Stealth Can Be Good: New Procedure Allows Governmental Entities to Relinquish Section 501(c)(3) Tax-exempt Status

Posted on January 5, 2012 by Elizabeth M. Mills

A new provision which was slipped in to the annual announcement of procedures for exempt organization determinations and letter rulings provides a way for governmental entities to voluntarily terminate their Section 501(c)(3) status. This is important for governmental hospitals that otherwise could be faced with new exemption requirements and penalties.

In the past, many local governmental entities, such as hospital authorities or hospital districts, obtained determinations from the IRS that they were tax-exempt organizations described in Section 501(c)(3) of the Internal Revenue Code. A common reason for obtaining recognition of Section 501(c)(3) status (in addition to their sovereign immunity as governmental entities from federal income tax) was so that the governmental entity’s employees could take advantage of Section 403(b) tax-sheltered annuities.  (A government entity may not establish or maintain a Section 401(k) plan unless it adopted the plan before May 6, 1986.  While governmental entities are permitted to maintain Section 457(b) plans, which are defined contribution plans providing for employee contributions similar to Section 401(k) plans, Section 457(b) plans are subject to lower contribution limits than the overall contribution limits for Section 401(k) plans and Section 403(b) annuities).

Section 501(c)(3) governmental entities were relieved of the burden of having to file a Form 990, which at that time was really the only disadvantage to Section 501(c)(3) status. (Governmental educational institutions were already subject to unrelated business income tax on their income that would have been taxable had they not been governmental institutions.) When the “intermediate sanctions” applicable to transactions with public charities became effective in 2005, imposing potential excise taxes on persons involved in transactions with Section 501(c)(3) organizations that were not public charities, the implementing regulations specifically provided that governmental entities with Section 501(c)(3) recognitions were not covered. 

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IRS Extends Filing Deadline for Certain Tax-Exempt Organizations

Posted on December 20, 2011 by Kathleen E. Gerber

The IRS has granted an automatic extension for certain tax-exempt organizations to file their annual returns electronically. The extension is being provided because the IRS’s electronic filing system (the “Modernized eFile system” or “MeF”) will not be available for filing Forms 990, 990-EZ, 990-PF, and 1120-POL from January 1, 2012 through February 29, 2012 (the “Suspension Period”). The extension is only available for organizations with filing due dates (whether original or extended) during the Suspension Period (“Affected Organizations”). Ordinarily, organizations with a fiscal year ending August 31 or September 30 would have filing deadlines during the Suspension Period. Under Notice 2012-4, Affected Organizations will automatically be granted an extension of time to file electronically to March 30, 2012.

Since the relief is automatic, an Affected Organization does not have to file Form 8868, Application for Extension of Time to File an Exempt Organization Return as long as the organization files its return by March 30, 2012. However, an Affected Organization will still have the option to file a Form 8868 to request an automatic extension of time to file during the Suspension Period. For example, if an Affected Organization’s original deadline to file its Form 990 is on February 15, 2012, the organization may properly complete and file a Form 8868 by such date to receive an automatic three-month extension of time to file ending on May 15, 2012. An Affected Organization that has previously received only one three-month extension of time to file will also continue to have the option to file Form 8868 to request a second automatic three-month extension.    

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Treasury Releases Long-Overdue Report on Supporting Organizations and Donor Advised Funds

Posted on December 9, 2011 by Elizabeth M. Mills

Along with making significant changes to the rules for supporting organizations (“SOs”) and donor advised funds (“DAFs”) in the Pension Protection Act of 2006 (the “PPA”), Congress directed that Treasury conduct a study on the organization and operation of SOs and DAFs. Congress gave Treasury one year after the enactment of the PPA to submit a report on the study. On December 5th, more than four years past the prescribed deadline, Treasury finally released its long-awaited report to Congress. The report suggests that the current treatment of SOs and DAFs is appropriate and did not recommend any changes. While the report comes as good news to SOs and DAFs, some aren’t so keen. Senator Chuck Grassley (R–Iowa), denounced the study as disappointing, superficial, and a missed opportunity to “advance the ball in closing abusive loopholes.” For more, see his press release. Interested in whether SOs and DAFs should continue to be treated similarly to public charities, Congress asked Treasury to consider three specific questions regarding SOs and DAFs. A discussion of each question and Treasury’s response is discussed below.

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Recaps from Proskauer's 16th Annual Trick or Treat Tax Exempt Seminar

Posted on November 4, 2011 by Jacob I. Friedman

Proskauer’s 16th Annual Trick or Treat Seminar was held on Monday, October 31, 2011. 

The Seminar discussed:

  • Corporate Governance for Not-for-Profit/Exempt Organizations
  • Maintaining Tax-Exempt Status During Election Season
  • Investment Management under UPMIFA: What’s Required, What’s Good Practice
  • Executive Compensation & Employee Benefits Developments

In her introductory remarks, Amanda H. Nussbaum , Partner, highlighted the Congressional hearings on proposals to modify the structure of tax breaks for charitable donations. In addition, she also discussed recent state legislation adopting flexible purpose corporations - - new companies that are part social benefit and part low-profit entities such as the L3C - - and whether these types of companies were really necessary or whether they would just fade away. She also mentioned the IRS monthly updates of the list of the names of organizations whose tax-exempt status has been automatically revoked due to the failure to file a Form 990 for three consecutive years and some of the IRS's recent projects such as its college and university compensation and unrelated business income study and its governance check sheet.

Here are some take-away points from each presentation:

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Recent Changes in Delaware Law Governing Not-for-Profit Corporations

Posted on October 5, 2011 by Kathleen E. Gerber

             Incorporating under Delaware law can be an attractive option for a not-for-profit organization because Delaware law often grants greater flexibility with respect to the governance and structuring of the organization.   For example, under Delaware law, a corporation (whether organized for profit or not) is only required to have one director, whereas the majority of states require a not-for-profit organization to have at least three directors, and Delaware law does not require a corporation to have officers.  

            Unlike many other jurisdictions, Delaware does not have a separate code governing not-for-profit corporations. Instead, not-for-profit corporations are governed by the same Delaware General Corporation Law (the “DGCL”) that applies to for profit corporations. Typically, although other entity options are available for forming a Delaware not-for-profit organization (such as a trust or a limited liability company), most Delaware not-for-profit entities choose to incorporate as a nonstock corporation (i.e., a corporation that is not authorized to issue capital stock and that has “members” and a “governing body” rather than “shareholders” and a “board of directors”). 

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IRS Tutorial Explains the Special Rules for International Activities of U.S. Charities

Posted on October 2, 2011 by Jacob I. Friedman

The IRS presents webinars on a variety of subjects.  In August, the IRS presented a webinar conducted by two IRS representatives on the special rules affecting charities that make grants to foreign organizations or engage in activities in foreign countries.


In a fairly comprehensive course, the following significant points were made:


1.    A U.S. charity can do anything in a foreign country that it can do here, provided that the activity is consistent with the charity’s exempt purposes.


2.    For purposes of the rule that a charity may not devote a substantial part of its activities to legislative lobbying:


a.    lobbying includes action by the public in a referendum, ballot initiative, constitutional amendment or similar procedure;


b.    actions by executive, judicial or administrative bodies are not considered legislation;


c.    legislation includes foreign laws; and


d.    in certain countries ruled by authoritarian or theocratic regimes, it is questionable whether the governing body is a legislature or if a legislative process even exists.

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Treasury Releases its Priority Plan and the Form 990 Implementation Regulations

Posted on September 13, 2011 by Jacob I. Friedman

Treasury just released the 2011—2012 Priority Guidance Plan. The Plan lists 317 projects that are priorities for Treasury resources through June 2012. Included in these projects are 13 projects directly related to Exempt Organizations. Many of the other projects such as the 66 employee benefits, executive compensation and employment taxes projects may affect Exempt Organizations. 

Among the projects directly relating to Exempt Organizations are:

  • Updating grantor and contributor reliance criteria; 
  • Regulations on additional requirements for charitable hospitals;
  • Final regulations on the new supporting organization requirements;
  • Update on guidance for distributions by private foundation to foreign charities;
  • Guidance on excess business holdings and program-related investments rules;
  • Regulations on new donor advised funds rules; and
  • Final regulations on church tax inquiries and examinations.

Treasury also released final regulations under various Code Sections to implement the redesigned Form 990 .  According to Treasury "All tax-exempt organizations required to file [990s] are affected by these regulations."

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New Form 8940 for Miscellaneous Exempt Organizations Determination Requests

Posted on August 14, 2011 by Christopher T. Bird

 The IRS released a new form last week for tax-exempt organizations to request determinations about their tax-exempt status (other than an initial application for exemption). There was previously no form for making such requests. The one-page Form 8940 , Request for Miscellaneous Determination, can be used to make a request for:

  • advance approval of private foundation scholarship procedures;
  • advance approval of certain private foundation set-asides;
  • advance approval of private foundation voter registration activities;
  •  exemption from Form 990 filing requirements;
  • advance approval that a potential grant or contribution constitutes an "unusual grant" excluded from certain public support calculations;
  • change in type (or initial determination of type) of a Code Section 509(a)(3) supporting organization;
  • reclassification of foundation status, including a voluntary request from a public charity for private foundation status;
  • termination of private foundation status under Code Section 507(b)(1)(B)　(advance ruling request); and
  • termination of private foundation status under Code Section 507(b)(1)(B)　(60-month period ended).
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IRS Releases New FAQ Guidance on Reporting Governance Practices on Form 990

Posted on June 29, 2011 by Kathleen E. Gerber

                 The IRS recently released a new list of FAQ and tips for Part VI of Form 990, which requires an exempt organization to provide certain information about its governing board and management, as well as its governance policies and disclosure practices. 

               Of particular interest is the clarification that questions in Section B (about whether an exempt organization has adopted certain governance policies such as a written conflict of interest policy and a written whistleblower policy) may be answered affirmatively if a committee of the board with the power to do so has approved such policies by the close of the tax year. This should come as welcome news to those exempt organizations that reacted negatively to a 2010 revision to the instructions, which stated that an organization should only answer yes to these questions if its entire governing board adopted the policies. Some exempt organizations complained that requiring full board approval was in contrast to their usual practice of delegating the authority to adopt such policies to a committee of the governing board. An IRS official indicated earlier this week that in addition to making this point clear in the new FAQ, the IRS will be revising the 2011 instructions to Form 990 accordingly. 

 

Some of the other key points of guidance in the new FAQ are highlighted below:

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URGENT: Treasury Must Receive FBAR Filings by June 30 - for Most Filers

Posted on June 27, 2011 by Amanda Nussbaum, Robert Projansky, Pamela Onufer

As reported in our prior blog entry, the Report of Foreign Bank and Financial Accounts, Form TD-F 90-22.1 (“FBAR”) must be filed by a U.S. person that holds a financial interest in, or signature or other authority over, a foreign financial account if the aggregate value of all such U.S. person’s foreign financial accounts exceeds $10,000 at any time during the year. These reporting requirements apply to a tax-exempt organization even if the organization is not required to file an annual return on Form 990.  

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275,000 Nonprofits Lose Tax-Exempt Status

Posted on June 20, 2011 by Christopher T. Bird

The IRS announced June 8, 2011 that approximately 275,000 organizations lost their tax-exempt status because they did not file annual returns for three consecutive years.  The IRS has published on its website separate lists of affected organizations for each state; OpenData also provides on its website a searchable combined list.

While Section 6033(a) of the Tax Code requires most tax-exempt organizations to file annual information returns, the Pension Protection Act of 2006 imposed a filing requirement on small organizations for the first time in 2007.  Despite the IRS’s information campaign over the last several years, it appears many organizations nevertheless remained unaware of their filing obligations and that, under Code Section 6033(j), organizations will lose their exempt status if they do not file for three consecutive years. 

 

 

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Type II Supporting Organizations Must Have Readily Identifiable Beneficiaries

Posted on May 11, 2011 by Jacob I. Friedman

In a tightly written plain English opinion, the D.C. Circuit Court of Appeals in Polm Family Foundation v. U.S.  explained an important requirement of Type II supporting organizations.

To be a Type II supporting organization, a charity must satisfy three tests:

 

1.                  the organizational test set forth in IRC Section 509(a)(3)(A),

2.                  the relationship test set forth in IRC Section 509(a)(3)(B)(ii), and

3.                  the control test set forth in IRC Section 509(a)(3)(C).

While the district court  concluded that the charity failed both the relationship test and the control test, the Court of Appeals based its decision on the failure to satisfy the organizational test. The Court said that this test was the most straightforward. 

 

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IRS Warns that Fringe Benefits Trigger Intermediate Sanctions

Posted on May 3, 2011 by Kathleen E. Gerber

               At a recent conference on nonprofit governance sponsored by Georgetown Law Center, an IRS official stated that fringe benefits have become the most common trigger of intermediate sanctions under Section 4958 of the Code. 

As most of you know, or should know, Section 4958 of the Code, enacted in 1996, imposes excise taxes on both “disqualified persons” who receive an “excess benefit” from an exempt organization and any organization manager who knowingly participates in an excess benefit transaction. 

When an economic benefit is not treated as compensation by the organization, the benefit is presumed to constitute an excess benefit transaction in its entirety, unless the disqualified person can establish that it was properly excludable from income for income tax purposes, or involved a legitimate non-compensatory transaction with the organization. 

In February of 2010, the IRS began its first Employment Tax National Research Project in 25 years. This three-year “study” focuses on uncollected taxes in the area of employment for both taxable and exempt entities. As part of this study, 2,000 taxpayers are being selected each year for a comprehensive audit. Fringe benefits are one of the main areas of focus in these audits, making this a priority issue for the IRS.

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Charity Loses Tax Exemption Because of Private Inurement - Is Your Charity Immune?

Posted on April 7, 2011 by A. Nicole Spooner

In PLR 20113041, the IRS revoked the tax exemption of a public charity based on excess benefit and private inurement issues.  This ruling highlights practices that charities should avoid in order to maintain their tax-exempt status.

The charity's primary purpose was to pursue the study of how the interaction of land use, disturbance, and climate impact the structure and biodiversity of a particular region, and publish papers relating to such study.  The charity had only one staff member who also functioned as the President.  The charity's governing board consisted of three immediate family members - the President, his father (Vice President), and his wife (Secretary/Treasurer).

The IRS noted that the President had no employment contract with the charity and the charity itself had no Conflict of Interest Policy in place to determine how any conflicts, potential or actual, would be addressed.

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Attorney General Issues Guide on the New York Prudent Management of Institutional Funds Act

Posted on March 25, 2011 by Yafang Deng

           On March 17, 2011, the New York State Attorney General’s Charities Bureau published “A Practical Guide to the New York Prudent Management of Institutional Funds Act” (the “Guide”).  The Guide provides a summary of the New York Prudent Management of Institutional Funds Act (“NYPMIFA”) as well as practical guidance on its application. Although the Guide is not an official regulation, since the Charities Bureau is tasked with enforcement of NYPMIFA, not-for-profit institutions are well advised to take this guidance into serious consideration.           

            As we have previously reported, NYPMIFA was enacted into law on September 17, 2010. It updates the Uniform Management of Institutional Funds Act, which had governed charitable endowment funds since 1978, with New York’s unique version of the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”). By doing so, New York became the forty-seventh state to have enacted a version of UPMIFA.   

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