dividends, or larger dividends . . . .’”) (quoting CARY, CASES AND MATERIALS ON CORPORATIONS 1587 (4th ed. 1969)). 157 Internal Revenue Service, 2006 Instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, at 2. 158 2006 Instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, at 1; see generally I.R.C. §§ 2701-2704 (establishing special rules for the valuation of certain gifts to a member of the taxpayer’s family, where the taxpayer or certain other individuals retain an interest in the donated property or entity).

- 21 - essential elements of the strategy were approved by the Tax Court in Snyder v. Commissioner, described in Part II.C.1 of this article, supra, and Congress rejected the holding of that case only in particular circumstances not applicable here.159 The IRS would seem to have only a few possible grounds to challenge this strategy. First, the Service might argue that there was an implied agreement or understanding that the political organization would not assert its rights as a preferred stockholder, or that the corporation’s directors would act improperly in determining the future dividend policy of the corporation. Put another way, the substance of the transaction (based on the true expectations of the parties) differs from its form. While this argument has some appeal, it is inconsistent with decades of caselaw in which the courts routinely accepted gift tax valuations based on dividend or income assumptions that differed substantially from reality,160 and refused to consider the possibility that a corporation’s directors would disregard their fiduciary duties.161 Second, the IRS might argue that the taxpayer has not made a gift “to” a political organization, as required by section 2501(a)(4). For example, the IRS might recast the corporation as a trust arrangement and assert that the taxpayer has, in fact, made a gift of an income interest in trust. As noted in Part III.B of this article, supra, a gift of an income interest in trust might not be treated as a gift “to” the donee. This argument seems quite weak, however, as other gift tax provisions evidence Congress’ intent to treat preferred stock and interests in trust as separate and distinct types of property interests.162 Further, there appears to be no precedent for recharacterizing an outright gift as a gift in trust, except where specifically provided by statute.163 Finally, the IRS might dispute the taxpayer’s valuation of the common stock on strictly factual grounds, challenging the taxpayer’s financial assumptions as in any other

159 Snyder v. Comm’r, 93 T.C. 529 (1989); see I.R.C. § 2701(a)(1) (overriding the valuation principles applied by the Snyder court, but only in cases where the taxpayer or certain other individuals retain an interest in the entity that is of a different class than the interest the taxpayer gives to a member of the taxpayer’s family). 160 See Rosen v. Comm’r, 397 F.2d 245, 247-48 (4th Cir. 1968) (valuing an income interest in corporate stock based on tables that assumed a income yield of 3.5%, even though the stock did not in fact pay any dividends); Hipp v. United States, 215 F. Supp. 222, 224-25, 228 (W.D.S.C. 1962) (valuing an income interest in corporate stock based on tables that assumed a yield five times as much as the stock’s actual income yield at the time of the gift). 161 See United States v. Byrum, 408 U.S. 125, 137-38 (1972) (holding that a taxpayer who retained the right to vote corporate stock nevertheless did not have the right to control the beneficial enjoyment of such stock for federal estate tax purposes, because both the taxpayer and the directors he elected were subject to fiduciary duties). Congress later overturned the result in Byrum by statute in specific circumstances, but nevertheless recognized the continued vitality of the court’s holding generally. I.R.C. § 2036(b); see S. Rep. No. 95-745, 95th Cong., 2d Sess. 91 (1978) (providing examples of cases outside the scope of the statute, in which the holding in Byrum would still apply); Rev. Rul. 81-15, 1981-1 C.B. 457 (acknowledging that Byrum remains good law, except as specifically modified by section 2036(b) of the Internal Revenue Code). 162 Compare I.R.C. § 2701 (establishing special valuation rules for transfers of interests in corporations and partnerships, where the donor retains other interests such as preferred stock) with id. § 2702 (establishing similar but not identical valuation rules for transfers of interests in trusts, where the donor retains an income interest or other interest in the trust). 163 See id. § 2702(c)(1) (providing that certain outright transfers of term interests in property will be treated as a transfers in trust).

- 22 - valuation dispute. The Service has pursued perhaps hundreds of such cases since the inception of the gift tax, and often comes out poorly in these controversies.164 In any event, this approach is very labor- and resource-intensive, requiring the IRS to hire valuation experts in each case to contest the taxpayer’s methodology.165 If the IRS is forced to fight this strategy on these grounds, then in an important sense it has already lost.

B. Beyond Snyder: Manipulating Debt

The Snyder case and the preceding example demonstrate how taxpayers use equity interests in corporations and other entities to exploit flaws in the gift tax system. Taxpayers may also use debt interests to exploit flaws in both the gift tax and income tax rules. The unlimited gift tax exclusion for political contributions provides a ready means to implement such strategies.

1. Use of Corporate Debt

If a taxpayer wishes to use corporate debt to facilitate gifts, he or she might take the following steps:

• First, the taxpayer would form a corporation to carry out a new business venture. The corporation would have only one class of stock: traditional common stock with voting rights. The corporation would not elect to be taxed as a subchapter S corporation.166

• The taxpayer would make a small capital contribution to the corporation (e.g., $100,000), and then make a much larger loan to the corporation (e.g., $900,000).167 This loan would be documented with a promissory note. The note would have a long term (perhaps in excess of 20 years) and bear interest at the

164 See, e.g., Clark v. United States, 36 A.F.T.R.2d 75-6417, 75-6418, 75-6420 (E.D. N.C. 1975) (valuing stock at $361.10 per share, rather than the $304.50 amount asserted by the taxpayers or the $463.50 amount asserted by the government); Boxley v. United States, 34 A.F.T.R.2d 74-6299, 74-6300 (W.D. Va. 1974) (valuing stock at $48.74 per share as claimed by the taxpayer, rather than $75 per share as claimed by the government); Messing v. Comm’r, 48 T.C. 502, 508, 510-11 (observing that valuation is “an oft-litigated and plaguingly elusive question,” and valuing stock at $13 per share rather than $10 per share as claimed by the taxpayer or $30 per share as claimed by the government); Hermelin v. Comm’r, 36 T.C.M. (CCH) 426, 428-29 (1977) (finding that stock was properly valued at $12,000 per share, rather than $5,405.21 as reported by the taxpayers or $25,860 as asserted by the government). 165 See I.R.C. § 7491 (“If, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A [income tax] or B [estate and gift tax], the Secretary shall have the burden of proof with respect to such issue.”). 166 See id. §§ 1361-1363 (establishing a “pass-through” income tax regime for certain corporations). 167 If the corporation’s debt-to-equity ratio is too high, the debt may be recharacterized as equity. Dixie Dairies Corp. v. Comm’r., 74 T.C. 476, 493 (1980), acq., 1982-2 C.B. 1. The debt-to-equity ratio is only one of several factors used by courts to determine whether a note is properly classified as debt or equity. Id.

- 23 - long-term “applicable federal rate” (which is very low).168 The note would provide for payment of interest only during its term, with a balloon payment of principal at maturity. However, the note would permit the corporation to prepay some or all of the principal early without penalty. Finally, the note would be unsecured.

• The taxpayer would donate the note to an independent political organization (not affiliated with any party or candidate) that is described in section 527(e)(1) of the Internal Revenue Code. The taxpayer would then transfer the common stock to his children. Thus, the taxpayer would have no further interest in the corporation and no portion of its value would be subject to estate tax at his death. At the time of this transfer, the corporation would have little value.

• As a result of these transactions, the taxpayer will have transferred the entire $1 million business enterprise to the taxpayer’s children at a gift tax value of $100,000 or less (because most of the corporation’s value is absorbed by the promissory note given to the organization). The corporation will pass to the children subject to the debt owed to the political organization, but that debt will bear interest at an artificially low rate and is not secured, giving the corporation significant flexibility in conducting its operations.

• Assuming the corporation earns a better return on its assets than the interest rate on the note, the excess return passes to the taxpayer’s children free of gift tax. For example, if the interest rate on the note is 5% but the corporation earns a 10% return on its assets, $45,000 per year will pass to the children free of gift tax. (Recall that the principal balance of the note is $900,000. 5% of $900,000 is $45,000.)

• These transactions also have favorable income tax consequences. It appears that the corporation could deduct its interest payments on the note, like interest on most other debt.169 As a result, this amount is taxed only once, upon receipt by the political organization.170 By contrast, if the corporation paid a dividend of the same amount to its shareholders, and the shareholders then made a political contribution, this amount would be taxed twice: once at the corporate level, and once upon receipt by the shareholders.171 In effect, the shareholders would be

168 The applicable federal rate (AFR) is published monthly by the Internal Revenue Service. I.R.C. § 1274(d)(1)(B). Different rates are published for loans of up to three years (the short-term rate), over three but not over nine years (the mid-term rate), and over nine years (the long-term rate). The AFR is deemed to be an appropriate interest rate for most federal tax purposes, and a note bearing interest at this rate will normally be valued at face value for federal gift tax purposes. I.R.C. § 7872; Frazee v. Comm’r, 98 T.C. 554, 589 (1992). The AFR is based on market rates for U.S. Treasury obligations, and therefore is quite low. I.R.C. § 1274(d)(1)(C). For example, the long-term AFR for loans made in February 2007, with annual compounding, is 4.86%. Rev. Rul. 2007-9, 2007-6 I.R.B. 169 I.R.C. § 163(a). 170 Id. § 527(b)(1), (c)(1). 171 Id. §§ 11(a), 1(h)(1), 1(h)(11).

- 24 - making political contributions out of corporate income on a tax-free basis. That runs contrary to the usual rule that political contributions are not deductible for federal income tax purposes.172

• Finally, these transactions could be used to exploit weaknesses in campaign finance regulations. First, the corporation may make what amount to political contributions by prepaying principal on the note. However, because these prepayments are not characterized as political contributions and are not made directly to any candidate, campaign committee, or political party, they may avoid legal restrictions on political contributions by corporations.173 Second, these prepayments might be timed to coincide with particular election cycles. The prepayments would represent “under the radar” infusions of cash into the political organization, which need not be reported and which would confound efforts by political opponents to determine the financial status of a political organization at any particular time.

Here, too, the Internal Revenue Service has few tools to restrain transactions of this type. The Service’s most promising line of attack may be to recharacterize the note as equity rather than debt (which, if successful, will cause the corporation to lose any interest deduction for its payments on the note). Past battles between the Service and taxpayers have generated a well-developed body of caselaw on this issue.174 Courts consider a variety of factors in making this determination, and will resolve the issue on a case-by-case basis.175 Generally, however, the note should be respected as debt if the corporation’s debt-to-equity ratio is not unreasonably high, the corporation observes all formalities, and the corporation makes all required payments on a timely basis.176 It should not be difficult for taxpayers to adhere to these rules.177 Furthermore, even if the

172 Id. § 162(e)(1). 173 See 2 U.S.C.A § 441b(a) (2005) (“It is unlawful . . . for any corporation whatever, or any labor organization, to make a contribution or expenditure in connection with any election at which presidential and vice presidential electors or a Senator or Representative in, or a Delegate or Resident Commissioner to, Congress are to be voted for, or in connection with any primary election or political convention or caucus held to select candidates for any of the foregoing offices . . . .”); id. §§ 441(b)(2), 431(8), 431(9) (defining the terms “contribution” and “expenditure” in a manner that would apparently exclude soft-money contributions to independent section 527 organizations not affiliated with any party or candidate); Thomas B. Edsall, Republican ‘Soft Money’ Groups Find Business Reluctant to Give, WASH. POST., June 8, 2004, at A21 (acknowledging that corporations continue to make contributions to independent section 527 organizations, albeit in smaller amounts than in prior years). 174 See generally Dixie Dairies Corp. v. Comm’r, 74 T.C. 476, 493 (1980) (reviewing this caselaw and identifying the factors considered by prior courts), acq., 1982-2 C.B. 1. 175 See id. at 493-94 (“The identified factors are not equally significant, nor is any single factor determinative. Moreover, due to the myriad factual circumstances under which debt-equity questions can arise, all of the factors are not relevant to each case.”) (internal citations omitted). 176 See id. at 493 (identifying factors to consider in determining whether debt should be reclassified as equity). 177 Of course, some taxpayers do fail to comply with such seemingly basic steps as following corporate formalities. See, e.g., Group Admin. Premium Services v. Comm’r, 72 T.C.M. (CCH) 834, 837, 840 (1996) (reclassifying alleged loans as capital contributions where the purported loans had no payment schedule or source documents, and observing that “[t]his case is another banal example of a sole shareholder who used

- 25 - note is recharacterized as equity, the taxpayer should still enjoy the gift tax benefits described above.

2. Use of Trust Debt

In some cases, a taxpayer may prefer to make his or her gift in trust, rather than via a corporation or other entity. The preceding strategy could easily be adapted to accommodate gifts in trust, causing similar damage to the gift tax system and campaign finance regime. For example, a taxpayer might take the following steps:

• First, the taxpayer would establish an irrevocable trust for the exclusive benefit of the taxpayer’s children. The taxpayer would retain the absolute power (unrestrained by fiduciary considerations) to reacquire the trust assets by substituting other property of equivalent value. This power should subject the taxpayer to federal income tax on the trust income,178 but should not subject the trust assets to federal estate tax upon the taxpayer’s death.179 Trusts of this type have become an increasingly popular tool of estate planners in recent years.180

• The taxpayer would make a small gift to the trust (e.g., $100,000), and then sell an asset of much greater value (e.g., $900,000) to the trust in exchange for a long- term unsecured promissory note. As in the preceding example, the note would bear interest at the long-term applicable federal rate.181 Also, the note would not require any principal payments until maturity, but would permit the trust to make principal payments earlier without penalty.

• Finally, the taxpayer would donate the note to an independent political organization (not affiliated with any party or candidate) that is described in section 527(e)(1) of the Internal Revenue Code. Thus, the taxpayer would have no further claim against the trust or its assets, and no portion of the trust’s value would be includible in the taxpayer’s estate. It appears that the gift of the promissory note should not be treated as a gift made in trust, even though the note

his C corporations not only to carry on his business but also as personal pocketbooks without observing corporate formalities and record-keeping requirements”). For purposes of this article, however, I will assume that the taxpayer is careful and well-advised. 178 I.R.C. §§ 671, 675(4)(C). 179 Jordahl v. Comm’r, 65 T.C. 92, 100-01 (1975), acq., 1977-2 CB 1; Priv. Ltr. Rul. 9843024 (July 24, 1998). The power described in Jordahl could be exercised only in a fiduciary capacity, but the court did not rely solely on that fact in reaching its conclusion. See Jordahl, 65 T.C. at 97 (observing that the grantor was restrained by his obligations as a fiduciary). 180 See KATHRYN G. HENKEL, ESTATE PLANNING AND WEALTH PRESERVATION: STRATEGIES AND SOLUTIONS ¶ 30.10[1] (1997) (describing the sale of assets to such trusts as “a very popular estate freezing device”). 181 I.R.C. § 1274(d)(1).

- 26 - was issued by a trust.182 Therefore, the gift should qualify for the section 2501(a)(4) gift tax exclusion.183

• As a result of these transactions, the taxpayer will have transferred assets worth $1 million to the trust at a gift tax value of only $100,000 (because most of the trust’s value is absorbed by the promissory note given to the political organization). The trust will take these assets subject to the debt, but that debt will bear interest at a very low rate and the principal need not be paid for many years.

• Assuming the trust earns a better return on its assets than the interest rate on the note, the excess return passes to the taxpayer’s children free of gift tax. For example, if the interest rate on the note is 5% but the trust earns a 10% return on its assets, $45,000 per year will pass to the children free of gift tax. (Recall that the principal balance of the note is $900,000. 5% times $900,000 is $45,000.)

• The transactions also have favorable income tax consequences. Because the taxpayer is subject to income tax on the trust’s income, transactions between the taxpayer and trust would be disregarded for federal income tax purposes.184 Accordingly, neither the taxpayer nor the trust would incur any income tax upon the sale of assets by the taxpayer to the trust. After the taxpayer donates the note to the political organization, future interest payments may arguably be deductible for income tax purposes as investment interest.185

• These transactions would have the same negative impact on the McCain-Feingold campaign finance regime as the strategies discussed above. The political organization must report its receipt of the taxpayer’s promissory note,186 effectively overstating its receipts for the year of the donation. Thereafter, the political organization apparently would not be required to report principal payments on the note, effectively understating its receipts in subsequent years. This would make it difficult for political opponents to monitor the organization’s cash flows.

The Internal Revenue Service might attack this strategy using the same arguments set forth in Parts IV.A and IV.B.1 of this article, supra. However, as noted above, those arguments are few and weak.

182 Cf. Rev. Rul. 86-60, 1986-1 C.B. 302 (providing that an outright transfer to charity of a donor’s beneficial interest in an existing trust should not be treated as a transfer “in trust” for federal income tax purposes). 183 See Part III.B of this article, supra (analyzing whether a gift in trust will qualify for the section 2501(a)(4) gift tax exclusion). 184 Rev. Rul. 85-13, 1985-1 C.B. 184. 185 See I.R.C. § 163(d) (allowing an income tax deduction for investment interest, subject to certain limits). 186 See I.R.C. § 527(j)(2) (requiring political organizations to file regular reports identifying the contributions they have received).

- 27 - C. Snyder Inverted: Political Contributions of Remainder Interests in Trust

Finally, a taxpayer could turn Snyder on its head. In each of the preceding examples, the taxpayer would give an income stream to a political organization, while giving the residual interest to the taxpayer’s children. Instead, the taxpayer could do precisely the opposite: Give an income stream to his or her children, while leaving the residual interest to a political organization. This approach is surprisingly simple:

• First, the taxpayer would establish a trust that pays all of its income to the taxpayer’s children for a term of years (e.g., 10 years). At the end of the term, the principal would be distributed to a political organization outright.

• Next, the taxpayer would contribute an unusually high-yield asset to the trust. For example, the taxpayer might contribute a diversified portfolio of below- investment-grade (“junk”) bonds. The portfolio could be expected to generate a very high level of income, but defaults would tend to erode the principal over time.187 Alternatively, the taxpayer might contribute wasting assets such as mineral interests, and direct the trustee to allocate receipts between income and principal in accordance with the law of a state that does not provide a generous reserve for depletion.188 A taxpayer might even replicate the approach used in Snyder, by contributing high-yield preferred stock in a family corporation to the trust. In this case, however, the taxpayer would encourage the directors of the corporation to make the dividend payments on time and in full.

• For purposes of illustration, assume the taxpayer contributes a royalty interest in oil, gas, and other minerals that are expected to be exhausted over the 10-year term of the trust. Assume also that the royalty payments are expected to be level during this term.189 Royalty interests of this type are commonly valued at

187 It appears that donors engaged in this investment strategy with charitable remainder trusts prior to the Tax Reform Act of 1969. See S. Rep. No. 91-552, 91st Cong., 1st Sess. (1969), reprinted in INTERNAL REVENUE ACTS 1966-1970, at 1639, 1728 (West 1971) (“The rules of present law for determining the amount of a charitable contribution deduction in the case of gifts of remainder interests in trust do not necessarily have any relation to the value of the benefit which the charity receives. . . . For example, the trust corpus can be invested in high-income, high risk assets. This enhances the value of the income interest but decreases the value of the charity’s remainder interest.”). 188 See, e.g., OKLA. STAT. tit. 60, § 175.411(A)(1), (3) (directing that 85% of each significant royalty, shut- in-well payment, take-or-pay payment, bonus, or delay rental from a mineral interest be allocated to income); 3A AUSTIN W. SCOTT & WILLIAM F. FRATCHER, THE LAW OF TRUSTS § 239.3 (4th ed. 1988) (describing the common-law “open mine doctrine,” since abolished in many states, which directs that 100% of the net proceeds from a mineral interest be allocated to income in certain cases). 189 In reality, the payments are likely to taper off over time. For ease of discussion I analyze the simpler case involving level payments, which tends to understate the tax benefits of this strategy. If the royalty payments are “front-loaded” and thereby received by the trust more quickly, these receipts will generate more interest income for distribution to the children during the term of the trust.

- 28 - between three and five times recent annual receipts,190 a rule a thumb that seems informally to be accepted even by the Internal Revenue Service. Thus, if the royalty payments have averaged about $200,000 per year, the royalty interest is likely to be worth between $600,000 and $1 million. Using the midpoint of these values, the royalty interest would be worth $800,000.

• The children’s and political organization’s respective interests in the trust would be valued in accordance with standard actuarial tables published by the Internal Revenue Service.191 These tables assume that the income yield from trust investments is relatively low. For example, for a gift made in February 2007, the tables assume an income yield of 5.6%, or $44,800 per year.192 (Recall that the royalty interest was valued at $800,000. 5.6% of $800,000 is $44,800.)

• In this case, the trust’s actual income is much greater than the tables assume. If the trust is established under Oklahoma law, approximately 85% of the annual receipts (i.e., 85% of $200,000, or $170,000) will be classified as income to be distributed to the taxpayer’s children.193 Only 15% of the annual receipts (i.e., 15% of $200,000, or $30,000) will be classified as principal to be held for ultimate distribution to the political organization. Viewed another way, the income yield on the trust’s royalty interest is 21.25% ($170,000 divided by $800,000).

• The results here would be similar to the results in Snyder and Hipp. The standard actuarial tables, which assume a 5.6% income yield, understate the value of the children’s interest in the trust. In fact, under these tables, the children’s income interest would be worth only 42% of the value of the royalty interest contributed to the trust,194 even though the children receive 85% of the royalty payments. Thus, for gift tax purposes, the value of the taxpayer’s gift to the children would be only $336,072 (i.e., 42% of $800,000). However, the children would actually receive $1.7 million over the trust term (10 years times $170,000 per year). Only $300,000 would be set aside for the political organization over the trust term (10 years times $30,000 per year). To add insult to the government’s injury, the children would also receive any interest income generated by the $300,000 that is set aside for the political organization during this period.

190 See, e.g., The University of Texas System Accounting Policies 71.6, at § 2.1, at http://www.utsystem.edu/bpm/71-6.htm (explaining that in the absence of better information, minerals held in trust for the University of Texas System are valued at three times the previous 12 months’ revenue). 191 See Treas. Reg. § 25.2512-5(d) (as amended in 2000) (providing for the valuation of term and remainder interests in property for gifts made after April 30, 1999). 192 Rev. Rul. 2007-9, 2007-6 I.R.B. 193 See OKLA. STAT. tit. 60, § 175.411(A)(1), (3) (directing that 85% of each significant royalty, shut-in- well payment, take-or-pay payment, bonus, or delay rental from a mineral interest be allocated to income). 194 The actuarial factor for a 10-year income interest, using a 5.6% interest rate, is 0.42009. Treas. Reg. § 20.2031-7(d)(6), Table D (as amended in 2000). 0.42009 times $800,000 is $336,072.

- 29 - • The overstated gift to the political organization should qualify for the section 2501(a)(4) gift tax exclusion. As discussed in Part III.B of this article, supra, the IRS has conceded in other contexts that a gift of a remainder interest in trust is a gift “to” the donee.195 Further, the gift to the political organization is clearly made “for the use of” such organization.

It would seem very difficult for the Internal Revenue Service to dispute these results. The IRS has conceded that taxpayers may use the standard tables to value an income interest where the actual income is substantially lower than the assumed income.196 Presumably, the IRS would also concede that taxpayers may use the standard tables to value an income interest where the actual income is substantially higher than the assumed income. If not, prior caselaw provides ample support for the taxpayer’s position.197 Only in the most extreme cases, where the principal is most severely impaired, might the IRS avoid application of the tables.198

D. A New Type of Private Foundation

Each of the strategies discussed above requires at least the passive cooperation of a political organization. The taxpayer must find an organization that is willing to accept gifts of an unusual nature and will not insist on being actively involved in the management of the trust or other entity that is used to facilitate the gift. To address this issue, a particularly well-heeled taxpayer might create his or her own private political organization to receive the gift. Taxpayers faced similar issues when trying to use the gift tax charitable deduction prior to the Tax Reform Act of 1969, and often responded by establishing their own private charities to receive their gifts.199 As described in Part II.A.2 of this article, supra, the use of such private charities (now known as “private foundations”) was curtailed by the enactment of rules harshly penalizing “self-dealing” transactions between such charities and certain insiders.200 However, political organizations are not subject to these rules.

195 Treas. Reg. § 1.170A-8(a)(2) (1972). 196 Rev. Rul. 77-195, 1977-1 C.B. 295. 197 See Rosen v. Comm’r, 397 F.2d 245 (4th Cir. 1968) (“Resort to the tables is justified in cases where valuation necessarily presents an element of speculation and where use of the tables is actuarially sound.”); Hipp v. United States, 215 F. Supp. 222 (W.D.S.C. 1962) (“Recognizing that the value of [a] future interest cannot be determined with any degree of certainty, those called upon to make valuations have resorted to established computations which seldom accurately predict the value in a particular situation but prove to be accurate when used in a great number of instances.”). 198 See Hamm v. Comm’r, 20 T.C.M. (CCH) 1814, 1837, 1839 (1961) (refusing to apply the standard tables where it appeared doubtful that a charitable beneficiary would ever receive any distributions), affd, 325 F.2d 934 (8th Cir. 1963), cert. den., 377 U.S. 993 (1964). 199 See, e.g., Hamm v. Comm’r, 20 T.C.M. (CCH) at 1816 (describing the taxpayer’s gift of an income interest in trust to a charity named for, and presumably controlled by, the taxpayer’s family). 200 I.R.C. § 4941.

- 30 - A political organization is subject to the looser, more general requirement that it operate “primarily” for the purpose of influencing elections.201 In an extreme case, where a political organization exhibits blatant disregard for its own interests when dealing with a donor, it might be viewed as making expenditures for improper purposes and not being operated “primarily” for permitted purposes. It seems doubtful, however, that this problem will arise where the political organization merely accepts a gift that confers limited legal rights on the organization. In that regard, charities are required to operate “exclusively” for their exempt purposes, yet the Internal Revenue Service has not suggested that charities’ participation in transactions of the type described in Part II.A.1 of this article, supra, violates this rule.202 Thus, there are few impediments to a taxpayer creating his or her own private political organization to receive political contributions, much as taxpayers have created their own private foundations to receive charitable contributions. It appears that the taxpayer may not personally serve as an officer or director of the political organization, or the taxpayer’s gifts may be considered to be “incomplete” for federal estate and gift tax purposes.203 However, the taxpayer may easily avoid that problem by appointing family members to control the political organization.

V. Estate Tax Treatment of Bequests to Political Organizations

201 See id. § 527(e)(1), (2) (providing that a political organization must be organized and operated “primarily” to accept contributions and make expenditures for certain exempt purposes); id. §§ 527(e)(4), 271(b)(3) (explaining that the term “expenditures” includes “a payment, distribution, loan, advance, or deposit, of money, or anything of value, and includes a contract, promise, or agreement to make an expenditure, whether or not legally enforceable”). 202 See, e.g., Hipp v. United States, 215 F. Supp. 222, 223 (W.D.S.C. 1962) (considering the donation of income interests in trust to unspecified charities); Hamm v. Comm’r, 20 T.C.M. (CCH) 1814, 1816 (1961) (considering the donation of income interests in trust to a charity named for the taxpayer’s family), affd, 325 F.2d 934 (8th Cir. 1963), cert. den., 377 U.S. 993 (1964). In neither case did the Internal Revenue Service argue that the charities were not operating exclusively for their exempt purposes, even though the charities appear to have acquiesced in the payment of substantially less than the reported value of the taxpayers’ gifts. 203 See I.R.C. § 2036(a)(2) (providing that the value of a decedent’s gross estate will include property transferred by the decedent in which the decedent has retained “the right, either alone or in conjunction with any other person, to designate the persons who shall possess or enjoy the property or the income therefrom”); Rifkind v. United States, 5 Cl. Ct. 362 (1984) (holding that the assets of a trust were includible in the donor’s gross estate for federal estate tax purposes because the donor was a director of the charity that was named as income beneficiary of the trust); Rev. Rul. 72-552, 1972-2 C.B. 525 (determining that a donor’s contributions to a charity were includible in the donor’s gross estate for federal estate tax purposes, because the donor was president and a director of the charity). This problem arises only where the donor gives an interest in a trust or other entity to a political organization and gives another interest in the same trust or entity to a member of the donor’s family, as described in Parts IV.A through IV.C of this article, supra. Otherwise, it appears that the donor’s contributions to a controlled political organization will be excluded from the donor’s gross estate. See Treas. Reg. § 1.527-5(c)(2) (1980) (“Where excess [political] funds are held by an individual who dies, and these funds go to the individual’s estate or any other person . . . the funds are income of the decedent and will be included in the decedent’s gross estate unless the estate or other person receiving such funds transfers the funds within a reasonable period of time” to a permitted recipient.).

- 31 - As the preceding sections of this article indicate, Congress seems to have given little thought to the estate and gift taxation of political contributions. With respect to lifetime contributions, this inattention results in surprisingly lenient gift tax treatment of such gifts. With respect to contributions at death, Congress’ insouciant approach has extremely harsh estate tax consequences (which nevertheless may be avoided through careful planning). The federal estate tax is imposed on a decedent’s entire estate (broadly defined), reduced only by those deductions specifically allowed by statute.204 The list of permitted deductions omits any mention of bequests to political organizations.205 Thus, bequests to political organizations are taxable by default, for the simple reason that Congress has not bothered to provide otherwise.206 It appears that Congress was not motivated by any policy considerations in denying an estate tax deduction, but merely failed to account for what one court termed an “unlikely” or infrequent event.207 Of course, political bequests may be uncommon precisely because they are subject to estate tax. Donors often choose to remember their favorite charitable causes in their will; it appears that some testators would also like to benefit their favorite political causes.208 Even under this stringent estate tax regime, a determined donor may arrange for property to pass (or become available) for political purposes upon his or her death, free of estate tax. The donor might use one of several possible strategies:

• The donor could establish a limited partnership, retain a general partnership interest, and give a limited partnership interest to a political organization during the donor’s lifetime. The lifetime gift to the political organization would be exempt from gift tax under section 2501(a)(4) of the Internal Revenue Code.209 Under state law or the terms of the partnership agreement, the partnership would

204 I.R.C. §§ 2001(a), 2051. 205 See id. §§ 2053-2058 (allowing deductions for various types of expenses and bequests). 206 Treasury regulations establish a limited exception to this rule, where the assets held by an individual for a section 527 organization are included in the individual’s estate by operation of law. In that event, the assets may escape estate tax if they are transferred to a permitted recipient within a reasonable period of time. Treas. Reg. § 1.527-5(c)(2) (1980). 207 Carson v. Comm’r, 71 T.C. 252, 262 n.12 (1978) (observing also that this creates a “minor flaw in the symmetry of the estate and gift taxes”), aff’d, 641 F.2d 864 (10th Cir. 1981). 208 See Motivated Political Donors Don’t Let Death Stop Them, WASH. POST, Oct. 31, 2005, at A17 (“Political donors are reaching from beyond the grave to support candidates and parties, setting up their estates to continue giving campaign money long after they die. . . . Presidential and congressional candidates and political parties have collected more than $1.3 million from at least 100 deceased donors since 1991, according to the Halloween-themed ‘From Coffins to Coffers’ report by the Center for Public Integrity in Washington.”); Neumann Bequest Benefits NRA-ILA and The NRA Foundation, AMERICAN RIFLEMAN, Feb. 28, 2001, at 74 (“NRA recently mourned the loss of Life member and competitive shooter Edward John Neumann. With a generous estate bequest, Neumann affirmed his support for America’s firearms traditions by providing $288,000 to NRA-ILA and The NRA Foundation.”); Obituary of James E. Fete, Sr., AKRON BEACON J., Sept. 20, 2000, at B6 (“In lieu of flowers, vote Bush.”); Obituary of Mary Frances Hallowell, PROVIDENCE J., Oct. 30, 2000 (“In lieu of flowers, please vote for Al Gore.”). In my estate planning practice, I recently had occasion to include the following proviso in a client’s trust agreement: “Settlor requests that this gift be used to promote ‘originalist’ judicial principles as exemplified by Justice Antonin Scalia.” 209 I.R.C. § 2501(a)(4).

- 32 - dissolve upon the donor’s death and the political organization would receive its share of the partnership assets outright.210 Assuming the partnership has a valid business purpose, the donor respects all entity formalities, and the donor manages and deals with the partnership on an arms-length basis, the distribution to the political organization should not be subject to federal estate tax.211

• The donor could make a significant lifetime gift to a political organization. This gift would be exempt from gift tax under section 2501(a)(4).212 In an independent transaction at a later date, the donor might sell another asset to the political organization in exchange for the organization’s agreement to pay a specified amount to the donor every month for the donor’s life (a “private annuity”). The present value of the annuity payments would equal the value of the asset sold to the political organization. Upon the donor’s death, the annuity obligation would terminate and the political organization would retain the transferred property free of any further obligations.

• The donor could make a bequest at death to a charity (e.g., Planned Parenthood or the Christian Broadcasting Network) that supports the donor’s political causes to the maximum extent permitted by law. This bequest should qualify for the estate tax charitable deduction and therefore be exempt from federal estate tax.213

Thus, the estate tax regime for bequests to political organizations constitutes little more than a trap for the unwary. From a policy perspective, this regime serves no apparent purpose. If (as commonly suggested) the purpose of campaign finance laws is to limit the corrupting influence of money on our political system,214 it makes no sense to

210 See, e.g., Del. Code Ann. tit. 6, §§ 17-801(3), 17-402(6)a (providing for the dissolution of a limited partnership upon the death of an individual who is the sole general partner). 211 See Kimbell v. United States, 145 F.3d 257 (5th Cir. 2004) (holding that partnership assets were not includible in decedent’s gross estate for federal estate tax purposes, where the decedent received partnership interests proportionate to her contributions and her contributions were properly credited to her capital account); Estate of Stone v. Comm’r, 86 T.C.M. (CCH) 551 (2003) (holding that partnership assets were not includible in decedent’s gross estate for federal estate tax purposes, where partnerships were created in part to resolve disputes within the family); but see Strangi v. Comm’r, 417 F.3d 468 (5th Cir. 2005) (holding that partnership assets should be included in decedent’s gross estate for federal estate tax purposes, where decedent transferred substantially all of his assets to partnership, relied on partnership distributions to support himself, and continued to live in a residence owned by the partnership); Reichardt v. Comm’r, 114 T.C. 144 (2000) (determining that all of the assets that decedent transferred to partnership should be included in his gross estate for federal estate tax purposes, where the decedent commingled personal and partnership assets, failed to pay rent for the use of a residence owned by the partnership, and otherwise treated partnership assets as if they were his own). 212 I.R.C. § 2501(a)(4). 213 See I.R.C. § 2055(a) (allowing an estate tax deduction for qualifying bequests to charities and certain other donees). 214 See Buckley v. Valeo, 424 U.S. 1, 25 (1976) (“[T]he primary interest served by the limitations [on campaign contributions] is the prevention of corruption and the appearance of corruption spawned by the real or imagined coercive influence of large financial contributions on candidates’ positions and on their actions if elected to office.”)

- 33 - treat bequests more harshly than lifetime contributions. Not even the most well- connected donor can demand favors from beyond the grave.

VI. Proposals for Reform

Establishing a rational estate and gift tax regime for political contributions is surprisingly simple. Congress need enact only six basic reforms, all of which are easy to implement and have a firm grounding in existing law.

A. Allow Donors to Make Gifts Either “To” or “For the Use Of” a Political Organization.

First, Congress should eliminate the present-law requirement that political contributions be made both “to” and “for the use of” a political organization.215 Eliminating this requirement would help simplify the tax system by conforming the gift tax treatment of political contributions with the gift tax treatment of charitable contributions. Moreover, the meaning of this provision is unclear and may be a source of future controversy between taxpayers and the Internal Revenue Service. Finally, the requirement does not significantly curtail the potential for manipulation of the section 2501(a)(4) exclusion.

B. Make Political Contributions Subject to the Chapter 14 Special Valuation Rules.

Second, Congress should make political contributions subject to the Chapter 14 “special valuation” rules described in Part II.B.3 of this article, supra. Specifically, Congress should provide that a political organization is an “applicable family member” and a “member of the transferor’s family” for purposes of sections 2701 through 2704 of the Internal Revenue Code.216 As a result, interests held by political organizations would generally be valued at zero when computing the value of the taxpayer’s gifts to other family members.217 A donor could avoid that harsh result by ensuring that the property he or she contributes to a political organization is structured in a form prescribed by

215 I.R.C. § 2501(a)(4). The implications of this requirement are described in Part III.B of this article, supra. 216 See I.R.C. § 2701(e)(2) (defining “applicable family member” to mean the transferor’s spouse, an ancestor of the transferor or the transferor’s spouse, and the spouse of any such ancestor); id. § 2701(e)(1) (defining “member of the family,” for purposes of section 2701, to mean the transferor’s spouse, a descendant of the transferor or the transferor’s spouse, and the spouse of any such descendant); id. §§ 2702(e), 2704(c)(2) (defining “member of the family,” for purposes of section 2702 and 2704, to mean the transferor’s spouse, any ancestor or descendant of the transferor or the transferor’s spouse, any brother or sister of the transferor, and any spouse of any such ancestor, descendant, brother, or sister). 217 See id. § 2701(a)(1), (a)(3)(A) (providing that when computing the value of a gift of an interest in a corporation or partnership, the value of any interest retained by the transferor or an applicable family member is generally deemed to be zero); id. § 2702(a)(1), (a)(2)(A) (providing that when computing the value of a gift of an interest in trust, the value of any interest retained by the transferor or an applicable family member is generally deemed to be zero).

- 34 - statute and designed to be easy to value.218 For example, under the proposed regime, the donor could give cumulative preferred stock to a political organization.219 Similarly, the donor could create a trust in which a political organization receives an annuity interest,220 a unitrust interest,221 or a remainder interest following an annuity or unitrust interest.222 Thus, this regime would still permit some tax planning, but would curtail the most aggressive strategies described in Parts IV.A and IV.C of this article (relating to contributions of noncumulative preferred stock or difficult-to-value remainder interests in trust). Alternatively, Congress could make political contributions subject to the gift tax “partial interest rule” currently applicable to charitable contributions.223 Under this rule, a gift to a political organization would qualify for the section 2501(a)(4) gift tax exclusion only if the donor contributes the donor’s entire interest in property, or contributes a partial interest that is structured in a form prescribed by statute and designed to be easy to value.224 For example, a gift would qualify for the section 2501(a)(4) exclusion if it were structured as an annuity interest,225 a unitrust interest,226 or a remainder interest following an annuity or unitrust interest.227 This approach would curtail the strategy described in Part IV.C of this article, relating to contributions of difficult-to-value remainder interests in trust. However, it may not preclude a donor from engaging in the strategy described in Part IV.A of this article, relating to contributions of noncumulative preferred stock, as in that case the donor would contribute the donor’s entire interest in the preferred stock. Therefore, applying the partial interest rule to gifts of political contributions would be less effective than applying the Chapter 14 special valuation rules.

C. Disallow Income Tax Deduction for Interest Paid to Political Organization.

218 See id. §§ 2701(a)(3)(A), 2702(a)(2)(B) (excluding certain “qualified” retained interests from the application of the Chapter 14 special valuation rules). 219 See id. § 2701(a)(3)(A), (c)(3) (providing for the valuation of qualified payments, which are defined as “any dividend payable on a periodic basis under any cumulative preferred stock (or a comparable payment under any partnership interest) to the extent that such dividend (or comparable payment) is determined at a fixed rate”). 220 See id. § 2702(b)(1) (defining the term “qualified interest” to include “any interest which consists of the right to receive fixed amounts payable not less frequently than annually”). 221 See id. § 2702(b)(2) (defining the term “qualified interest” to include “any interest which consists of the right to receive amounts which are payable not less frequently than annually and are a fixed percentage of the fair market value of the property in the trust (determined annually)”). 222 See id. § 2702(b)(2) (defining the term “qualified interest” to include “any noncontingent remainder interest if all of the other interests in the trust consist” of annuity or unitrust interests). 223 See id. § 2522(c)(2) (denying any gift tax charitable deduction for most gifts of partial interests in property). This rule is discussed in Part II.A.2 of this article, supra. 224 See id. (prescribing the required forms for gifts of partial interests in property). 225 See id. § 2522(c)(2)(B) (allowing a gift tax charitable deduction for an interest “in the form of a guaranteed annuity”). 226 See id. (allowing a gift tax charitable deduction for an interest that is “a fixed percentage distributed yearly of the fair market value of the property (to be determined yearly)”). 227 See id. § 2522(c)(2)(A) (allowing a gift tax charitable deduction for a remainder interest in a charitable remainder annuity trust or a charitable remainder unitrust).

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Third, Congress should disallow any income tax deduction for interest paid to a political organization. This would curtail the strategies described in Part IV.B of this article (relating to the contribution of a promissory note to a political organization). In particular, this reform would prevent corporations from making what amount to deductible, pre-tax political contributions cast as interest payments. An exception could be made for interest on “qualified debt,” which would be defined to include interest the political organization receives on bank accounts, certificates of deposit, publicly traded debt instruments, and other routine investments made in the ordinary course of business.

D. Extend Self-Dealing and Excess Benefit Transaction Rules to Political Organizations.

Fourth, Congress should made political organizations subject to the “self-dealing” and “excess benefit transaction” rules currently applicable to charities.228 These rules are described in more detail in Part II.A.2 of this article, supra. Under this reform, severe penalties would be imposed on donors who engage in almost any transaction with certain closely affiliated political organizations.229 Penalties would also be imposed on donors who engage in transactions with other political organizations, if the transactions are not fair to the political organization.230 In each case, penalties may also be imposed on the persons who manage the political organization.231 This regime would impede any strategy that relies on the political organization not asserting its rights or defending its interests in a transaction with the donor.

E. Require Donors to Report Political Contributions on Gift Tax Returns

Fifth, the Internal Revenue Service should require that political contributions in excess of a specified amount be reported on a donor’s federal gift tax return. The Service’s failure to require such reporting under present law makes it all-but-impossible to monitor or police use of the section 2501(a)(4) gift tax exclusion.232 Even without a substantive change in the law, this simple reform would deter some planning and help to identify practices that Congress may wish to regulate.

F. Allow Estate Tax Deduction for Political Bequests

228 See id. § 4941 (relating to self-dealing transactions between disqualified persons and private foundations); I.R.C. § 4958 (relating to “excess benefit transactions” between disqualified persons and public charities). 229 See id. § 4941 (imposing onerous excise taxes on transactions between disqualified persons and private foundations). 230 See id. § 4958 (imposing excise taxes on “excess benefit transactions” between disqualified persons and public charities). 231 See id. §§ 4941(a)(2) (penalizing “foundation managers”), 4958(a)(2) (penalizing “organization managers”). 232 See Internal Revenue Service, 2006 Instructions for Form 709, United States Gift (and Generation- Skipping Transfer) Tax Return, at 2 (“These transfers [political contributions] are not ‘gifts’ as that term is used on Form 709 and its instructions. You need not file a Form 709 to report these transfers and should not list them . . . if you do file Form 709.”).

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Finally, Congress should allow an estate tax deduction for bequests to political organizations. This reform would simplify the law by conforming the estate tax treatment of charitable and political bequests.233 This change would also eliminate the present disparity between the estate tax treatment and gift tax treatment of political bequests.234 Further, allowing an estate tax deduction would seem consistent with the public policy objectives of campaign finance laws.235 To prevent manipulation of this new estate tax deduction, Congress should make political bequests subject to the “partial interest” rules presently applicable to charitable bequests.236 There is no need to devise a new and complex system of rules to limit such bequests; the existing body of law governing charitable bequests will do quite nicely.

VII. Conclusion

Political giving has exploded in the quarter-century since the Tax Court recognized a gift tax exclusion for political contributions.237 Congress has devoted much attention to the substantive regulation of such contributions,238 but in the process has neglected to modernize related tax rules.239 It is only a matter of time before taxpayers and the Internal Revenue Service begin to refight old battles, reanimating long-dead litigation over the gift tax charitable deduction240 and the exclusion for retained interests.241 Congress should act first, by harmonizing the estate and gift tax treatment of political contributions with the estate and gift tax treatment of charitable contributions and retained interests.

233 See I.R.C. 2055(a) (allowing a federal estate tax deduction for most bequests to charity). 234 See Carson v. Comm’r, 71 T.C. 252, 262 n.12 (1978) (observing that this inconsistent treatment creates a “minor flaw in the symmetry of the estate and gift taxes”), aff’d, 641 F.2d 864 (10th Cir. 1981). As political bequests become more prevalent, this flaw may no longer be viewed as minor. 235 This issue is considered in more detail in Part V of this article, supra. 236 See I.R.C. § 2055(e)(2) (disallowing the estate tax charitable deduction for bequests of partial interests in property, except where such interests are in a form prescribed by statute and designed to be easy to value). 237 See Carson v. Comm’r, 71 T.C. 252, 263-64 (1978) (holding that political contributions are not subject to federal gift tax), aff’d, 641 F.2d 864 (10th Cir. 1981); 2004 Election-Overview: Stats at a Glance, http://www.opensecrets.org/overview/stats.asp?cycle=2004 (reporting total campaign contributions of $1.35 billion to all candidates for federal office in the 2004 election cycle). 238 See Bipartisan Campaign Reform Act of 2002, Pub. Law No. 107-155, 116 Stat. 81 (2002) (amending Federal Election Campaign Act of 1971, 2 U.S.C. 431). 239 Section 2501(a)(4) of the Internal Revenue Code has been renumbered, but otherwise remains unchanged since its enactment in 1974. Compare I.R.C. § 2501(a)(5) (1976), as reprinted in 1976 U.S.C.C.A.N. 1066 (showing the text of the statute as originally enacted), with I.R.C. § 2501(a)(4) (West. Supp. 2007) (showing the identical text in the current Internal Revenue Code). 240 See, e.g., Hipp v. United States, 215 F. Supp. 222, 228 (W.D.S.C. 1962) (allowing a generous gift tax charitable deduction for an income interest in trust, where the income actually paid to charity may have been less than the taxpayer’s calculation assumed). 241 See, e.g., Snyder v. Comm’r, 93 T.C. 529, 545 (1989) (allowing the taxpayer to place a very low value on the common stock she transferred to her great-grandchildren, in view of her retention of difficult-to- value preferred stock).

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999999 999999 DALLAS 2154403.1

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