Continued IRS Regulatory Activity in the Nonprofit Sector Recent Developments: Spring 2008

April 30, 2008

IRS Releases Draft Instructions to the New Form 990 for 2008

Most tax-exempt organizations must file an annual return on Form 990. In December 2007, the IRS released the revised Form 990 for the 2008 tax year. The redesign of Form 990 is based on three guiding principles: (1) enhancing transparency to provide the IRS with a realistic picture of the organization and its operations, along with the basis for comparing the organization to similar organizations; (2) promoting tax compliance by accurately reflecting the organization’s operations and use of assets so that the IRS can efficiently assess the risk of noncompliance; and (3) minimizing the burden on the filing organization by asking questions in a manner that makes it relatively easy to fill out the form without imposing unwarranted additional recordkeeping or information gathering burdens.

On April 7, 2008, the IRS released the draft instructions to accompany the 2008 Form 990. The IRS seeks public comments on the instructions to ensure that they address the needs of the tax-exempt community. The IRS is particularly interested in comments on the areas identified in the highlights at the beginning of the instructions, the definitions in the glossary, and the instructions regarding new or significantly revised areas such as compensation, governance, foreign activities, disregarded entities and joint ventures, group returns, hospitals, and tax-exempt bonds.

The public may submit comments to the IRS on the instructions until June 1, 2008 by email at [email protected] or by mail at IRS, Draft 2008 Form 990 Instructions, SE:T:EO, 1111 Constitution Ave., N.W., Washington, DC 20224.

IRS Plans Voluntary Compliance Program for Nonfiling Organizations

Currently, organizations may correct Form 990 errors in several ways. To correct a tax return, an organization may file an amended return. For non-filing issues, an organization may discuss the problem with an IRS area manager, prepare delinquent returns, provide explanations, and take steps to ensure that the problem does not occur again. For exemption issues, the organization may seek a closing agreement with the IRS. Frequently, correction will involve the imposition of significant penalties against the organization.

Provisions of the Pension Protection Act of 2006 make the failure to file a Form 990 particularly devastating for tax-exempt organizations if continued for a certain period of time. Any organization that fails to file an annual return for three consecutive years will be considered as having had its exempt status revoked as of the date the third annual return was due to be filed. The IRS must publish and maintain a list of the organizations whose exemptions are revoked under this provision. Any organization seeking reinstatement must apply to the IRS (even if a filing was not originally required by the organization). The reinstatement may be retroactive if the failure to file was due to reasonable cause. These rules apply to returns with respect to annual periods beginning after 2006.

As recommended by the IRS Advisory Committee on Tax-Exempt Organizations, the IRS plans to release a revenue procedure that will provide a new voluntary compliance program for tax-exempt organizations wishing to resolve past tax mistakes. The key feature of the transitional program is to allow all tax-exempt organizations not under audit, in appeals, or in litigation to file outstanding Forms 990, 990-EZ, 990-PF, or 990-T for the most recent three tax years. The tax-exempt organization would be required to pay all taxes due, with interest, but would not be subject to penalties.

IRS Continues to Promote Good Governance

Despite continued protests that the realm of governance is outside the scope of the IRS’s jurisdiction, the IRS continues its emphasis on good governance for tax-exempt and nonprofit organizations in several ways. The revised Form 990 includes a new governance section, including questions on compliance and board independence, on policies and procedures, and on the availability of information to the public regarding governance and financial information. The recently released draft instructions for the Form 990 include a definition of an independent board member.

The IRS also provides educational tools online about governance and related topics such as a mission, organizing documents, transparency, and accountability. One such publication is Governance and Related Topics – 501(c)(3) Organizations. The Service also intends to provide a “cyber assistant” in 2009 to help charities prepare their applications for exemption on Form 1023.

While acknowledging that governance matters may be outside its jurisdiction, the IRS believes it has authority to inquire about an organization’s governance and policies as part of its compliance and enforcement functions. The IRS asserts that an organization that exercises good governance practices is likely to be a tax compliant organization.

The Independent Sector’s Nonprofit Panel has also offered recommendations on education and enforcement efforts as well as actions to improve the law. In October 2007, the Panel on the Nonprofit Sector published guidance titled “Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations.” This report can be found at

IRS Follows Path of Senate Finance Committee and Plans Compliance Check of Colleges and Universities

The IRS recently announced that it intends to send compliance check letters to approximately 400 colleges and universities in 2008 to determine adherence to recordkeeping and reporting requirements. The letters will be sent to a wide cross-section of different sizes of four-year colleges and universities. Based upon the responses, the IRS will conduct focused examinations. The colleges and universities will receive the questionnaire on a CD to give the option of responding to the questionnaire electronically or by mail.

Matters to be addressed include the reporting of income and expenses on Form 990, how the institutions calculate and report losses on Form 990-T, the allocation of income and expenses in calculating unrelated business taxable income, the investment and use of endowment assets, and the determination of executive compensation.

The IRS Continues its Attack on Abusive Transactions Involving Supporting Organizations

The IRS recently issued several private letter rulings revoking certain organizations’ exempt status under Internal Revenue Code section 501(c)(3). In one instance, the IRS found that the organization was not operated exclusively for exempt purposes because a substantial part of its activities benefited private interests rather than public interests.

The organization was established in the form of an irrevocable trust, as a supporting organization to several publicly supported charities. The founder of the organization contributed three furnished condominiums at a beach resort to the organization and took a charitable deduction for the contribution. As the trustee for the organization, the founder then engaged in self-dealing by renting the condo units to a vacation travel company that the founder owned, without a board meeting, without obtaining competitive bids from disinterested parties, and without a lease. The founder thereby benefited at the expense of the organization. In addition, the organization made no grants over a period of four years to the charities that it listed in its application for exemption (Form 1023) as the supported organizations.

Meanwhile, an affiliated entity of the organization was under federal investigation by the Securities and Exchange Commission (“SEC”) for tax shelter schemes involving offshore transactions, including the repatriation of funds in the form of tax-free “borrowing.” After the IRS contacted the organization to inquire about these separate issues, the founder took steps to correct the self-dealing in which he was engaged. The organization executed a lease for the condo units and began making grants to the named charities.

The IRS held that the organization was not a supporting organization because it failed to make distributions or provide any support through its activities to the organizations that it claimed to support. The IRS held that the net earnings and assets inured to the benefit of its creators, trustees, and directors, which is prohibited by Internal Revenue Code section 501(c)(3). The IRS found no evidence that organization participated in any offshore financial activity, but it revoked the organization’s tax exempt status retroactively back to the date of its incorporation.

McGuireWoods LLP routinely represents tax-exempt organizations in a variety of legal matters. If you have any questions, please do not hesitate to contact us at your convenience.

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