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June 7, 2016
IRS Operational Changes Cited in Revocation of Casino's Exemption
by David van den Berg

Full Text Published by Tax Analysts®

An Iowa casino, racetrack, and hotel complex is facing revocation of its tax exemption under section 501(c)(4) despite having held that status since 1989, and the group's representative -- a former Exempt Organizations Division chief -- is attributing the apparent change of heart to an agency restructuring.

Prairie Meadows Race Track & Casino Inc., located near Des Moines, had its exempt status examined and signed off on by the IRS in the mid-2000s, and was the subject of an earlier ruling request and technical advice memorandum, according to its representative, Marcus Owens of Loeb & Loeb LLP in Washington.

But the IRS is now proposing to revoke the exemption, and that proposed revocation, along with the casino's response, will be publicly released in about two weeks, Owens said.

So what's different now? According to Owens, the biggest change is IRS operational modifications that resulted in no clear link between revenue agents in the field and attorneys in Washington who can advise them on cases. "Front-line" agents now aren't as well connected to historical, institutional knowledge and the legal assistance that goes with it, he said.

"I think the agency's a little bit at sea," he said.

Because of the disconnect he described between revenue agents and attorneys in Washington, Owens said he's afraid there will be more occurrences of "this reinvention of the wheel."

Eve Borenstein of the Borenstein and McVeigh Law Office LLC in Minneapolis, raised a similar concern. From her experience in the last year and a half working on audits, she said, it's clear to her that group offices and examination agents have fewer points of contact now with specialists in the EO division national office than in the past, and only infrequent contact with chief counsel attorneys on points of law.

In March 2014 the agency announced it would relocate its EO headquarters from Washington to Cincinnati. It also announced it would realign some legal resources within the Tax-Exempt and Government Entities Division and would move to the IRS Office of Chief Counsel some technical law specialists and support staff responsible for published guidance, as well as the handling of some private letter ruling requests and technical advice. At the time, Owens told Tax Analysts the changes would "require a wholesale reordering with how the work is done, and in particular how the issues are identified that need to go to chief counsel" for in-depth review. He wondered how the facts of taxpayers' cases would be communicated to the offices having a role in resolving tough cases under the new alignment.

Speaking more recently on the casino matter, Owens said he doubts there has been any official directive to agents not to approach agency lawyers, but he said revenue agents and their managers appear to be under considerable pressure to close cases. He also said there has been an increasing trend moving away from technical advice over the last decade.

"I think with the separation of the revenue agent cadre from the specialized lawyers in the D.C. office, when the EO Division moved to Cincinnati and most of the EO technical function moved to chief counsel, the line [of] authority overseeing EO exams did not intersect with the national office the way it did before 2015," he said.

One function of the "old EO division" was to "ride herd on the field agents" to make sure positions taken were consistent with other cases and the trajectory of the law, Owens said. Other than having the field review itself, which historically hasn't worked, it's unclear whether there's a "realistic mechanism" for addressing consistency issues now, he said.

The IRS did not respond to a request for comment by press time.

While there have been changes in how the agency operates, Owens said that when it comes to Prairie Meadows, "factually speaking, nothing of significance" has changed since prior IRS reviews of its activities. The only change he could point to is a change in the number of Polk County board members serving on the casino's board after tax-exempt bonds that the casino was issued were paid off.

A Case of More IRS Focus, Not Less?

The Des Moines Register reported in January 2014 that the total compensation of Prairie Meadows CEO Gary Palmer rose 62 percent over a period of six fiscal years ending June 30, 2013, when over the same period revenues rose just 1 percent.

Stephen Gara, director of Drake University's School of Accounting, said the federal government appears to be taking a harder look at section 501(c)(4) organizations, and especially the nature of their activities. The use of raised funds isn't determinative, he said.

"The government also appears to be concerned that Prairie Meadows is being run too much like a for-profit business, as stated in the regulations," he said.

Owens said the IRS did not express concern about compensation or use of assets in its proposed revocation. "The debate is going to be around the justification for tax-exempt status," he said.

Prairie Meadows, according to its website, began operations as a nonprofit designed to promote economic development, jobs, agriculture, and tourism for the state of Iowa in 1989, and it launched its first season of horse racing that March. Casino operations started six years later. Prairie Meadows added table games in 2004, a conference center and restaurants in 2007, and a hotel in 2012, its website says. The casino's board of directors has 11 meetings scheduled in 2016, and Polk County, where it is located, has a representative on the executive committee and three on the board, including a current government employee.

According to a 1994 graduate thesis by Randy Dwain Parvin at Iowa State University, Prairie Meadows was constructed with $40 million in bonds, which Polk County guaranteed by entering into a lease-purchase agreement with the nonprofit organization operating it. The track, according to Parvin, failed to come close to projections in feasibility studies and the county had to lend large sums to the track operator so bond payments could be made and operating expenses could be covered.

Prairie Meadows is located in eastern Polk County, which in the late 1980s was an economically distressed area. The county created a study committee to determine ways to develop that part of the county, and one prospect it identified as a mechanism for economic development was a racetrack, which would also encourage agriculture with a focus on racehorses, Owens said.

Economic development is both a 501(c)(3) and a 501(c)(4) exempt purpose, he said.

"That's where the debate with the IRS will be joined," he said. "The organization was formed for economic development and that economic development is occurring in conjunction with government involvement."

The economic development Prairie Meadows has generated is the primary argument supporting its exemption, while the economic development relieving the burdens of government is a secondary one, Owens said.

But there's another tax issue Prairie Meadows and the IRS face, Borenstein said. If the agency, on legal grounds, "got it wrong" on the proposed revocation -- if there are sufficient "expositions" of government involvement with Prairie Meadows to have its operations be like government -- then not only are there no grounds for revocation, but all of the organization's "functionally integrated" revenue streams, including the casino operation, would not be subject to unrelated business income tax, she said.

In a 1993 IRS continuing professional education article, Robert Louthian and Amy Henchey wrote that the determination of whether an organization's activities lessen government burdens involves two tests. First, it has to be determined whether the governmental unit considers the activities its burden, and an activity is a government burden if there is an "objective manifestation" by the governmental unit that it considers the activities as such. A variety of factors can demonstrate that objective manifestation, and funding sources can be relevant. Second, performance of the activity must actually relieve government burdens.

Prairie Meadows's 2014 Form 990 shows the organization generated more than $2.1 billion of revenue, but it also says that under state law it is required to and does distribute profits to "educational, civic, public, charitable, patriotic or religious" uses defined by state law. In 2014 approximately $10.4 million of the organization's profits went to Polk County, $3.92 million to the city of Des Moines, and $1 million to the city of Altoona, where it is located. Other recipients included the Des Moines Community Playhouse, which got $227,500, and the Greater Des Moines Botanical Garden, which got $155,474.

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