Trends and developments in the nonprofit sector

The last 18 months have presented extraordinary challenges for the philanthropic sector in the United States. This memorandum will briefly examine recent developments and trends within the sector, as well as Internal Revenue Service (“IRS”) audit priorities and other issues of note.

1. Impact of the pandemic on philanthropy and the sector’s response

With the emergence of the Covid-19 pandemic, the nation has experienced staggering losses of human life, along with significant negative economic effects. The rapid development and widespread distribution of vaccines against Covid-19 have brought some relief, but the pandemic’s end is not yet in sight. In this environment, effective philanthropy has never been  more crucial.

Throughout the country, there have been significant calls for various actors within the charitable sector—including both charitable organizations and state and federal governments— to step up and “think outside the box” to ensure that charitable dollars flow to those who need them the most. Charities across the US have implemented measures to increase their giving efforts, and these have included increases in annual spending limits, a significant uptick in disaster relief programs, and a re-focusing of grantmaking efforts, particularly in the housing and small business context.

2. Potential tax law changes that may impact charitable giving

While the pandemic has generated an increased focus on the ability of charitable organizations and philanthropic donors to effect positive change during difficult times, the legal landscape in which these activities take place is ever shifting. Below are several possible tax law changes that may influence charitable giving by entities and individuals in the coming years.

3. IRS audit focus: high net worth individuals, related foundations and conservation easements

In addition to the possible tax law changes described above, the priorities of the IRS may help to shape the activities of the charitable sector in the near future—particularly because at present, the IRS is focused on the tax returns of the wealthy. While the IRS’s current ability to implement its priorities may hinder its short-term success, new potential Congressional appropriations for enforcement may mean more audits for wealthy individuals in the near future.

In June of 2020, the IRS announced plans to audit the tax returns of high net worth individuals (“HNWIs”) and private foundations. This initiative is part of a campaign by the IRS’s Large Business and International Division (“LB&I”) to examine complex tax planning used by HNWIs and root out abusive tax strategies. Thus far, however, the IRS has had some difficulty undertaking and managing joint audits of HNWIs and audits of private foundations controlled by HNWIs, because private foundation audits are carried out by the IRS’s Tax-Exempt and Government Entities Division (“TE/GE”); due to the structure of the IRS, the LB&I exam agents would likely need to file an internal “referral” to TE/GE, and coordinating audits between divisions poses a significant administrative challenge. Further, the IRS remains generally understaffed as a result of Congressional budget cuts, which impacts its ability to carry out complex audit investigations. However, the Build Back Better Act, recently passed in the House, contains significant appropriations—nearly $79 billion—for IRS enforcement and other priorities, which may increase the IRS’s ability to undertake audits of HNWIs.3

The IRS is also continuing its work auditing syndicated conservation easement transactions, as it has classified these transactions as tax-abusive, and has showed no diminution of interest in litigating if proposed audit settlements are not accepted.

4. Disaster- and climate-focused giving

Finally, we wanted to identify a noteworthy and ongoing trend within the charitable sector relating to an upswing in grants in the disaster and environmental spaces, which have recently been closely intertwined. In the past several years, with the rise of significant wildfires in California, out-of-season hurricanes in the American South, ongoing drought conditions in the Southwest and other climate change-related emergencies facing communities throughout the world, many major players in the charitable sector have refocused their efforts on grants and/or investments intended to mitigate or reverse the effects of climate change. The years 2020 and 2021 in particular brought increased fervor to the environmental grantmaking space, and these grants have included not only efforts to ameliorate climate change but to help individuals and communities manage the immediate and ongoing effects of climate disasters. IRS disaster relief guidance is helpful in this context, but does not sufficiently address how to assist those impacted on a long-term basis by environmental and other disasters. Further, IRS guidance regarding the charitability of environmentally focused grantmaking is somewhat disjointed, lending uncertainty to some proposed grantmaking and investment efforts in this space. We anticipate that this area of grantmaking will receive increased scrutiny as charitable organizations begin and continue to utilize more innovative mechanisms to combat the extraordinary harms caused by climate change, particularly those mechanisms focused on generating and enhancing for-profit technologies that may help to predict, manage, or prevent climate change and its adverse effects.