Dallas CPA Society Continuing Education Conference

Douglas N. VarleyCaplin & Drysdale, Chartered

Washington, D.C. 20005

Exempt Organizations UpdateFY 2011 EO Work Plan

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Roadmap

• Exempt Organizations

– News from Capitol Hill– IRS (EO) Guidance – Noteworthy Court Cases

• Looking Ahead to FY 2011

– Treasury Guidance Plan– IRS (EO) Workplan– Focus on International Issues

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News from Capitol HillSen. Baucus Calls for Investigation Re Political

Activity

• On September 29, 2010, Senate Finance Committee Chairman Max Baucus asked IRS Commissioner Shulman to survey major 501(c)(4), (c)(5),and (c)(6) organizations to determine compliance with limits on political activity.

“With hundreds of millions of dollars being spent in election contests by tax exempt entities, it is time to take a fresh look at current practices and how they comport with the Internal Revenue Code's rules for nonprofits.”

• Issues include:– “primary purpose” test – compliance with the proxy tax requirements of IRC section

6033(e) – excess benefits to donors?

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News from Capital HillGift Tax and Section 501(c)(4)

• IRS is auditing five returns of donors who contributed to (c)(4) organizations.

• Rev. Rul. 82-216, 1982-2 C.B. 220. (c)(4) gifts are taxable.

• Carson, 71 TC 252 (Affirmed, 641 F2nd 864, 10th Cir. 1981); Stern, 436 F.2d 1327 (5th Cir. 1971).

• IRS: “not part of a broader effort”• GOP Senators weigh in.

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News from Capital HillWays and Means Report on AARP

In March, Ways & Means issues “Behind the Veil” report on AARP. Questions:

• Use of Subsidiary corporations

• Lobbying on Health Care bill

• Compensation

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News from Capital HillExemption as a Tax Expenditure?

• At a hearing in March, Senator Grassley questioned tax exemption for fee for service charities – hospitals, software companies.

• Congress should calculate the “tax expenditure” associated with exemption, not just deductions.

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News from Capitol HillSenate Finance Staff Report re Megachurches

• Sen. Grassley’s Staff Report re: Tax Issues Raised by Media-Based Ministries – released in January 2011

• Citing his positive experience with the Independent Sector, Sen.Grassley asked the Evangelical Council for Financial Accountability (ECFA) to lead a discussion about how to address the issues raised by his staff.

• ECFA announced the establishment of its Commission on Accountability and Policy for Religious Organizations, which will address tax and policy issues involving religious organizations –for example:

– whether churches should file Form 990,

– whether legislation is needed to curb abuses of the clergy housing allowance exclusion, and

– whether the current prohibition against political campaign intervention by churches and other nonprofits should be repealed or modified. 

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IRS (EO) Guidance

In March, the IRS released proposed regulations under section 6104(c), as amended by the Pension Protection Act of 2006 . Section 6104(c) expands permitted disclosures to appropriate state officers,

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IRS (EO) Guidance

PLR 201043041 holds that “blocker” subsidiary works to prevent attribution of UBTI to CRUT.

PLR 201114036 “providing services on a regular basis for fees is a trade or business ordinarily carried on for profit and is not an activity that is substantially related to any exempt purpose except insofar as it provides revenue.” Really?

The IRS recently released proposed regulations under section 6104(c) of the Internal Revenue Code, as amended by

the Pension Protection Act of 2006 (reprinted below). Section 6104(c) expands permitted disclosures to appropriate state

officers,

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IRS (EO) Guidance

• Denial 201113036: EO’s operations are so functionally interrelated with relate company, so as to result in an impermissible private benefit to Company and Company's shareholder.

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IRS (EO) Guidance

• The IRS issued Notice 2011-6 to provide guidance regarding the implementation of new Treasury regulations governing tax return preparers.

• Beginning January 1, 2011, a Preparer Tax Identification Number (PTIN) must be obtained by all tax return preparers who are compensated for preparing, or assisting in the preparation of, all or substantially all of any U.S. federal tax return, claim for refund, or other tax form submitted to the IRS except specified forms.

• Forms 990, 990-T, 1023, 1024 are not excluded.

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Mayo Foundation v. United States

• IRS victorious in upholding regulations under which medical residents and similar full-time employees cannot qualify as students exempt from FICA.

• Supreme Court held that tax regulations are entitled to higher Chevron deference.– Rejected arguments based on absence of a specific statutory

delegation of power.

– Rejected arguments based on age of regulation, past inconsistency, timing of promulgation, etc.

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Hastings Law School Case

• Supreme Court upholds Law School’s “open to all students” recognition policy against first amendment challenge. Christian Legal Society v. Martinez.

• SC ruled for the school on grounds that the state does not have to subsidize all activity equally.

• Similar to Taxation w/ Representation v. Reagan. Implications for Citizens United and exempt organizations?

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Governance Requirements

• Ohio Disability Association, 2009 TCM. Organization with one director denied exemption in part b/c insufficient oversight.

• Rev. Rul. 66-219 held on director not a per se bar to exempt status.

• But, calls for candid and full disclosure. Otherwise, there is an inference that the organization will not operate for exempt purposes.

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501(c)(6) Exemption Denied

Asmark Institute v. Commissioner , T.C. Memo. 2011-20 (filed Jan. 24, 2011).

• Asmark provided a series of services to promote regulatory compliance to agribusiness; converted to nonprofit status.

• Services provided for a fee were held commercial, and the services offered for free were marketing tools to promote its commercial activities.

Bluetooth SIG v. United States, 611 F.3d 617 (9th Cir. 2010)

• Association’s primary functions were to develop, market, and license Bluetooth technology, for which it held the trademarks and patents.

• Its activities were not directed at the improvement of business conditions for an entire line of business (didn’t benefit nonmembers).

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Unrelated Business Cases

Ocean Pines Ass’n v. Comm’r, 135 T.C. No. 13 (2010).• A section 501(c)(4) homeowner’s association was deemed to

have unrelated business income from the operation of parking lots and a beach club not open to the general public.

• Revenue from parking lots did not qualify as rental income .• NOTE: no convenience exception under section 513(a)(2).

Bartels Trust v. U.S., 2010-2 U.S.T.C. ¶50,602 (Fed. Cir. 2010).• Trust income from the sale of margin-financed securities was

subject to UBIT because margin-financed securities are debt-financed property under sections 512 and 514.

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Treasury/IRS Priority Guidance Plan for FY2011

Of interest to Exempt Organizations:

• Unfinished business from last year:

– Final regulations re: supporting organizations– Regulations re: donor-advised funds– Regulations on group returns– Final regulations on IRS investigations of churches (IRC section

7611)

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Treasury/IRS Priority Guidance Plan for FY2011

New Projects:

• Guidance on new requirements (section 501(r)) for nonprofit hospitals.• Guidance updating grantor and contributor reliance criteria under Code

sections 170 and 509.• Guidance on excess business holdings rules in IRC section 4943, as amended

by the PPA. • Guidance on program-related investments under IRC section 4944.• Update final regs under IRC section 6104, relating to disclosure to state charity

agencies. • Final regulations under Code section 6104 reading disclosure of certain

administrative actions that are required to be made available to the public. • Final regs under Code section 170 regarding updated appraisal requirements

for certain charitable contributions.

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EO Work Plan for FY 2011

Audit/Compliance projects winding down to be integrated into general casework:

• Combined Annual Wage Reporting– EO reviewed employment tax reporting by comparing information reported

on Form W-2 (to SSA) and Form 941 (to IRS)

• Consumer Credit Counseling

– 63 Organizations examined; IRS revoked, terminated or proposed revocation in 41 cases.

• Down Payment Assistance

– EO examined DPA organizations that are funded solely by home sellers. IRS revoked, terminated or proposed revocation for 87 of 91 orgs.

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EO Projects Winding Down…

• Executive Compensation Compliance Initiative: Loans Project – Executive Comp Compliance Initiative Report (March 2007) raised

concerns about substantial loans to “TDOKEs.”– Loans Project began with 200 compliance checks and 50 single

issue exam. Based on those results, additional organizations were selected – total of 169 audits ensued.

• Results?– Assessment of > $5.5 million in section 4958 taxes– Assessment of >$480 thousand in employment taxes for income

not previously reported.– Proposed revocation or termination (18 cases)– Written advisory issued (75 cases)– Change or delinquent return secured (including related returns)

(39 cases)– No Change (37 cases)

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IRS College & University Audit Project (in progress…)

• October 2008: Questionnaire sent to 400 colleges and universities

• May 2010: Interim Report released

• Today: Selective audits of 40 schools underway– Focused on UBIT, executive compensation and endowment

issues

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Controlling OrganizationsSection 512(b)(13) Project

• IRS is focusing on tax treatment of payments between controlled entities and their tax-exempt parent organizations. Issues include:– UBIT– Allocation of Income and Deductions among taxpayers– Transfer of Property

• PPA changed the rules (but only for pre-PPA arrangements)

• IRS is collecting information through college/university audits and other initiatives.

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National Research ProgramStudy of Employment Tax Returns

Lois Lerner has said that IRS is increasingly interested in EOs as employers. Closing the “tax gap.”

IRS is examining the employment tax returns of 1500 organizations, with 500 selected randomly each year over a three-year period.

• Specific areas of interest included: worker classification, fringe benefits, officer compensation, employee expense reimbursements, and non-filers.

• Tax year 2008 returns are being examined now. Exams of 2009 returns will commence in early 2011.

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Non-501(c)(3) Compliance Project

• IRS is increasing its focus on section 501(c)(4), section 501(c)(5) and section 501(c)(6) organizations to determine compliance with IRC requirements.

• Private inurement?

• Primary purpose test?

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Supporting Organizations Compliance Project

• To combat reported and perceived abuses by section 509(a)(3) organizations, IRS has taken a two-pronged approach: (1) Instructions to EO Determinations function and (2) Audits.

• 300 Examined, with 280 closed so far . . .– 30 terminated– 72 revoked– 59 reclassified as private foundations or public charities

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Charitable Spending Initiative

• Study of sources and uses of funds in the sector and their relationship to the accomplishment of charitable purposes.

• Examined organizations include those where returns indicate: – high fundraising costs– UBIT and little program service expense– low ratios of program service expense to total revenues

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International Focus: Charities

• EO concern is whether charitable assets are being diverted internationally for non-charitable purposes. Current efforts intended to explore:– Foreign entities receiving IRS recognition of exempt status– Information referred from the JITSIC– Charities reporting foreign addresses on Form 990– Charities that participate in “gifts in kind” programs– Large private foundations with international operations or

international transactions

• OFACwarning against terrorist exploitation of charities– FAQs, Voluntary Guidelines, Risk Matrix, other materials at

http://www.treasury.gov/resource-center/terrorist-illicit-finance/Pages/protecting-index.aspx

– Dialogue with Treasury Guidelines Working Group has ended

• Schedule F changes

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Questions?

Thank You

For questions, feel free to contact:Douglas N. VarleyCaplin & Drysdale

One Thomas Circle N.W., Suite 1100Washington, D.C.  20005

Office -- 202-862-5000; Fax -- 202-429-3301Email: mowens@capdale.com; dholmes@capdale.com; mdurham@capdale.com

www.capdale.com

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