LAPHAM FOUNDATION, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee., United States Court of Appeals, Sixth Circuit., 389 F.3d 606, No. 03-1229., Nov. 18, 2004., Argued: June 15, 2004

LAPHAM FOUNDATION, INC., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

United States Court of Appeals, Sixth Circuit.

389 F.3d 606

No. 03-1229.

Nov. 18, 2004.

Argued: June 15, 2004.

Decided and Filed: Nov. 18, 2004.

ARGUED : James C. Thomas III, Husch & Eppenberger, Kansas City, Missouri, for Appellant. Francesca Ugolini, United States Department of Justice, Washington, D.C., for Appellee. ON BRIEF : James C. Thomas III, Husch & Eppenberger, Kan╜sas City, Missouri, for Appellant. Frances╜ca Ugolini, Kenneth L. Greene, United States Department of Justice, Washington, D.C., for Appellee.

Before: DAUGHTREY and SUTTON, Circuit Judges; COOK, District Judge.*

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* ═ The Honorable Julian A. Cook, Jr., United States District Judge for the Eastern District of Michigan, sitting by designation.

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DAUGHTREY, Circuit Judge.

The petitioner, Lapham Foundation, Inc., appeals from a Tax Court judgment classifying it as a private foundation under 26 U.S.C. ╖ 509(a)(3). The Tax Court based its decision on a finding that the Foundation did not meet the "integral part" test set forth in 26 C.F.R. ╖ 1.509(a)-4(i)(3). On appeal, the Founda╜tion argues that it does meet the requisite test and is therefore a supporting organi╜zation, rather than a private organization. The Commissioner of Internal Revenue, in response, claims that the Tax Court was correct in holding that the Foundation did not meet the "integral part" test and that, even if the Foundation does meet that test, the Tax Court's decision should be af╜firmed because the Foundation has not shown that it is not controlled by disquali╜fied persons, as required by 26 U.S.C. ╖ 509(a)(3)(C) in order to be classified as a supporting organization. The Tax Court did not address the latter question and, because we conclude that the Tax Court's ruling on the Foundation's failure to meet the integral part test was correct, we like╜wise find it unnecessary to address the issue raised under ╖ 509(a)(3)(C).

FACTUAL AND PROCEDURAL BACKGROUND

Lapham Foundation, Inc. (the Founda╜tion), is a Michigan non-profit corporation, organized under its articles "to operate exclusively for the benefit of the American Endowment Foundation" in a manner in╜tended to "enable [it] to qualify as a sup╜porting organization of the American En╜dowment Foundation within the meaning of Section 509(a)(3) of the Code." In turn, the American Endowment Foundation (AEF) is an Ohio non-profit corporation that the IRS has recognized both as tax-exempt as an organization described in ╖ 501(c)(3) and as a publicly supported entity under ╖ 509(a)(1). AEF runs a do╜nor-advised fund program through which the donors have the right to advise AEF on how they wish their contributions to be distributed, but AEF is not obligated to follow the recommendations and retains control over the timing, manner, and recip╜ients of the distributions.

The Foundation's sole asset was a prom╜issory note, payable to Charles and Maxine Lapham, in a face amount of $1,554,244. The maker of the note was Estate Storage Co., a corporation owned by the Laphams, and it was collateralized with real estate owned by Estate Storage. The principal amount was due in full no later than De╜cember 30, 2013. The interest rate on the note was 7.75%, to be paid in equal quar╜terly payments of $30,113.48. In exchange for the note, the Laphams received a gift annuity, under which the Foundation agreed to pay them $116,568 annually over their joint lives.

In July 1999, the Foundation filed Form 1023 with the IRS, seeking to be recog╜nized as a tax-exempt organization under ╖ 501(c)(3) and as a supporting organiza╜tion under ╖ 509(a)(3). The application indicated that the Foundation would sup╜port AEF "by receiving and administering funds for the benefit of [AEF]" and listed its sources of financial support as "[d]ona╜tions from the Lapham family and its friends, including individuals and busi╜nesses," and interest on investments. On a financial disclosure form, the Foundation noted that it had received $1,554,244 in 1998 (the promissory note) and that it expected to receive $5,000 a year in gifts, grants, and contributions in 1999 and 2000. The form also noted that the entity anticipated receipt of $120,454 in gross in╜vestment income in 1999 and in 2000, and that it had a gift annuity obligation of $116,568 per year. The Foundation thus expected an excess of revenue over ex╜penses of $8,886 per year for 1999 and 2000. Because it intended to give at least 85 percent of its income to the supported organization, the application estimated a donation of $7,600 annually to AEF.

During the administrative process, the Foundation reported that it would receive outright testamentary gifts of approxi╜mately $693,000 at the death of the Lap╜hams, which it estimated would occur in 25.5 years, and that it was the beneficiary of a charitable lead trust under the revoca╜ble living trusts of Charles and Maxine Lapham, which, if certain assumptions proved to be true, would distribute $355,834 annually for 17 years after the Laphams' deaths. The report also indicat╜ed that the Laphams had pledged an addi╜tional $207,733 to the Foundation contin╜gent upon the approval of its status under ╖ 501(c)(3) and ╖ 509(a)(3).

In a later communication to the IRS, the Foundation stated that it would recom╜mend that AEF use one-third of the sup╜port provided through the donor-advised fund to expand its representation in South╜eastern Michigan, and the remaining two-╜thirds to support charities in Northville, Michigan. It also estimated that AEF's total annual income was $7,997,910, al╜though the Tax Court later determined that, in 1998, AEF received total contribu╜tions in the amount of $7,350,000 but had income of only $650,000.

On April 19, 2000, the IRS recognized the Foundation as exempt from taxation as a ╖ 501(c)(3) organization but determined that it was a private foundation, rather than a supporting organization under ╖ 509(a)(3). In response, the Foundation offered to make various changes in its organizational structure in order to achieve supporting organization status. The Tax Court found it unclear from the administrative record whether any of the proposed changes were actually made, al╜though it appears that the Foundation did amend its by-laws concerning the make-up of the board of directors. The Foundation nonetheless received an adverse ruling as to its request for a supporting organization classification under ╖ 509(a)(3). The IRS explained that the Foundation had failed to meet the "attentiveness" test under the "integral part" test found in section 1.509(a)-4(i)(3)(iii) of the Income Tax Reg╜ulations, and that it had also failed to meet the test for control by disqualified persons set forth in section 1.509(a)-4(j)(1) of the Regulations. The IRS further explained, as to the control test, that the Founda╜tion's primary asset was a promissory note payable by a corporation controlled by dis╜qualified persons and secured by assets of that corporation. It found, therefore, that "[d]isqualified persons are in a position to control [the Foundation] by means of the power they exercise, through their corpo╜ration, with respect to [the Foundation's] primary asset."

Dissatisfied with this ruling, the Foun╜dation filed a petition for declaratory judgment in the Tax Court, seeking a de╜termination that it was a supporting or╜ganization as described in ╖ 509(a)(3), rather than a private foundation. The case was submitted for a decision on the basis of the pleadings and the administra╜tive record. The Tax Court found that the Foundation did not meet the "integral part" test and, because that decision was fatal to the Foundation's claim that it was a supporting organization, did not reach the issue of whether the Foundation was controlled by disqualified persons.

The Foundation now appeals the Tax Court's determination. In response, the Commissioner argues that if the Tax Court's decision is not upheld on the ground that the Foundation does not meet the "integral part" test, it should be upheld on the ground that the Foundation has not shown that it is not controlled by disquali╜fied persons.

ANALYSIS

I. Standard of Review

Under well-settled rules, we review the Tax Court's factual findings for clear error and legal questions de novo. See Kenco Rests., Inc. v. Comm'r, 206 F.3d 588, 593 (6th Cir.2000). The line between the two is not always obvious, however. In this case, for example, the parties dis╜pute whether the issues to be resolved are factual or legal in nature. The Foundation asserts that the facts are undisputed and that the case therefore presents a pure question of law, whereas the Commissioner contends that whether the Foundation is operated "in connection" with AEF, a dis╜positive question in this case, is a question of fact.

We have held that the determination that an organization is not "organized and operated exclusively for" exempt purposes, for purposes of ╖ 501(c)(3), is a question of fact. See Ohio Teamsters Educ. and Safe╜ty Training Trust Fund v. Comm'r, 692 F.2d 432, 435 (6th Cir.1982). It could be argued that the question of whether an organization is operated "in connection" with another organization is similar in kind to the question of whether it is operated exclusively for certain purposes. On the other hand, what is being reviewed here is not actually the existence of a fact, but the application of the law to the facts, a situa╜tion requiring de novo review. See Sher╜win-Williams Co. Employee Health Plan Trust v. Comm'r, 330 F.3d 449, 453-54 (6th Cir.2003). Although the question is an interesting one, in the end we conclude that we need not decide it here, because the standard of review is not outcome-determinative in this case. Regardless of which standard is employed, the decision of the Tax Court must be affirmed for the reasons detailed below.

II. Qualification under ╖ 509(a)(3)

Under 26 U.S.C. ╖ 509(a), a ╖ 501(c)(3) organization is a "private foundation" un╜less it meets one of the exemptions speci╜fied in ╖ 509(a)(1)-(4). Private foundations are subject to various taxes, such as an excise tax based on investment income and taxes on self-dealing and failure to distrib╜ute income. See 26 U.S.C. ╖╖ 4940-4948. "Public charities [are] excepted from pri╜vate foundation status on the theory that their exposure to public scrutiny and their dependence on public support [will] keep them from the abuses [of the tax-exempt status] to which private foundations [are] subject." Quarrie v. Comm'r, 603 F.2d 1274, 1277 (7th Cir.1979). The Foundation claims that it should not be classified as a private foundation because it is a support╜ing organization, as described in ╖ 509(a)(3). Supporting organizations are exempt from private foundation status "in so far as they are subject to the scrutiny of a public charity." Quarrie, 603 F.2d at 1278. "The Treasury Regulations there╜fore provide that the supporting organiza╜tion must be responsive to the needs of the public charity and intimately involved in its operations." Id.

Under ╖ 509(a)(3), an organization is ex╜empt from private foundation status if it:

(A) is organized, and at all times there╜after is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organization described in paragraph (1) or (2),

(B) is operated, supervised, or con╜trolled by or in connection with one or more organizations described in para╜graph (1) or (2), and

(C) is not controlled directly or indirect╜ly by one or more disqualified persons (as defined in section 4946) other than foundation managers and other than one or more organizations described in para╜graph (1) or (2); . . . .

The Commissioner contends that Lapham fails to meet the criteria of subsections (B) and (C); subsection (A) is not at issue in this case.

In order to qualify under ╖ 509(a)(3)(B), an organization must be "(i) [o]perated, supervised, or controlled by, (ii) [s]uper╜vised or controlled in connection with, or (iii) [o]perated in connection with, one or more publicly supported organizations." 26 C.F.R. 1.509(a)-4(f)(2). The Founda╜tion claims that it is operated in connection with AEF and therefore fulfills the third of these relationships. However, the Trea╜sury Regulations further elaborate that an organization will only be considered to be operated "in connection with" a publicly supported organization if it meets a "re╜sponsiveness test" and an "integral part test." See 26 C.F.R. ╖ 1.509(a)-4(i)(1). The Tax Court found that the Founda╜tion's structure satisfied the responsive╜ness test, and the Commissioner does not challenge that finding on appeal. Thus, the only question that remains with regard to ╖ 509(a)(3)(B) is whether the Founda╜tion meets the "integral part" test.

That test "is designed to insure that the publicly supported organization will be at╜tentive to the supporting organization." Cockerline Mem'l Fund v. Comm'r, 86 T.C. 53, 61, 1986 WL 22074 (1986). A supporting organization meets the integral part test if "it maintains a significant in╜volvement in the operations of one or more publicly supported organizations and such publicly supported organizations are in turn dependent upon the supporting or╜ganization for the type of support which it provides." 26 C.F.R. 1.509(a)-4(i)(3)(i). There are two ways in which an organiza╜tion can fulfill the integral part test: by meeting either the "but for" test set out in 26 C.F.R. 1.509(a)-4(i)(3)(ii) or the "atten╜tiveness" test described in 26 C.F.R. 1.509(a)-4(i)(3)(iii).

A. The Attentiveness Test

The "attentiveness" test focuses on whether the supported organization will be attentive to the supporting operation. In order to satisfy this test, the support╜ing organization must donate substantially all of its income to the supported organi╜zation, and the amount of support re╜ceived by the supported organization must be "sufficient to insure the atten╜tiveness of such organization[ ] to the op╜erations of the supporting organization." 26 C.F.R. 1.509(a)-4(i)(3)(iii)(a). In order for the amount of support received to be considered sufficient, either the amount of support must "represent a sufficient part of the [supported] organization's total support so as to insure such attentive╜ness," id ., or it must be demonstrated that "in order to avoid the interruption of the carrying on of a particular function or activity, the beneficiary organization will be sufficiently attentive to the operations of the supporting organization." 26 C.F.R. 1.509(a)-4(i)(3)(iii)(b). "This may be the case where either the supporting organization or the beneficiary organiza╜tion earmarks the support received from the supporting organization for a particu╜lar program or activity, even if such pro╜gram or activity is not the beneficiary organization's primary program or activity so long as such program or activity is a substantial one." Id. In determining whether the amount of support received is sufficient, "[a]ll pertinent factors, in╜cluding the number of beneficiaries, the length and nature of the relationship be╜tween the beneficiary and supporting or╜ganization and the purpose to which the funds are put" will be considered. 26 C.F.R. 1.509(a)-4(i)(3)(iii)(d). "[E]vidence of actual attentiveness by the beneficiary organization is of almost equal impor╜tance" with the substantiality of the amount involved in determining the atten╜tiveness of the supported organization. Id.

With regard to the first way of satisfying "attentiveness," the Tax Court pointed out that the Foundation anticipat╜ed giving only $7,600 per year to AEF in the near future and concluded that such a small contribution was insufficient to en╜sure AEF's attentiveness. The Founda╜tion argues that the Tax Court erred by over-emphasizing the amount AEF would be receiving in the Foundation's first two years of operation, while failing to take into consideration the nearly $7 million the Laphams had pledged to the Foundation on a long-term basis, at least 85 percent of which the Foundation intended to donate to AEF. It points out that taxpayers often establish charitable-giving programs that are modest during their lifetimes but sig╜nificant after death, and that such pro╜grams are beneficial in that they allow taxpayers to teach a charitable philosophy to their children and help to avoid post╜mortem litigation by enabling taxpayers to address potential IRS objections during their lifetimes. The Foundation contends that we should follow the analysis used in National Foundation, Inc. v. United States, 13 Cl.Ct. 486 (1987), a case in which a foundation was given ╖ 501(c)(3) status based on proposed activities, and that we allow a "declaratory judgment based upon proposed activities before substantial time and resources have been committed to╜ward actual operations." Id . at 495.

Although the Laphams have pledged significant funds to the Foundation, and although the Foundation has indicated that it will distribute at least 85 percent of its future income to AEF, we agree with the Tax Court's determination that the future contributions are not sufficient to fulfill the "attentiveness" test, given how far in the future AEF anticipates receiving them. It is difficult to believe that AEF will give the Foundation the sort of regular over╜sight contemplated by the test when it will not be receiving substantial support from the organization for another two decades. Furthermore, although the relevant docu╜ments recording the various trusts set up by the Laphams are not in the record, it appears that the trust through which the Foundation will supposedly receive $355,834 a year for 17 years is, in fact, revocable. If this is the case, there is no assurance that the Foundation, and through it AEF, will ever receive those contributions. Finally, as the Commis╜sioner has pointed out, once AEF actually receives enough support to ensure its at╜tentiveness, i.e., once the Laphams have died and the Foundation begins to receive their funds and make donations to AEF, then the Foundation can petition, under 26 U.S.C. ╖ 507(b)(1)(B), to convert from a private organization into a supporting or╜ganization.

With regard to the second method of fulfilling the "attentiveness" test, the Foundation asserts that AEF intends to place contributions from the Foundation in a special account for making grants to support charitable activities in southeast╜ern Michigan in general and in Northville, Michigan, in particular. Without its sup╜port, the Foundation argues, the donations in those areas would likely cease. In other words, it is arguing that, without its sup╜port, the "particular function or activity" of giving charitable donations in southeastern Michigan would be "interrupted." As the Tax Court points out, however, the regula╜tions specify that the program or activity to which the Foundation has earmarked its funds must be a "substantial" one; it must be important enough to the supported or╜ganization that the fear of its loss will cause the supported organization to be properly attentive to the supporting organ╜ization. Supporting charitable organiza╜tions in Michigan is not a substantial part of AEF's work. In 1998, for example, of $1,300,000 it distributed to organizations similar to those the Foundation proposes to recommend, AEF distributed only $5,500 in Michigan. Furthermore, the Foundation's contributions can hardly be said to be earmarked for a specific pro╜gram or activity when the Foundation has simply named a geographic area in which it wants the funds to be spent, rather than naming specific charities to which it wants the funds distributed and when, in any case, AEF does not have to abide by the Foundation's recommendations.

Finally, the Foundation claims that it has demonstrated actual attentiveness on the part of AEF. In particular, it points out that AEF appointed one of the Foun╜dation's directors, that this director has access to all of the Foundation's financial information, that the Foundation sends fi╜nancial reports to AEF, and that the Foundation and AEF have had ongoing communications. Although 26 C.F.R. 1.509(a)-4(i)(3)(iii)(d) uses the imposition of the requirement that the supporting or╜ganization furnish reports to the supported organization as an example of evidence of actual attentiveness, there is no evidence here that AEF requires the Foundation to furnish such reports, nor that the require╜ment is in the Foundation's by-laws or articles of incorporation. Absent more specific evidence about the communica╜tions between the Foundation and AEF, we, like the Tax Court, "remain uncon╜vinced that the [ ] features highlighted por╜tend the type of ongoing monitoring and attentiveness envisaged in the regulation."

For all these many reasons, we conclude that the Tax Court was correct in finding that the Foundation does not meet the "attentiveness" test.

B. The But-For Test

The "integral part" test is also ful╜filled if "[t]he activities engaged in for or on behalf of the publicly supported organizations are activities to perform the func╜tions of, or to carry out the purposes of, such organizations, and, but for the in╜volvement of the supporting organization, would normally be engaged in by the pub╜licly supported organizations themselves." 26 C.F.R. 1.509(a)-4(i)(3)(ii). We conclude that the Foundation does not meet this test any more than it meets the "attentive╜ness" test. To begin with, it is unclear that the Foundation is engaging in any activity "for or on behalf" of AEF, given that its only activity is contributing money to AEF. Even if donating money to AEF was considered an activity "for" AEF, it is not an activity AEF itself would be doing but for the Foundation. The Foundation simi╜larly fails the but-for test if its activity is viewed as giving grants to charitable or╜ganizations, which it does by giving money to its donor-advised fund at AEF. As the Tax Court pointed out, "such grant-making activities cannot properly be characterized as something in which AEF would be en╜gaged but for petitioner's support. Rath╜er, distributing grant moneys is something in which AEF is and will continue to be engaged regardless of support from peti╜tioner." If the Foundation's activity is construed as giving grants within South╜eastern Michigan, it still cannot be said that but for the Foundation's involvement, AEF would engage in the activity itself. As described above, absent significant funding from the Foundation, AEF distrib╜utes very little money in Michigan.

CONCLUSION

Because we agree with the Tax Court's determination that the Foundation fails to qualify as a supporting organization under 26 U.S.C. ╖ 509(a)(3)(B), we also conclude that it is unnecessary to address the con╜tention that the Foundation also fails to qualify under subsection (C). The failure to meet the requirements of any one of the three subsections of ╖ 509(a)(3) is a suffi╜cient basis on which to deny the petitioner status as a supporting organization. For the reasons set out above, we AFFIRM the judgment of the Tax Court in all re╜spects.

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