December 11, 1997 | Read Time: 2 minutes
In a long-awaited decision, the U.S. Tax Court has ruled that the Internal Revenue Service was right to revoke the tax-exempt status of an Indianapolis health charity that had a contract with a controversial fund-raising consultant, the Watson and Hughey Company. The court concluded that part of the net earnings of the United Cancer Council had improperly inured to the benefit of an insider — Watson and Hughey, a Virginia company that later changed its name to Direct Response Consulting Services.
At the heart of the I.R.S.’s case was United Cancer Council’s five-year fund-raising contract with Watson and Hughey — and the mailing lists that were the product of the agreement.
The original contract provided that mailing lists developed for the charity by Watson and Hughey were the joint property of both organizations. The charity was not allowed to rent, exchange, lease, or give away donor names and other information generated during the contract period.
After the contract expired in 1989, the charity was permitted to use the mailing lists only for its own solicitations but could not rent the lists to other groups. Watson and Hughey, however, was allowed to make full use of the lists.
In his opinion, Judge Herbert L. Chabot said that Watson and Hughey was an insider at the charity — even though company officials were not charity board members or officials — because its contract gave the company so much control over the charity’s finances and fund raising.
Mr. Chabot concluded that the compensation that Watson and Hughey received from United Cancer Council — through the company’s use of mailing-list names and from direct payments for its services — exceeded reasonable compensation.
The judge rejected the premise that the $2.25-million that United Cancer Council “cleared” during the course of the contract was enough to justify Watson and Hughey’s high compensation. The cancer council’s receipts, said Mr. Chabot, were so small in comparison to the company’s compensation and other costs “as to be almost an incidental product of the fundraising campaign.”
The I.R.S. pulled the cancer charity’s exemption in 1990. The government made the revocation retroactive to 1984, when the charity signed its contract with Watson and Hughey, a decision that Judge Chabot also supported in his ruling (United Cancer Council v. Commissioner of Internal Revenue, 109 T.C. No. 17).
