The Internal Revenue Service remained busy during the last weeks of 2008, issuing a series of announcements describing the direction its Tax Exempt and Government Entities Division (the “TE/GE”) would take in 2009. Some of the more notable of these announcements are described below.
Annual Report and Fiscal Year 2009 Work Plan
For the first time, the Internal Revenue Service’s TE/GE Division issued an annual report (the “Annual Report”) which includes a fiscal year 2009 work plan (the “Work Plan”).
The Annual Report includes statistics on exempt organization examiners,
returns, compliance contacts, and other accomplishments of the TE/GE
Division. The Work Plan announces the Internal Revenue Service’s plans in a
variety of areas, including voluntary compliance, forthcoming new guidance,
and new enforcement and tax-compliance initiatives.
The Work Plan sets out several methods by which the Internal Revenue Service plans to communicate with exempt organizations to ensure their tax compliance, including several web-based tools to assist exempt organizations with the new Form 990 filing requirements. The Internal Revenue Service will continue outreach efforts to small tax-exempt organizations informing them about the new Form 990-N filing requirement. In an effort to improve the Exempt Organizations area of its website, the Internal Revenue Service will seek public comments regarding how it can make its website easier to use and information easier to find and display. Finally, the Internal Revenue Service expects to implement a new voluntary compliance program to encourage noncompliant exempt organizations to contact the Internal Revenue Service regarding their outstanding issues before the Internal Revenue Service initiates enforcement actions.
The Work Plan indicates that the Internal Revenue Service also intends to provide new guidance in several areas. These areas include modifying the provision that requires private schools to publish their non-discrimination policies; issuing proposed regulations for the changes to, and new requirements for, supporting organizations; issuing proposed regulations for excise taxes on donor-advised funds; issuing proposed regulations relating to the additional disclosures by the Secretary of the Treasury to state officials that are permitted by the Pension Protection Act of 2006; and releasing guidance on church plans.
Under the Work Plan, the Internal Revenue Service also intends to focus its compliance initiatives in 2009 on the sources and uses of charitable funds, valuation issues regarding non-cash gifts, the member income test for mutual organizations under Section 501(c)(12), and private benefits issues related to student loan organizations. It will also continue its focus on governance of tax-exempt organizations by (1) developing a checklist to identify whether governance practices impact tax compliance issues, (2) training its employees about governance implications, and (3) identifying governance questions that are now included on the revised Form 990 that could be used in compliance initiatives.
The Internal Revenue Service also plans to issue a public report on the information gathered through its compliance questionnaire issued to 400 colleges and universities in 2008 seeking information about endowments, unrelated trade or business activities, and executive
compensation. The responses are due on February 6, 2009. Still unknown is the effect that the responses will have on the consideration of a mandatory payout requirement on college and university endowments being raised by Senator Charles Grassley (R-Iowa).
Finally, the Work Plan indicates that the Internal Revenue Service will issue reports on other on-going compliance initiatives, including a report on the prohibition against political intervention by tax-exempt organizations and a follow-up report on the community benefit and executive compensation issues for non-profit hospitals. It also intends to design a project to identify certain organizations that are currently, and perhaps improperly, classified as community foundations.
IRS Considers Examining Sufficiency of Charitable Spending
Following comments originally made in April of 2008, Steven Miller, Commissioner of the Internal Revenue Service’s TE/GE Division recently confirmed that the Internal Revenue Service will look beyond traditional compliance standards to determine whether charities are spending in line with their charitable purposes. Doing so will require an analysis of charity spending in relation to revenues in areas such as fund raising, public contributions, grants, compensation, and unrelated trade or business. In particular, the Internal Revenue Service intends to focus on organizations with unusual levels of fund raising or unrelated trade or business activity accompanied by relatively low levels of program service expenditures.
Long ignored, Revenue Ruling 64-182 sets forth a “commensurate in scope” test. Under the test, organizations meet the primary purpose test of Section 501(c)(3) if they carry on, through contributions and grants, charitable programs “commensurate in scope” with their financial resources. Although Mr. Miller has acknowledged that the commensurate test may be antiquated and in need of some revision, he believes that it is a “compelling” description of the argument that “a charity has to do charity” and that a charity’s financial capacity plays an integral role in determining the amount of charitable funds it must spend.
However, Lois Lerner, the Internal Revenue Service Director of Exempt Organizations, has stated that the Internal Revenue Service is not trying to simply benchmark an appropriate amount of spending by charities. The Internal Revenue Service will continue to base its reviews of spending in examinations on traditional exempt organization standards such as private benefit and private inurement, rather than focusing instead, only, or immediately on the commensurate test. As a result, while some examinations may focus solely or mostly on spending, their number will be small compared to the number of organizations examined.
The Internal Revenue Service plans to continue to push for greater transparency in the governance of tax-exempt organizations, notwithstanding criticism that the issue is a state, and not a federal, issue. The Internal Revenue Service has long believed that an organization with an engaged, independent board of directors which is accountable to the community it serves (i.e., a well-governed organization) is more likely to obey tax laws and serve its exempt purposes. Thus, the Work Plan specifically indicates that the Internal Revenue Service will focus on governance in 2009.
The initial focus of the governance initiative is the revised Form 990, which has an entire part of the core form devoted to governance issues. To that end, the Internal Revenue Service will focus on questions involving the composition and independence of the exempt organization’s board, the organization’s internal financial controls, compensation practices, and adoption and adherence to a conflict of interest policy.
The Internal Revenue Service also intends to use its examination process to further its understanding of governance issues. It is already doing so on an informal basis – at the completion of examinations, revenue agents are now completing a form identifying governance issues that either led to or prevented issues or adjustments. There are plans, however, to institute a more formal process in which the Internal Revenue Service and organizations will discuss the organization’s existing governance policies before the examination starts, to help determine an appropriate scope for the examination. Finally, the Internal Revenue Service also plans to review other information on governance gathered by agents during examinations.
The Internal Revenue Service has restated that it intends to be “exceptionally active” in reviewing the executive compensation paid in tax-exempt organizations. As indicated in the Work Plan, executive compensation issues for non-profit hospitals will be a focal point, especially since the study of 500 tax-exempt hospitals has indicated “pretty high” compensation figures, as well as extensive use of the rebuttable presumption of reasonableness under the excess benefit transaction rules. In addition, as part of its current study of colleges and universities, the Internal Revenue Service is examining how colleges and universities determine and report salaries and “may go a little deeper” into the question of executive compensation.
Fast Track Settlement Now Available
On December 1, 2008, the Internal Revenue Service announced the expansion of its Fast Track Settlement (FTS) Program to tax-exempt organizations. Previously, only taxpayers in the Large/Middle Sized Business Division and Small Business/Self-Employed Division were allowed to take advantage of the FTS Program. During its two-year pilot program, the FTS Program will allow entities with unagreed issues in a tax period that is under examination to work together with the Examination Division and the Office of Appeals to resolve the issues in a more timely and efficient manner.
The FTS Program is available for cases involving issues related to income tax, exclusion of income from interest paid on municipal obligations, employment tax, estate and gift tax, excise tax, and exemption, foundation, or qualification issues when the issues are fully developed, the organization has stated its positioning writing, and there are a limited number of unagreed issues.
Organizations under audit which are interested in participating in the FTS Program should contact the revenue agent’s group manager to discuss whether an application is appropriate. The FTS Program application may be filed any time after the issue under consideration is fully developed but before the revenue agent issues the revenue agent report. The Internal Revenue Service will then prepare the revenue agent report for submission with the FTS Program application, and the organization will need to submit a written response to the revenue agent report with the FTS Program application.
If the Internal Revenue Service accepts the FTS Program application, it will assign an FTS Appeals Officer as a neutral party to mediate the dispute. The mediation will typically occur within sixty days (60) after acceptance of the FTS Program application. If the parties do not resolve their issues at the conclusion of the mediation, the revenue agent will close the case as an unagreed case, and the organization will retain all of its usual rights to request standard appeals consideration of issues.
Senator Grassley Requests More Charitable Reforms
In December 2008, Senator Grassley renewed his call for additional examination and possible reformation of the Internal Revenue Code provisions relating to charities. Citing Bernard Madoff's $50 billion Ponzi scheme that left many charitable endowments in financial upheaval, Grassley claimed that the fraud suggests new legislation is still needed, especially provisions relating to a prudent investor rule. The Senate Finance Committee staff proposed a prudent investor rule in 2004, but no such provision was included in the charitable reforms enacted as part of the Pension Protection Act of 2006.
McGuireWoods Nonprofit and Charitable Advisory Services
McGuireWoods Nonprofit and Charitable Advisory Services provides charitable and other nonprofit organizations with comprehensive advice on all issues they might face, including organizational, compliance, planning, governance, tax, and employment issues. Through its full-range of advisory services, the Nonprofit and Charitable Advisory Services enables charities and other nonprofits to operate successfully in the increasingly complicated, regulated, and competitive environment facing nonprofits today. McGuireWoods' Nonprofit and Charitable Advisory Services also handles tax controversies against the Internal Revenue Service and has broad experience representing clients in matters related to reportable transactions, related penalty examinations, and transaction and penalty disclosure requirements. If you have any questions, please do not hesitate to contact us at your convenience.