2014 nonprofit tax update: navigating through … · 2015. 2. 4. · 2014 nonprofit tax update –...

2014 Nonprofit Tax Update – Navigating Through Changing Waters

2014 NONPROFIT TAX UPDATE: NAVIGATING THROUGH CHANGING WATERS

BDO Institute for Nonprofit Excellence April 17, 2014


YOUR PRESENTERS:


INTRODUCTION: IRS ACTIVITY AND TAX REFORM

• Congress and IRS have been focusing on nonprofits • The IRS studies often result in legislation, e.g. hospital study resulted in 501(r) • Recent College and University Compliance Program Final Report also has had an

impact, especially with regard to UBIT and Compensation • Congress has held dozens of hearings and conducted 11 working groups on Tax

Reform • Rep. Camp came up with draft legislation, the Tax Reform Act of 2014 (TRA

2014) that covers the gamut and we will be talking about the provisions that could impact exempt organizations.

• The Joint Committee on Taxation (JCT) has “scored” TRA 2014 • Prognosis


WHAT HAS BEEN HAPPENING AT IRS?

Lack of workplan but many items from previous plans stay on the agenda: • Group Rulings:

- Questionnaire developed for central organizations with group rulings and distributed to some 2,000 such organizations early in 2013 and data being analyzed

- Central and subordinate organizations should understand their responsibilities under the group ruling to be sure they are in compliance

• Self Declarers: - Many non-charitable organizations can operate as tax exempt without filing an exemption

application (Form 1024) - Questionnaire developed and distributed to 501(c)(4), (5) and (6) organizations who self declared

on 2010 or 2011 Form 990 to determine if properly classified and if complying with applicable rules


APPLICATIONS FOR EXEMPTION

• Reinstatement of exemption for organizations revoked for non-filing—New procedure--Rev. Proc. 2014–11 - Streamlined retroactive reinstatement process for small organizations - Retroactive reinstatement process (within 15 months of revocation) - Retroactive reinstatement process (application more than 15 months from

revocation)

• EO developed an interactive version of the Form 1023 Exemption Application featuring pop-up explanations—now available

• Form 1023-EZ-Draft - 2 page form - Draft instructions are 34 pages long - IRS seeks comments


HEALTHCARE

• Hospitals - Two sets of proposed regulations implementing IRC 501(r) (effective dates) - Notice 2014-3—proposed revenue procedure for correction and disclosure for failures

to meet the requirements of 501(r) - Senator Grassley is asking the IRS for reports on 501(r) compliance - Schedule H instructions changed reporting of community benefit for 2013 tax year

• Small employer healthcare tax credit— - If you offer health insurance to your employees and there are less than 25 full time

equivalents (FTEs) your organization may be eligible for a tax credit. Additional criteria include average wages of not greater than $50,000.

- In general, the credit (that cannot be greater than payroll taxes paid) is equal to 25 percent of healthcare premiums paid. For tax years 2014 and beyond the credit is increased to 35 percent.

- Calculator on Resource Page


UPHEAVAL AT IRS AND CHANGES IN PERSONNEL-WHO IS OUT AND WHO IS IN

OLD IRS Commissioner:

(Acting) Daniel Werfel (Acting) Steve Miller

Previous: Doug Schulman Commissioner, TE/GE Division:

(Acting) Michael Julianelle Previous: Sarah Hall Ingram

Director, Exempt Organizations: (Acting) Ken Corbin

Lois Lerner

NEW IRS Commissioner:

John Koskinen

Commissioner, TE/GE Division: Sunita Lough

Director, Exempt Organizations:

Tamera Ripperda


501(c)(4): WHAT HAPPENED?

• Historically, many 501(c)(4) social welfare organizations engaged in some political activity in connection with their exempt purposes

• After the Supreme Court ruling in the Citizens United case, the IRS saw a significant increase in 501(c)(4) applications and was concerned that organizations applying for exemption were formed primarily to engage in political activity

• These organizations can engage in political activity if it is not their primary purpose

• IRS attempted to weed out organizations during the determination process, otherwise they would later have to audit the organizations to find out what is happening


501(c)(4): WHAT HAPPENED?

• Application process was particularly slow for “political” 501(c)(4)s • Word got out that organizations with political sounding names (e.g., “tea party”

or “conservative”) were being targeted for lots of additional questions in the determination process

• It can be debated that the IRS was doing its job as it understood it or that it was acting politically; but the controversy ensued, headlines were written, hearings were held, and many heads rolled!

• After the uproar, the IRS made it easier for such organizations to get expedited determinations if they certified that political activity was not primary purpose (using a more restrictive standard)


501(c)(4) PROPOSED REGULATIONS

• Released in November 2013 and now officially delayed • Thousands of comments received that all seem to have one thing in common:

dislike for these provisions! • Per the IRS, this is attempt to get away from intensive facts and circumstances

analysis and to create some more definitive rules


501(c)(4) PROPOSED REGULATIONS: MAJOR PROVISIONS

• Defines “candidate” broader than FEC rules to include appointment / approval of executive branch officials and judges (in addition to the more traditional election of Federal, state and local office holders)

• Enlarges the definition of “express advocacy” to include broader range of candidates (above) and includes “selection, nomination, appointment of individuals, or on the election or defeat of one or more candidates of a political party”

• Defines political communications to include all forms of communication that refer to a candidate directly or indirectly (e.g., the “incumbent” or other distinguishing characteristic)

• Any communication within 60 days of primary or 30 days of general election would be political activity


501(c)(4) PROPOSED REGULATIONS: MAJOR PROVISIONS (CONTINUED)

• Political contributions defined to include volunteer hours, use of mailing lists and other in-kind forms

• Get out the vote activities, voter guides and candidate debates become political activity under the new rules

• Any event hosted on premises of the organization which includes a candidate within the 30/60 days of elections is automatically considered a political activity even if it is a non political event (e.g., a ribbon cutting for new facility)


GENERAL TAX UPDATE AND TAX REFORM Including TRA2014 Provisions

• Status of “Extenders” Bills • Internet Sales Tax Proposals • Supporting Organizations/DAF Guidance Issued 2013 • Other - Current • House Ways and Means Committee - draft tax reform package Dave Camp - TRA2014


TRA2014 PROVISIONS House Ways and Means Committee/Dave Camp

• February 2014 release of comprehensive draft tax reform plan • Broad and dramatic provisions impacting many areas • Charitable Giving

- An individual’s contributions could be deducted only to the extent in which they exceed 2% of the individual’s AGI.

- Deductions for most donations of real property would be limited to cost basis. - The 50% income-based (AGI) percentage limit for certain contributions would be reduced to 40%.


TRA2014 PROVISIONS Draft “Tax Reform Act of 2014”

• Elimination of Special Rule – College Athletic Event Seating Rights - Under existing law a special rule permits taxpayers to deduct as a charitable contribution 80% of

the value of a contribution made to an educational institution to secure the right to purchase tickets for seating at an athletic event in a stadium at that institution.

- Under the provision, the special rule that provides a charitable deduction of 80% of the amount paid for the right to purchase tickets for athletic events would be repealed.

• Provisions Impacting Tax Exempt Entities . . .


TRA2014: INCREASE IN PENALTIES Information Returns Reasonable cause exceptions allowed JCT estimate: provision would increase revenues by $0.1 billion over 2014-2023

Current law: • Failure to file information return $20

- For an organization > $1 million gross receipts $100

• Managers failure to allow public inspection $10 per day

• Public inspection - Returns/application $20 per day

• Tax-shelter disclosure $100 • Dissolution/liquidation notice $10

Provision - Penalty increase: $40

$200

$20 per day $40 per day $200 $20


TRA2014: SELF-DEALING TAX MODIFICATIONS Private Foundation Excise Tax

• Current law: - Disqualified persons and managers who engage in self-dealing transactions with private

foundations (PF) are subject to an excise tax - Self-dealing transactions between a PF and a disqualified person generally include:

- (1) a sale or exchange, or leasing, of property; - (2) lending of money or other extension of credit; and - (3) the transfer to, or use by or for the benefit of, a disqualified person of the income or

assets of the private foundation - Excise tax imposed on the very act of self-dealing, irrespective of whether FMV is paid, except for

the payment of compensation, permitted at FMV - Tax is imposed on the entire amount involved in the transaction, except for compensation, where

the tax is imposed on compensation in excess of FMV


TRA2014: SELF-DEALING TAX MODIFICATIONS (Continued) • Draft Provision:

- Excise tax of 2.5% imposed on a PF (new!) when the self-dealing tax is imposed on a disqualified person, not just on the persons involved.

- Rate of 10% for cases in which the self-dealing involves the payment of compensation. - Foundation managers would no longer be able to rely on the professional advice safe harbor. A

manager’s reliance on professional advice, by itself, would not preclude the manager from being subject to the excise tax for participating in a self-dealing transaction.

- JCT estimate: provision would have negligible revenue effect over 2014-2023.


TRA2014: EXCISE TAX ON FAILURE TO DISTRIBUTE Donor Advised Funds (DAF) – 5 Year Limit • Current law:

- Public charities are permitted to establish Donor Advised Funds (DAF) - Donors generally claim contribution at the time of contribution - Sponsoring charities own and control, but are not required to distribute within any specific time

period - DAFs are not subject to the private foundation net investment income excise tax

• Draft Provision: - DAFs would be required to distribute contributions within 5 years of receipt - An eligible distribution is made to a public charity - Failure to make distribution would subject the sponsoring charitable organization to an annual

excise tax equal to 20% of undistributed funds. - JCT estimate: provision would increase revenues by less than $50 million over 2014-2023.


TRA2014: EXCISE TAX SIMPLIFICATION Private Foundation Investment Income Tax • Current law:

- PFs are subject to a 2% excise tax on net investment income, but may reduce the rate to 1% by meeting certain requirements regarding distributions to qualifying tax-exempt organizations during a tax year

- A special rule excludes “exempt operating foundations” (EOF) from this excise tax

• Draft Provision: - Excise tax rate on net investment income would be reduced to 1% - Rules providing reduction in excise tax rate from 2% to 1% would be repealed. - Repeal the exception from the excise tax for EOFs - JCT estimate: provision would reduce revenues by $1.6 billion over 2014-2023


TRA2014: PRIVATE OPERATING FOUNDATIONS Repeal of Exception on Failure To Distribute Income • Current law:

- PFs generally required to pay minimum distributions each year to accomplish organization’s exempt purposes (includes reasonable and necessary admin)

- Failure to pay results in an initial excise tax on the foundation of 30% of undistributed amount - Plus, an additional tax of 100% of the undistributed amounts not made up in the following year(s) - Private Operating Foundations (POF) are not subject to payout requirements

- To qualify as a POF the organization must spend at least 85% of its adjusted net income or its minimum investment return, whichever is less, directly for the active conduct of its exempt activities.

• Draft Provision: - Special exclusion for POF would be repealed - POFs would become subject to the excise tax for failure to distribute income like PFs, generally.

They would be required to pay out a minimum amount each year in distributions to accomplish one or more of the organization’s exempt purposes, through grants or other qualifying expenditures.

- JCT estimate: provision would have negligible revenue effect over 2014-2023


TRA2014: REPEAL OF TYPE II AND TYPE III Supporting Organizations

• Current law: - Certain organizations that provide support to another public charity may also be classified as

public charities rather than private foundations, even if not publicly supported

• Supporting Organization (SO) must meet three tests. Essentially, the classification depends on how close its relationship is to the supported organization, with Type I supporting organizations having the closest relationship (akin to a parent-subsidiary relationship)

- SUPPORTING ORGANIZATION TESTS - to qualify as a supporting organization, an organization

must meet all three of the following tests: - (1) the organizational-and-operational test, - (2) the lack-of-outside-control test, and

- (3) the relationship test.


TRA2014: REPEAL OF TYPE II AND TYPE III Supporting Organizations (Continued)

• RELATIONSHIP TEST - a supporting organization must hold one of three relationships with the supported public charity. The organization must be:

- Type I - operated, supervised, or controlled by a publicly supported organization; - Type II - supervised or controlled in connection with a publicly supported org.; or - Type III - operated in connection with a publicly supported organization.

• Draft Provision: - Type II and Type III supporting organizations would be repealed - Organizations that support public charities would need to qualify as Type I supporting

organizations, or they would be treated as private foundations - Type II and III existing on date of enactment would have until the end of 2015, to qualify under

Type I definition or as a public charity, or be treated as a PF - JCT estimate: provision would increase revenues by $1.4 billion over 2014-2023


TRA2014: EXCISE TAX ON INVESTMENT INCOME Private Colleges And Universities

• Current law: - 2% excise tax on net investment income of PFs and certain charitable trusts

• Draft Provision: - Certain private colleges and universities would be subject to

- 1% excise tax on net investment income - provision would only apply to -

- private colleges and universities - assets valued at the close of the preceding tax year

- other than those used directly in carrying out the institution’s educational purposes - of at least $100,000 per full-time student

- State colleges and universities would not be subject to the provision - JCT estimate: provision would increase revenues by $1.7 billion over 2014-2023


COMPENSATION PROVISIONS • Current law: The deduction allowed to publicly traded C corporations for

compensation paid with respect to chief executive officers and certain highly paid officers is limited to no more than $1 million per year. Similarly, current law limits the deductibility of certain severance-pay arrangements (“parachute payments”).

• TRA 2014: A tax-exempt organization would be subject to a 25-percent excise tax on compensation in excess of $1 million paid to any of its five highest paid employees for the tax year. Tax would apply to all remuneration paid to a covered person for services, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, except for payments to a tax-qualified retirement plan, and amounts that are excludable from the executive’s gross income.

• JCT estimate: increase revenues by $4.0 billion over 2014-2023.


TAX EXEMPT PRIVATE ACTIVITY BONDS Current law: Interest on both governmental bonds and private activity bonds (PABs) is excluded from gross income (and thus exempt from tax)

• Governmental bonds typically are issued to finance projects that constitute public goods (e.g., roads, schools, and parks).

• PABs finance the activities of, or loans to, private parties, with indirect benefits accruing to the State or locality that issues the bond.

TRA 2014: Under the provisions, interest on newly issued PABs would be included in income and thus subject to tax. JCT estimate: the provisions would increase revenues by $23.9 billion over 2014-2023.


INTERMEDIATE SANCTIONS –CURRENT LAW

• Intermediate Sanctions are applicable to excess benefit transactions (EBTs) between 501(c)(3) or 501(c)(4) organizations and Disqualified Persons (DPs).

• Penalties are imposed on the DPs and on organization managers who knowingly and willingly approve (EBTs). The organization itself is not subject to a penalty tax.

• A DP generally is any person in a position to exercise substantial influence over the affairs of the public charity (e.g., officers, directors, or trustees) at any time in the five-year period before the excess-benefit transaction occurred. Special rules apply to donor advised funds and supporting organizations. A disqualified person also includes certain family members of such a person, and certain entities that satisfy a control test with respect to such persons.

• A rebuttable presumption can be established that shifts the burden of proof to the IRS to show that compensation or transactions are not reasonable. Also, managers can rely on professional advice to avoid penalties.


INTERMEDIATE SANCTIONS –TRA 2014

• Extends Intermediate Sanctions to 501(c)(5) and 501(c)(6) organizations • Imposes an excise tax of 10 percent on the tax-exempt organization when the

excess-benefit excise tax is imposed on a disqualified person. The entity-level tax would be avoidable if the organization follows minimum standards of due diligence or other procedures to ensure that no excess benefit is provided by the organization to a disqualified person.

• Eliminates the rebuttable presumption of reasonableness that shifts the burden of proof to the IRS

• Managers would no longer be able to rely on the professional advice safe harbor under Treasury regulations. Thus, a manager’s reliance on professional advice, by itself, would not preclude the manager from being subject to the excise tax for participating in an excess-benefit transaction.

• Specifically includes in the definition of a DP athletic coaches and investment advisors

JCT estimate: Negligible revenue effect over 2014-2023


TRA 2014 EXEMPTION PROVISIONS

Repeal of tax-exempt status for professional sports leagues currently exempt under sec. 501(c)(6) of the Code) JCT Estimate: increase revenues by $0.1 billion over 2014-2023. Repeal of exemption from tax for certain insurance companies and CO-OP health insurance issuers JCT Estimate: increase revenues by $0.7 billion over 2014-2023. In-State requirement for certain tax-exempt workmen’s compensation insurance organizations (sec. 501(c)(27) of the Code) JCT Estimate: would increase revenues by less than $50 million over 2014-2023


UNRELATED BUSINESS INCOME TAX (UBIT)

• Current IRS Initiatives

• Proposed Tax Reform Provisions


CURRENT IRS UBIT INITIATIVES

• Current IRS initiative to examine sample of organizations with substantial gross UBI but no taxable income for 3 years

• Results of IRS College and University Compliance Project (CUCP)* - Disallowance of more than $170M in losses and NOLs due to:

- Errors in computation or substantiation of NOLs - Lack of profit motive - Improper expense allocations - Unrelated activities classified as exempt or excluded

- Major areas included fitness/rec centers, sports camps, golf, advertising and arenas - IRS disagreed with about 40% of colleges who got outside opinions on UBI activities

* Not indicative of higher education in general, but rather the 34 colleges selected for examination as result of answers to questionnaires given to 400 institutions.


GENERAL INFORMATION ON NOLS, COMPUTATION AND SUBSTANTIATION NOLs in General: • Can be carried back 2 years and forward 20 • Default is to carry back first and then forward if not used up- can irrevocably

elect to carry forward only when filing return for year of loss • IRS can go back to first year of NOL origination to disallow, but can only change

tax liability for open tax years (generally last 3 years), i.e., cannot change liability in closed years even when the NOL is denied or decreased

• States generally follow Federal NOL rules

Computation and Substantiation: • Must carefully track and document origination and utilization • Keep old returns and all calculations, allocations, memos, agreements, etc.


CUCP ISSUE: LACK OF PROFIT MOTIVE

• To be an unrelated business, an activity must be: • A trade or business, regularly carried on and unrelated to exempt purposes • In the CUCP Final Report and other examinations, the IRS found many cases

where there was no trade or business because of lack of profit motive evidenced by history of continual losses

• For open years with continual losses, the IRS typically disallows the losses, resulting, of course, in much additional tax

• There may be extenuating circumstances for continual losses: business in start-up phase, actual costs significantly greater than anticipated or budgeted, business cycle downturn or in wind-up phase, alternative investment structured to not turn around for many years

• If organization is taking position that the activity will turn around, must document it carefully


CUCP ISSUE: IMPROPER EXPENSE ALLOCATION

• No precise IRS guidelines other than “reasonable” • Cannot use expenses from related activity to offset unrelated—often an issue

with expenses that support both related and unrelated activities • Expenses must be deductible for tax purposes (e.g. 50% of meals and

entertainment, etc.) • Three buckets of expenses

- Directly connected to UBIT activity—deduct in whole - Exempt expenses—do not deduct at all (e.g. fundraising, etc.) - Dual use—allocate on a reasonable basis (see Rensselaer Polytechnic v. Commissioner)


NOL AND LOSS PROPOSAL UNDER TRA 2014

• Under current law, assuming that an activity does not lack a profit motive, losses from a particular trade or business are aggregated with profitable lines of business to determine if there is overall taxable income or a loss which becomes an NOL

• Under TRA 2014, eliminate the ability to aggregate losses from one trade or business with income from another trade or business

• A loss from a particular trade or business could only be carried forward or back to offset income from that same trade or business


UBIT PROPOSALS TRA 2014

• Corporate sponsorship: - Currently, mention of a sponsor’s product lines or products is excluded as a acknowledgement

of the sponsor - TRA 2014 proposes that mention of a sponsor’s product lines is not excluded from being a

“return benefit” and would become taxable UBI

• Name and logo royalties - Passive royalty income from use of organization’s name or logo is currently excluded from UBI

(e.g., affinity cards and logo items) - Under TRA 2014, this would be taxable

• Exclusion of research income from UBI modified to only allow exclusion for fundamental research with results freely available to the public –but other exclusions still remain for colleges and hospitals as well as for research done for the government

• Increase of specific deduction from $1,000 to $10,000 for most organizations


OTHER UBI PROPOSALS TRA 2014

• Charitable deduction for trusts subject to same 10% limitation as for a nonprofit corporation--so instead of unlimited deduction under current law for trusts, charitable deduction is limited to 10% of taxable income before the charitable deduction and excess gets carried forward for 5 years

• New manager level penalty for underpayment of tax under IRC 6662 - 5% of underpayment amount with $20K limit - Applies jointly and severable to any manager “under duty to perform an act in respect of

which the underpayment occurs”


Resource Page

TRA 2014: http://waysandmeans.house.gov/uploadedfiles/ways_and_means_section_by_section_summary_final_022614.pdf

CUCP Final Report: http://www.irs.gov/pub/irs-tege/CUCP_FinalRpt_042513.pdf Self-Declarers Questionnaire: http://www.irs.gov/pub/irs-tege/Form14449.pdf Draft 1023-EZ: http://www.reginfo.gov/public/do/PRAICList?ref_nbr=201402-1545-033 Interactive Form 1023: http://www.stayexempt.irs.gov/StartingOut/InteractiveForm1023Application.aspx Calculator for Small Employer Tax Credit- See calculator at: http://www.taxpayeradvocate.irs.gov/calculator/SBHCTC.htm BDO Nonprofit Practice and Blog: http://www.bdo.com/industries/nonprofit/

http://waysandmeans.house.gov/uploadedfiles/ways_and_means_section_by_section_summary_final_022614.pdf

http://www.irs.gov/pub/irs-tege/CUCP_FinalRpt_042513.pdf



http://www.irs.gov/pub/irs-tege/Form14449.pdf



http://www.reginfo.gov/public/do/PRAICList?ref_nbr=201402-1545-033





http://www.stayexempt.irs.gov/StartingOut/InteractiveForm1023Application.aspx

http://www.taxpayeradvocate.irs.gov/calculator/SBHCTC.htm

http://www.bdo.com/industries/nonprofit/


CONCLUSION AND QUESTIONS & ANSWERS

To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this presentation (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. Material discussed in this tax presentation is meant to provide general information and should not be acted on without professional advice tailored to your organization’s individual needs.

2014 nonprofit tax update: navigating through … · 2015. 2. 4. · 2014 nonprofit tax update –...

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