Family Trust of Massachusetts, Inc. v. United States

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued May 15, 2013 Decided June 28, 2013

No. 12-5360

FAMILY TRUST OF MASSACHUSETTS, INC.,

APPELLANT

v.

UNITED STATES OF AMERICA,

APPELLEE

Appeal from the United States District Court

for the District of Columbia

(No. 1:11-cv-00680)

Christopher S. Rizek argued the cause for the appellant.

Matthew C. Hicks was on brief.

Jennifer M. Rubin, Attorney, United States Department of

Justice, argued the cause for the appellee. Ronald C. Machen

Jr., United States Attorney, and Kenneth L. Greene, Attorney,

were on brief.

Before: HENDERSON, TATEL and GRIFFITH, Circuit Judges.

KAREN LECRAFT HENDERSON, Circuit Judge: The Family

Trust of Massachusetts, Inc. (FTM) manages a pooled trust

established pursuant to 42 U.S.C. § 1396p(d) to provide

supplemental services and benefits to disabled individuals

receiving Medicaid, Supplemental Security Income (SSI) or

other public benefits. FTM applied to the United States Internal

2

Revenue Service (IRS) for a charitable tax exemption under

I.R.C. § 501(a) and (c)(3) based on its trustee services. After the

IRS preliminarily denied FTM’s application, FTM filed this

action seeking a declaration that it is a tax exempt charitable

organization. The district court granted summary judgment to

the government, concluding that FTM failed to satisfy two of the

statutory requirements to constitute a charitable organization: (1)

that it be “operated exclusively for . . . charitable . . . purposes”

and (2) that “no part of [its] net earnings . . . inure[] to the

benefit of any private shareholder or individual.” I.R.C.

§ 501(c)(3); see Family Trust of Mass., Inc. v. United States, 892

F. Supp. 2d 149 (D.D.C. 2012). We agree with the district court

that FTM is not operated exclusively for charitable purposes

and, accordingly, affirm the grant of summary judgment on that

ground.

I.

Eligibility for some government benefit programs, including

Medicaid and SSI, is limited by a claimant’s income and assets,

which affect whether and to what extent the claimant may

receive benefits. See Sai Kwan Wong v. Doar, 571 F.3d 247,

251 (2d Cir. 2009); Lewis v. Alexander, 685 F.3d 325, 333 (3d

Cir. 2012). Under statutory “trust-counting” rules, a trust corpus

generally is counted as an asset for the purpose of the eligibility

limits. Lewis, 685 F.3d at 333 (citing Omnibus Budget

Reconciliation Act of 1993, Pub. L. No. 103–66, Title XIII

§ 13611(d(1)(C), 107 Stat. 312 (codified at 42 U.S.C.

§ 1396p(d)(1)(C)). The Congress made an exception, however,

for a qualifying “special needs” or “supplemental needs”

trust—that is, “ ‘a discretionary trust established for the benefit

of a person with a severe and chronic or persistent disability and

[] intended to provide for expenses that assistance programs

3

such as Medicaid do not cover.’ ”1 Id. (quoting Sullivan v.

Cnty. of Suffolk, 174 F.3d 282, 284 (2d Cir. 1999)); see 42

U.S.C. § 1396p(d)(4). One form of such a trust is the “pooled”

special needs trust, which “ ‘is a special arrangement with a

non-profit organization that serves as trustee to manage assets

belonging to many disabled individuals, with investments being

pooled, but with separate trust “accounts” being maintained for

each disabled individual.’ ” Id. (quoting Jan P. Myskowski,

Special Needs Trusts in the Era of the Uniform Trust Code, 46

N.H. Bar J., Spring 2005, at 16); see 42 U.S.C.

§1396p(d)(4)(C)(iii).2 FTM was organized in March 2003, inter

alia, to manage such pooled account trusts. See Articles of

Organization, Family Trust of Mass., art. II (filed July 31, 2002)

(JA 256). FTM’s Articles of Organization identify four

individuals as directors, including Peter M. Macy. Macy is also

identified as President and Treasurer and his law office address

is listed as FTM’s “principal office.” Id. art. VII (JA 259).

In March 2004, FTM executed a trust agreement

establishing the “Family Trust for Supplemental Needs II”

(Trust)—with FTM as its trustee—“to provide for the collective

management and distribution of the Trust Estate on behalf of

persons who are disabled, as defined in 42 U.S.C. §1382c(a)(3),

for whom trust accounts are established.” Trust Agreement,

Family Trust for Supplemental Needs II § 2.020 (Mar. 23,

2004) (JA 116) (Trust Agreement). The Trust Agreement sets

the minimum contribution level for a trust account at $25,000,

payable over three years, and provides that, upon the death of a

1

Expenses the trust account covers include “books, television,

Internet, travel, and even such necessities as clothing and toiletries.”

Lewis, 685 F.3d at 333.

2

Each pooled account must have been established solely for the

benefit of a disabled individual by himself, his parent, grandparent or

legal guardian or a court. 42 U.S.C. § 1396p(d)(4)(C).

4

beneficiary, the Trust retains a portion of the residual corpus

equal to $1,000 plus five to twenty per cent of the remaining

funds, depending on the length of the account’s life. Each

account is assessed a minimum annual trustee fee of $750. The

number of pooled trust accounts grew from about 20 in 2005 to

300 by 2010, largely through referrals from “elder law”

professionals, including Macy himself. See Letter from FTM to

IRS at 4 (Mar. 2, 2009) (JA 456) (“Macy refers his own disabled

clients to the pooled trust if they meet the criteria of FTM’s

charitable class.”); Mem. from FTM to IRS ¶ 3 (Dec. 26, 2006)

(JA 313) (“Information about the benefits of or through [FTM]

is disseminated primarily through word-of-mouth in the Elder

Law legal community, but it also is presented in various treatises

and other source books for Medicaid law in Massachusetts.”).

In November 2005, FTM applied to the IRS for a tax

exemption as a “charitable” organization under I.R.C. § 501(a)

and (c)(3).3 There followed substantial correspondence between

FTM and the IRS. On February 12, 2008, the IRS sent FTM a

proposed denial of the application, stating that FTM’s trust

management services lacked the “donative element necessary”

to establish a charitable purpose. Letter from IRS to FTM at 6-7

(Feb. 12, 2008) (JA 400-01) (Proposed Exemption Denial). The

IRS explained:

You state that you charge the Trust fees that are

reasonable, consistent with the laws of Massachusetts.

Thus, you have not established that the services you

provide to the Trust are charitable within the meaning

of section 501(c)(3).

3

Section 501(a) exempts from taxation “[a]n organization

described in subsection (c),” which includes “[c]orporations . . .

organized and operated exclusively for . . . charitable . . . purposes, . . .

no part of the net earnings of which inures to the benefit of any private

shareholder or individual.” I.R.C. § 501(a), (c)(3).

5

In addition, although you state that the fees you

charge the Trust are below commercial trustee rates for

administration of trusts of the size and nature of the

assets you manage, you have not established that these

fees are substantially below your cost . . . . Therefore,

your services to the Trust are not charitable within the

meaning of section 501(c)(3) of the Code.

Id. at 7 (JA 401). The IRS also reasoned that FTM is not

“operated exclusively for the relief of the poor and distressed”

because it is the Trust—for which FTM provides “trustee

services and trust management and investment services”—that

provides such relief. Id.

Additional correspondence followed, culminating in an

August 3, 2010 conference, after which the IRS sought

additional information, including tax returns for “tax years 2007

to the present.” Letter from IRS to FTM at 3 (Aug. 18, 2010)

(JA 519). FTM responded with copies of its 2007 and 2008

returns, advising that its 2009 return would “be filed by October

15, 2010.” Letter from FTM to IRS at 11 (Oct. 8, 2010) (JA

554). FTM filed the 2009 return with the IRS on November 11,

2010.

On April 6, 2011, FTM filed a complaint in district court,

pursuant to I.R.C. § 7428(a),4 seeking a declaration that FTM “is

exempt from federal income taxation under Section 501(a) of

the Internal Revenue Code as an organization described in

Section 50l(c)(3) of the Internal Revenue Code.” Compl. at 3,

FTM v. United States, C.A. No. 11–680 (D.D.C. Apr. 6, 2011)

(JA 9). The government moved to supplement the stipulated

4

Section 7428 allows an organization that requests a section

501(c)(3) exemption but does not receive a final determination of

exemption eligibility within 270 days to seek a declaration of

exemption from the United States Tax Court, Court of Federal Claims

or District Court for the District of Columbia. I.R.C. § 7428(a), (b).

6

administrative record with FTM’s 2003 and 2009 tax returns,5

which motion FTM opposed. The district court granted the

motion, concluding that the tax returns were “pertinent returns”

within the meaning of Tax Court Rule 210(b)(12)

(“ ‘Administrative record’ includes, where applicable, . . . all

pertinent returns . . . .”). Family Trust of Mass., Inc. v. United

States, 2012 WL 3194421 (D.D.C. June 7, 2012). In September

2012, on cross-motions for summary judgment on the merits, the

district court granted summary judgment in the government’s

favor. Family Trust of Mass., 892 F. Supp. 2d at 161. FTM

timely appealed.

II.

The district court granted summary judgment on the

alternative grounds that FTM failed to meet two requirements

for a section 501(c)(3) exemption: (1) “that it is operated solely

for exempt purposes” and (2) “that its net earnings do not

provide a private benefit to any individual.” Family Trust of

Mass., 892 F. Supp. 2d at 161. “[T]he determination of whether

an organization is organized and operated exclusively for

exempt purposes is a factual determination reviewed only for

clear error.” Fund for the Study of Econ. Growth & Tax Reform

v. IRS, 161 F.3d 755, 758 (D.C. Cir. 1998); see also ASA

Investerings P’ship v. Comm’r, 201 F.3d 505, 511 (D.C. Cir.

2003) (“[I]n tax cases mixed questions of law and fact are to be

treated like questions of fact” (citing Fund, 161 F.3d at 759)).

5

The IRS sought to include the 2003 and 2009 returns in order to

emphasize the substantial increase in FTM’s “profitability” from

2003—its first year of operation when it had no revenue or

expenses—to 2009, its most recently documented tax year when it had

revenues of $667,679 and expenses of $305,155. See U.S. Separate

Filing re: Admin. R. and/or Mot. to Supplement Agreed Admin. R.,

FTM v. United States, C.A. No. 11–680, at 3-4 (Sept. 21, 2011) (JA

64-65); id. Ex. A, at 1 (JA 68).

7

Because the district court did not clearly err in determining that

FTM is not operated exclusively for a charitable purpose, we

affirm the district court on the first ground without reaching the

second.6

To qualify for the section 501(c)(3) charitable exemption,

FTM must, inter alia, be “operated exclusively for . . . charitable

. . . purposes.” I.R.C. § 501(c)(3). See IHC Health Plans, Inc.

v. Comm’r, 325 F.3d 1188, 1194 (10th Cir. 2003) (“Under

section 501(c)(3), an organization must meet three requirements

to qualify for tax exemption: (1) the corporation must be

organized and operated exclusively for exempt purposes; (2) no

part of the corporation’s net earnings may inure to the benefit of

any shareholder or individual; and (3) the corporation must not

engage in political campaigns or, to a substantial extent, in

lobbying activities.”) (footnote and quotation marks omitted);

accord Church of the Visible Intelligence that Governs the

Universe v. United States, 4 Cl. Ct. 55, 61 (1983). Under the

IRS’s test, “[a]n organization will be regarded as operated

exclusively for one or more exempt purposes only if it engages

primarily in activities which accomplish one or more of such

exempt purposes specified in section 501(c)(3)”; conversely,

“[a]n organization will not be so regarded if more than an

insubstantial part of its activities is not in furtherance of an

exempt purpose.” 26 C.F.R. § 1.501(c)(3)-1(c)(1) (emphases

added). The administrative record establishes that “more than

an insubstantial part” of FTM’s activities has been in

furtherance of a commercial rather than a charitable purpose.

In determining whether an organization “operates for a

substantial commercial purpose” we consider “various objective

6

Moreover, the parties agree regarding the operational purpose

prong that we need not decide who bore the burden of proof in district

court. See Appellee’s Br. 64; Tr. of Oral Argument at 26 (May 15,

2013).

8

indicia[, e.g., t]he particular manner in which an organization’s

activities are conducted, the commercial hue of those activities,

competition with commercial firms, and the existence and

amount of annual or accumulated profits.” Living Faith, Inc. v.

Comm’r, 950 F.2d 365, 372 (7th Cir. 1991). The objective

indicia here point to a commercial purpose underlying FTM’s

activities which are, as the district court described them,

“shrouded with a ‘commercial hue.’ ” 892 F. Supp. 2d at 159;

cf. Better Bus. Bureau of Wash., D.C. v. United States, 326 U.S.

279, 283-84, (1945) (“commercial hue permeating . . .

organization” disqualified organization from “exclusively for

. . . educational purposes” exemption from social security tax).

To all appearances, FTM operates as a commercial, for-

profit trustee. It charges fees to establish and manage the pooled

trusts and retains residual funds—the “residuals”—from the

accounts of deceased beneficiaries. As the following data show,

FTM’s operations have consistently produced revenue in excess

of expense:

Tax Year Revenue Expenses

2003 $ 0 $ 0

2004 $ 5,825 $ 628

2005 $ 53,125 $ 34,054

2006 $ 54,790 $ 53,927

2007 $194,235 $ 95,443

2008 $303,083 $182,230

2009 $667,679 $305,155

Pl.’s Reply Mem. in Supp. of its Cross-Mot. for Summ. J. at 8,

FTM v. United States, C.A. No. 11–680 (D.D.C. Dec. 21, 2011)

(JA 993); Ex. A , U.S. Separate Filing re: Admin. R. and/or Mot.

to Supplement Agreed Admin. R., FTM v. United States, C.A.

No. 11–680, at 1 (D.D.C. Sept. 21, 2011) (JA 68); id. Ex. B, at

9

1, 10 (JA 71, 79).7 Notwithstanding FTM’s profitability, its

operations manifest no countervailing “donative element” to

mark them as charitable. There is no evidence that the fees

FTM charges are below market rate, much less below cost—at

least if the residuals are taken into account. Moreover, FTM

dismissed as “not appropriate for trust administration” the

solicitation of charitable donations to defray trust costs. Letter

from FTM to IRS at 11 (Oct. 8, 2010) (JA 554); see Living

Faith, Inc., 950 F.2d at 373-74 (“lack of below-cost pricing

militates against granting an exemption,” while “lack of plans to

solicit contributions” is “relevant factor” in determining

commercial nature vel non) (citing Fed’n Pharmacy Servs., Inc.

v. Comm’r, 625 F.2d 804, 807 (6th Cir. 1980)); B.S.W. Grp., Inc.

v. Comm’r, 70 T.C. 352, 356 (1978) (furnishing services even

“at cost lacks the donative element necessary to establish . . .

activity as charitable”); id. at 359 (noting among “factors

7

FTM opposes consideration of its 2009 return, asserting the

district court erred in including it in the Administrative Record

“[d]espite the complete absence of the[] return[] at the administrative

level.” Appellant’s Br. 27. In November 2010 (when FTM filed the

return), however, the parties were still at “the administrative

level”—the IRS had not filed a final determination (and in fact never

did so) and this action was not filed in district court until April 6,

2011—some six months thence. See Family Trust of Mass., 2012 WL

3194421, at 5*. Moreover, FTM acquiesced in the IRS’s request for

the returns and, in any event, cannot claim unfair surprise at the

contents. Under the circumstances, the district court did not abuse its

discretion in including the 2009 return in the administrative record as

a “pertinent return[]” under Tax Court Rule 210(b)(12). See Cape

Cod Hosp. v. Sebelius, 630 F.3d 203, 211 (D.C. Cir. 2011) (district

court did not abuse discretion in supplementing administrative record

with comment letter agency “accepted . . . without objection”

notwithstanding party failed to comply with requirement that

commenter planning hand-delivery of comments telephone agency to

schedule same).

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weigh[ing] against” charitable tax exemption that petitioner

“ha[d] not solicited, nor ha[d] it received, voluntary

contributions from the public” and its income came from “fees

for services . . . set high enough to recoup all projected costs . . .

and indeed, to produce a net profit”). Nor has FTM used its

burgeoning residuals revenue to offset or waive trust

management fees. Reply Br. 23; cf. Lewis, 685 F.3d at 348-49

(“Retaining the residual enables the trust to cover administrative

fees and other overhead without increasing charges on accounts

of living beneficiaries.”).8

The charitable purpose of FTM’s operations is further

undercut by the commercial trappings of its operations. The

interrelationship between FTM and Macy’s law firm—FTM’s

headquarters are in Macy’s law offices, he refers clients to FTM

and he has performed legal services for it as well—cast FTM’s

operations as a commercial offshoot of Macy’s elder law

practice. Moreover, FTM has actively marketed its services

through “word-of-mouth in the Elder Law legal community,”

Mem. from FTM to IRS ¶ 3 (Dec. 26, 2006) (JA 313)—Macy’s

professional milieu—where it is likely to find affluent and

disabled elder law clients eager to obtain FTM’s services and

able to afford the minimum $25,000 deposit and $750 annual

fee. See http://www.familytrustofmass.org/ right_for_you.html

(promoting “Family Trust” as “right for you . . . if you . . . [a]re

an Elder Law attorney or financial professional assisting clients

8

Regarding retained residuals, FTM asserted to the IRS that “all

such amounts received since the inception of FTM in fact have been

earmarked for FTM’s charitable guardianship program.” Letter from

FTM to IRS at 11 (Mar. 12, 2008) (JA 415). No guardianship

program has been established. See Tr. of Oral Argument at 6 (May

15, 2013); see also Proposed Exemption Denial at 7 (JA 401)

(“Whether the guardianship services you expect to perform in the

future will constitute a charitable activity remains to be seen. At the

present time, these services are remote and speculative.”).

11

to preserve assets against the cost of long-term care through

estate planning”) (JA 522); Living Faith Inc., 950 F.2d at 373

(noting “use of promotional materials and commercial catch

phrases to enhance sales are relevant factors in determining

whether an organization operate[s] in the same manner as that

of any profitable commercial enterprise” and concluding

materials promoting organization’s restaurants, bible classes and

cooking classes had “strong commercial hue, and thus

provide[d] an indicia of a forbidden commercial purpose”)

(brackets in original; quotation marks omitted). FTM’s

marketing practices highlight its already-pervasive commercial

hue.

For the foregoing reasons, we conclude FTM is not operated

exclusively for a charitable purpose and accordingly affirm the

district court’s grant of summary judgment to the government.

So ordered.