Editors’ Note: 2019 marked the 50th anniversary of the Tax Reform Act of 1969 (TRA), the most significant package of legislative reforms directed at the philanthropic sector in recent memory. We missed the actual semi-centennial, but there’s no reason to think that philanthropic reform will be any less important a topic to consider in 2020 than it was in 2019. So here we launch a new HistPhil forum on the legacy and contemporary relevance of the TRA–51 years later. James J. Fishman opens up the forum with a comprehensive post outlining the developments that led to the act. This post is adapted from an article that will be published in the spring issue of Pittsburgh Tax Review, based on papers presented to a symposium on the TRA held last November at the University of Pittsburgh School of Law. Several of the other posts in this forum are adapted from articles that will be published in that volume and HistPhil would like to thank the volume’s editors, Philip Hackney and Anthony C. Infanti, for granting permission to adapt them.
From the early twentieth century American private foundations came under critical scrutiny from Congress, yet it was not until the 1969 Tax Reform Act that Congress enacted a regulatory regime more restrictive for private foundations than for other charitable organizations. This essay focuses on the hearings in the U.S. House of Representatives’ Ways and Means and Senate Finance Committees on the Tax Reform Act of 1969 that resulted in the private foundation regulatory regime.
Normally, the consideration of tax legislation relating to the nonprofit sector is of interest only to tax practitioners, certain government officials, and affected nonprofit constituencies. At most, the proposed legislation may get modest mention in the national press if at all. In contrast, the 1969 Congressional hearings that led to the Tax Reform Act were front page news and became a public relations disaster for the foundation community that resulted in unexpected restrictions, mandates and penalties.
Because of a growing concern about the acquisition and operation of unrelated businesses by exempt organizations and a lack of accurate data to deal with the problem, in 1943 Congress first separated private foundations from “public charities” (which generally relied on public support or were accountable to a broad constituency) by requiring foundations but not public charities to file information returns. Congress drew a significant distinction in the Revenue Act of 1950 between public and private charities through the imposition of the Unrelated Business Income Tax (UBIT), as well as restrictions on some financial transactions and income accumulation by private foundations but exempted public charities. The penalty for violating prohibited transactions was revocation of exempt status, but it was rarely invoked.
The 1950 reforms did little to stem the growth and popularity of foundations or to rein in the form’s abuses. Foundations became a focus of tax and business planners as a method for wealthy individuals and families to retain control or transfer control to heirs without paying taxes. They offered income and estate tax deductions. Though charity was always mentioned in the organizational documents, it was often absent from the minds and practices of donors.
The Revenue Act of 1964 sharpened the distinction between private foundations and public charities by excluding foundations from the expansion of the class of organizations that could receive charitable contributions that were deductible by individuals up to 30% (from 20%) of their adjusted gross income. According to the 1964 Senate Finance Committee report, the reason private foundations were excluded from the increase was the delay in contributions to foundations being used for charitable purposes. Instead, foundations used the contributed funds for investment. The extra ten percent deduction for non-private foundation donors would encourage contributions to publicly supported charitable organizations that more readily benefited the public.
A principal antagonist of private foundations was a populist, conservative Texas Congressman, Wright Patman, who for three decades conducted a personal crusade against Wall Street, chain stores, monopolies, banks, the Federal Reserve, and private foundations. Commencing in 1961, Patman focused on foundations, admitting they did some good things but questioning the motives of some of their donors. The next year the House Small Business Committee authorized him to hire a staff, conduct studies and hold hearings on the impact of foundations on the American economy. He conducted several investigations of foundations with vigor and in a series of reports leading up to and beyond the 1969 legislation, ratcheted up his criticism charging financial misconduct as well as capitalistic or communist bias.
Patman had a Trumpian ability to use inflammatory rhetoric to gain attention and support. His reports accumulated large amounts of data, some of which was inaccurate, that showed misdeeds of foundations including short sales of securities, speculation in commodities, manipulation of stock prices, and attempts to gain control of businesses. What was missing from the reports was a sense of the extent of the misdeeds alleged. Patman criticized Treasury and the Internal Revenue Service for lax oversight and demanded that Treasury study the foundation sector. Although Patman had little influence on or respect from the tax-writing committees in Congress, his allegations of foundation wrongdoing did have a significant impact on public opinion and the development of the private foundation legislation.
The Treasury Department attempted to interest the Senate Finance Committee in a proposal made in President Kennedy’s 1963 tax message to repeal the unlimited charitable deduction, which allowed taxpayers whose income tax bill and charitable donations were more than ninety percent of their adjusted gross income for the past ten years to avoid all taxes. Treasury specifically pointed to foundations as undeserving of the deduction’s benefits. The Finance Committee was more interested in the state of private foundations than the unlimited charitable deduction. To avoid sidelining the 1965 Revenue Act, Treasury promised to conduct a thorough study of private foundations and report findings, conclusions, and recommendations by early 1965.
Treasury examined a sample of 1,300 private foundations, including all with assets of $10 million or more. The Report issued in early 1965 was generally supportive of the role foundations played in society. It gave credit for their capacity to serve as powerful instruments for evolution, growth and improvement in the shape and direction of charity. Treasury did find serious abuses among a minority and offered legislative recommendations to cure them.
It recommended a proscription on all acts of self-dealing between private foundations and related parties. To expedite donated funds in reaching the charitable stream, all foundations should be required to spend or distribute their income annually, and grantmaking foundations should be required to distribute an amount, whether or not in excess of income, at least equal to a specified percentage of the value of its investment assets. The Report also proposed percentage interest limitations on foundation holdings in corporations and other business enterprises—i.e. foundations would be prevented from owning more than 20% of combined voting power or 20% of the value of the entire equity.
Treasury suggested deferral of tax deductions for gifts of property to a private foundation where the donor retained control and recommended prohibiting foundation financial transactions unrelated to exempt purposes such as borrowings for investment purposes, restrictions on loans by foundations, and prohibitions on speculative trading practices and investments.
The Treasury Report provided a partial template for the 1969 legislation, but when published it received substantial criticism for being too lenient to the foundation sector. In the four years after 1965, little changed concerning foundation behavior. Nor was there Congressional legislation. However, there had emerged a movement for tax reform against the unfairness of the tax laws, particularly the loopholes for the affluent. Congress and the public’s perception of foundations had grown harsher. Congress scheduled hearings for early 1969.
Less than a week before the Congressional hearings were to commence, the New York Times reported that the Ford Foundation had given what were essentially bereavement grants to eight former staffers of the recently assassinated Senator Robert F. Kennedy, totaling $131,000 (over $1,062,000 inflation adjusted in 2019) for travel up to one year or for any other activity the grantees wished to pursue.
The first witness called before the House Ways and Means Committee was Rep. Patman, who came with a list of cringe-inducing foundation misdeeds. His testimony offered several examples of foundation malfeasance and questionable activities, but some reflected his general hostility to foundations, his nativism, and his pettiness. He played to the American public by noting that the Rockefeller Foundation spent over $1.6 million in India but not a penny in Arkansas and offered similar disparities between other foreign grantees and American states. Patman seemed to be particularly outraged by the Mellon family’s foundations.
“The Bollingen Foundation of New York City, a creation of the Mellon banking family of Pittsburgh, spends tax-free dollars on such esoteric research subjects as … ‘The origin and significance of the decorative types of medieval tombstones in Bosnia and Herzegovina’…Congress certainly cannot complain if the entire Mellon banking family assembles in one of their Pittsburgh mansions each evening for a round-table discussion on the origin and significance of the decorative types of medieval tombstones in Bosnia and Herzegovina…If the Mellons are more interested in medieval tombstones than in Pittsburgh poverty, and care to spend their money studying 12th and 13th Century church construction, that is the Mellons’ affair. However, there is no obligation upon either the Congress or the American citizenry to give the Mellons’ tax free dollars to finance their exotic interests. In sum: the foundation programs contain ample fat that could and should be trimmed, and the Federal government can find better uses for the money than studies of medieval tombstones.”
This was incendiary but effective in the court of public opinion. In fact, the Bollingen Foundation sponsored the first English translations of many works of poetry, philosophy and other subjects. While the studies often were of arcane subjects, they attracted prominent writers and world-renown scholars and published a few best sellers. Its roster of authors included Isaiah Berlin, Joseph Campbell, Kenneth Clark, C. G. Jung, Andre Malraux, Jacque Maritain, and Vladimir Nabokov. The Foundation ceased operation in 1968.
On the second day of the hearings John J. Rooney, a long-serving representative from Brooklyn, appeared before the Committee. He offered testimony chilling to every member of Congress: “I am the first known Member of Congress to be forced to campaign for reelection against the awesome financial resources of a tax-exempt foundation…This time, Mr. Chairman, it happened in my district. It can—and probably will—happen in your districts.” An industrialist and philanthropist, Frederick Richmond, challenged Rooney in a primary. To finance his campaign and to woo voters, he used the resources of his private foundation. When visiting community groups, churches, or synagogues, Richmond would conveniently announce a grant to the organization from the Richmond Foundation. Rooney, who was born in the district, turned back the challenge.
On the third day McGeorge Bundy, President of the Ford Foundation, testified. At age 34, Bundy had become dean of Harvard’s Faculty of Arts and Sciences. In 1961, he joined the Kennedy administration as National Security Advisor and was instrumental in the expansion of the Vietnam conflict. He became president of the Ford Foundation in 1966 and redirected the Foundation’s emphases into controversial areas of civil rights, voter registration, and seemingly political activities.
Ford’s voter registration grants were not to traditional groups like the League of Women Voters, but to organizations that enabled underrepresented groups to vote, a definite challenge to Southern political leaders, whose seniority controlled the committees and leading positions in Congress. In 1967 Ford gave a large grant to the Cleveland branch of CORE, the Congress of Racial Equality, which used the funds for a voter registration drive in African-American areas of the city to elect Carl Stokes as the first black mayor of Cleveland. In New York City Ford financed community school boards and a desegregation experiment in the Ocean-Hill, Brownsville section of Brooklyn, which led to a teacher’s strike by the United Federation of Teachers, and confrontation with the African-American community.
The Committee quickly turned to the travel grants to the former Kennedy staffers, which according to a Foundation press release, “provided up to a year of leisure and freedom from immediate financial concerns.” Bundy claimed they were educational in nature, of the normal type—a feeble argument. Representative John Byrnes’ responded that such a rationale stretched the meaning of educational too far, and the grants seemed more like severance pay. As for the grant to Cleveland CORE for a voter registration drive, Bundy stated that Ford never examined the question of the relations between any voter registration campaign and the election of any candidate, an answer largely met with disbelief.
Bundy’s testimony was unyielding and unconvincing. While no one ever claimed McGeorge Bundy had a common touch, he came across as especially supercilious and condescending. As one member of the House Committee said: “I walked into that hearing this morning basically friendly to the foundations; I came out feeling that if Bundy represents the prevailing attitude among them, they are going to have to be brought down a peg. For all their Ph.D.’s they are not above the law.” Committee members repeatedly asked witnesses why should some pay taxes and others with a large amount of wealth avoid taxes by putting assets into foundations? This unfairness increased the burdens on middle class Americans, who were already heavily taxed.
Several days after Bundy’s testimony the unofficial chairman of the philanthropic establishment, John D. Rockefeller III, testified. Rockefeller was against any proposal that might discourage gifts to foundations. He casually mentioned he had qualified for the unlimited deduction privilege since 1961, meaning he had to pay no income taxes but added he had voluntarily paid a five to ten percent tax in those years, a rate substantially below the tax rates of almost all taxpayers. In a time of substantial tax protest, for a Rockefeller to have no tax bill because he gave money to projects that interested him, and for the rest of American taxpayers to bear the costs of government with no choice where their tax dollars are spent, seemed outrageous and unfair to the Committee, not to speak to the general public.
The general foundation position was that there should be no changes in the law; the abuses uncovered by Patman or in the Treasury Report were of a very few bad apples, which could be fixed by more rigorous IRS enforcement and by state attorneys general. Foundation witnesses seemed blind to the level of hostility and distrust from Congress.
As if the Ways and Means hearings did not offer enough bad publicity, a few weeks before the issuance of the Committee’s Report, it became known that Supreme Court Justice Abe Fortas had received a secret lifetime retainer of $20,000 per year (over $136,000 in 2018 dollars) from the Louis Wolfson family foundation. Wolfson, a Wall Street financier and former client of the justice, was later imprisoned for securities fraud violations. It was alleged that Wolfson expected Fortas would help him stave off criminal charges and, if necessary, assist in obtaining a presidential pardon. On May 15, 1969, Fortas resigned from the Court. It also became public knowledge that Justice William O. Douglas had received an annual $12,000 stipend as president of the Parvin Foundation, a family foundation of Albert Parvin, who owned casinos and hotels in Las Vegas. Douglas resigned from the Parvin Foundation but not from the Court. And so, a new charge was added against philanthropic foundations—that they served as a means of corrupting public officials.
On May 27, 1969, the Ways and Means Committee issued its Report and an accompanying bill. The Report’s tone reflected the country’s demand for tax reform, as well as the Committee’s anger over some of the witness testimony, and reaffirmed a deep distrust of private foundations. The proposed bill stunned the philanthropic community. While many of the recommendations echoed Treasury’s views, it contained unexpected surprises, including restrictions on foundations’ programmatic activities and a more visible separation of private foundations from public charities. The equivalent of a user fee of 7 ½ percent of the investment income of private foundations was recommended, presumably for oversight of private foundations though the sums raised would go directly into the Treasury without specific designation.
Witness testimony that angered the Committee led to I.R.C. § 4945, the prohibition against taxable expenditures. Excise taxes would be imposed upon prohibited private foundation expenditures such as lobbying, electioneering, and grass-roots campaigning or activities more appropriately carried on by for-profit organizations. The Ford Foundation’s awards to Kennedy staff members led to restrictions on grants to individuals for travel, study or similar purposes, unless the award fulfilled certain restrictions including the requirements of achieving a specific objective, producing a report, or improving or enhancing the skill or talent of the grantee.
Because of Representative Rooney’s testimony, foundations were prohibited from expenditures “to influence the outcome of any specific public election campaign.” The Ford grant to Cleveland CORE resulted in restrictions on voter registration drives unless they were run by nonpartisan organizations active in at least five states and not confined to just one election. The grants to the Ocean Hill-Brownsville School District resulted in the requirement of expenditure responsibility for awards to organizations other than public charities. To ensure funds were spent solely for the purposes for which they were given foundations would have to provide complete accounting of funds expended to the Secretary of the Treasury.
After the disclosures involving the two members of the Supreme Court, the seeming validation of Patman’s charges over the years, and those of the Ways and Means Hearings, private foundations found themselves in a defensive position with few allies. The grants for African-American voter registration and foundation activism in the inner cities brought hostility from conservatives. The AFL-CIO opposed foundations as tax shelters for the wealthy, which caused some loss of support from liberal Congress members. Those who opposed the Vietnam war had not forgotten Bundy’s role in the escalation of the conflict. Politically influential state universities were no friends of foundations, who generally favored the Ivy League and elite private colleges and universities with their grants.
As the tax reform bill of which foundations were but a part moved to the Senate, larger and more politically powerful interests took precedence in Congress’s attention. The oil, real estate and tobacco interests lobbied to protect their tax benefits. The foundations’ lobbying efforts paled in comparison to those of the industry lobbyists. The foundations put together a group of the good and great from universities, research centers, civil rights groups and business leaders, who paid individual calls on members of the Senate and House. A coordinated series of statements was prepared defending the foundation position and prominent witnesses were recruited to testify in the Senate. A problem with the foundation witnesses was they were largely people of the upper classes and members of the “establishment” and couldn’t hide it or didn’t try. Most members of Congress were not part of that establishment and were less than impressed by individuals who were. Furthermore, the new Nixon administration was far less supportive of foundations than its predecessor.
In this atmosphere the House bill was taken up by the Senate Finance Committee. There were relatively few changes. A major addition was the insertion of a forty-year lifetime limit on the tax-exemptions from income, estate and gift taxes for private foundations. One key justification was the fear that if tax-exemption was in perpetuity, foundations’ economic power might increase to such an extent they would have an undue influence both on the private economy and on governmental decisions. There was no empirical confirmation of this danger, and the presumption had been rejected in the 1965 Treasury Report. The foundation life expectancy limit was rejected on the floor of the Senate and has not reappeared in the subsequent decades.
The Senate passed the bill by a vote of 69 to 22 on December 11, 1969. It was sent to the Conference Committee, which reported it out on the fifteenth of December. The Conference Report was approved on December 22 by votes of 381 to 2 in the House, and 71 to 6 in the Senate. President Nixon signed the bill into law on December 30, 1969. Aside from the amendments discussed above and a few other tweaks, the bill as presented by Ways and Means became the final law.
Most of the significant changes in the 1969 Tax Reform Act emanated from the 1965 Treasury Report or were generated from prior concerns dating to the 1940s. Despite the revelations, controversies, and headlines about foundations from the Hearings, their most direct result was the addition of I.R.C. § 4945, taxes on taxable expenditures; but even here many of the changes consisted of clarifying ambiguous or incomplete language of preexisting law. An example is the prohibition on propaganda or attempting to influence legislation. The previous law required “no substantial part of the activities of a private foundation could consist of carrying on propaganda or attempting to influence legislation.” Larger foundations could engage in such activities by slipping under the substantial test. Other foundations could evade the no substantial part test, knowing they would not have their tax-exempt status revoked.
The hearings, however, changed the tenor of the discussion and led to a regulatory framework that was far more restrictive than would have resulted in a less volatile and partisan era. The restrictions on the private benefits accruing to foundation donors and board members had long been a concern. The discouragement of foundation activities in controversial areas such as civil rights and school desegregation can be seen and were viewed in the African-American community as a racist backlash to undermine gains achieved from the Civil Rights Act of 1964 and other efforts to remove barriers based on race or ethnicity. Whitney Young, executive director of the National Urban League, testified at the Senate Finance Committee hearings, for instance, that the “Black Community” felt the proposed legislation was a “hostile bill, a bill…with a purpose as much to intimidate as to legislate,” that meant to steer foundations toward noncontroversial causes.
“For years the White Community has been able to organize different ethnic and regional groups, vested interest groups, and they have been able to use the resources of the private sector through foundations, to address themselves to their problems as they see them…It has only been in very recent years that we have managed to acquire in our black community the kind of sophistication and know-how to make it possible to organize and to make our requests for resources to help ourselves and to meet our needs. And to have at this point in the game suddenly to be told that the rules are changing seem to us—again to say to black people–that the rules are changing only when you are about to be benefited.”
One of the unique innovations in the legislation was the adoption of a graduated penalty scheme of excise taxes placed on foundations and their managers (trustees, officers and other insiders) if they engaged in prohibited activities or failed to meet the minimum annual distribution or the excise tax on investment income requirements. Previously the only remedy was loss of tax-exemption, which was rarely used.
For the first time under the 1969 Act, private foundations were specifically defined. Under prior law, the words “private foundation” referred to an organization, contributions to which could be deducted only up to twenty percent of an individual donor’s adjusted gross income. Rather than say what private foundations were, the Act assumed that all charities were private foundations unless they could prove otherwise. Those organizations that could show they were not private foundations, based on relying on a broad donor base, were “public charities” eligible to receive contributions up to fifty percent of an individual’s adjusted gross income. The 1969 Act broadened those organizations required to file information returns, expanded the amount of information required and increased the penalties for failure to file. In the 1970s and 80s, the Internal Revenue Service increased its audits of private foundations, but this activism waned in the late 1980s and 90s.
The legislation’s initial impact was a sharp decrease in the foundation birth rate and an increase in their death rate (termination). The negative impact resulted from two provisions that directly discouraged contributions to private foundations. The first was the rule pertaining to contribution of appreciated property in I.R.C. § 170(e), which permitted all charitable organizations except non-operating private foundations to receive gifts of appreciated property without subjecting the donor to the tax on the long-term capital gains. The second cause was the excess holdings provision, which in effect prevented foundations from receiving a gift of the donor’s corporate control stock unless the combined voting interest of the donor was brought below a twenty percent threshold within the periods mentioned in the statute. Prior to the Tax Reform Act, eighty percent of gifts to foundations of more than $1 million were composed of gifts of appreciated property, and more than half of foundations with more than $10 million in assets had, at one time, held stock of companies in which the foundation and donor together held a twenty percent or more interest to which the divestment provision of I.R.C. § 4943 would apply.
Additionally, wealthy donors were deterred by the increased regulation, the tax disincentives for lifetime gifts, administrative burdens, and the availability of alternative philanthropic vehicles such as community foundations, donor-advised funds, and supporting foundations. Attorneys played a major role in discouraging the formation of foundations during the 1970s and early 1980s. They conveyed the message that foundations were expensive, time consuming, inefficient and complicated: a minefield for someone who didn’t know what they were doing. Yet prognostications about the death of private foundations turned out to be premature.
More recently, private foundations have enjoyed a resurgence as Congress relaxed some of the disincentives and philanthropists and their advisors adapted to the regulatory regime. Congress in 1984 created incentives for foundation creation by allowing donors to deduct the full fair market value of appreciated stock of public companies.
By almost any measure the 1969 Tax Reform Act has been a success for the private foundation community. It has remained the framework for private foundation regulation for fifty years. There have been remarkably few amendments to the original legislation. Of course, there are contemporary criticisms: too few foundations spend more than the minimum mandatory distribution requirement; their administrative expenses are higher than they should be; their grant policies reinforce the existing hierarchies and privileges of the wealthy; too many are indifferent to issues of inequality and poverty. Still, in the fifty years since the Tax Reform Act of 1969, private foundations have largely escaped from the distrust and hostility evinced in the legislative hearings and are generally recognized for the positive role they play in society.
-James F. Fishman
James Fishman is Professor of Law Emeritus at the Haub School of Law at Pace University. He is the author of The Faithless Fiduciary (2007), a history of the enduring problem of opportunistic behavior by charitable fiduciaries, and the inability to create an effective system of oversight or accountability for charitable assets and The Transformation of Threadneedle Street (1993), a study of the deregulation of the U.K.’s securities markets. He is a coauthor (with Stephen Schwarz and Lloyd Hitoshi Mayer) of Nonprofit Organizations Cases and Materials (5th ed. 2015).