Correction of Plan Errors

Final Internal Revenue Code Section 403(b) regulations which became effective January 1, 2009 require that plan sponsors adopt written 403(b) Plan documents.  A 403(b) Plan is a form of defined contribution retirement plan that may only be offered by employers that are tax-exempt entities under Section 501(c)(3) of the Internal Revenue Code or that are public educational organizations and for the benefit of certain clergy members.  If a 403(b) Plan sponsor did not adopt a written plan document by December 31, 2009, the sponsor’s 403(b) plan is technically no longer considered to be a qualified tax-deferred retirement plan as of January 1, 2009.  The benefit of correcting the written document failure is that all money that has been contributed to the 403(b) Plan will remain tax-deferred and that all investments under the 403(b) Plan will retain their tax-favored status.

To help 403(b) Plan sponsors voluntarily correct any plan document errors, the IRS recently updated its Employee Plans Compliance Resolutions System (referred to as EPCRS).  Plan document errors are cured through the voluntary correction program (referred to as VCP) by having the 403(b) Plan sponsor adopt a written plan document that complies with the final regulations, make a VCP submission, and pay a compliance fee based on the number of employees eligible to participate in the 403(b) Plan.  To simplify this procedure, the IRS has made available a 403(b) VCP Submission Kit, and to encourage 403(b) Plan sponsors to take advantage of this program, the IRS has reduced the compliance fee by 50% if the VCP filing is made by December 31, 2013.

IRS Exempt Organizations group has sent out more than 1,300 questionnaires to self-declared Section 501(c)(4) social welfare organizations; 501(c)(5) labor, agricultural or horticultural organizations; or 501(c)(6) business leagues.  The questionnaires are part of IRS efforts to increase voluntary compliance, learn more about self-declared exempt organizations, and determine whether self-declared exempt organizations are complying with applicable tax-exempt law.  The questionnaires are directed to organizations that are not recognized by the IRS as tax-exempt, but claim exemption under Section 501(c)(4), (5) or (6) and filed a Form 990 for tax years beginning in 2010 or 2011.  Unlike most Section 501(c)(3) organizations, these types of exempt organizations are not required to apply to the IRS for recognition of exemption.

Note:  This article is a recap of Lesley Rosenthal’s presentation at Proskauer’s 17th Annual Trick or Treat Tax Exempt Seminar, November 29, 2012

Attorneys can reap enormous rewards by serving on nonprofit boards.  Lawyers derive tremendous personal satisfaction in governing an organization that is meaningful to them.  They can do the public good by participating in a charity that feeds the poor, heals the sick, enlightens through culture and education, or preserves the environment.

Nonprofit board service is prestigious, and invaluable for professional networking.  It is also a great remedy for the ennui that sometimes sets in when lawyers work inside big law firms, corporate departments or government agencies, and a cure for the isolation of solo or small-firm practice.  A lawyer who serves as a nonprofit trustee is likely to quickly become a trusted and valued member of the team, whose individual contributions markedly enhance a worthwhile enterprise.

At the end of January, 2013, the IRS Exempt Organizations Group (“EO”) released its annual report, highlighting EO’s 2012 accomplishments and outlining its priorities for 2013.  This year’s report was significantly more detailed and informative than last year’s report and workplan.  Some accomplishments and priorities of interest are described below, with something for nearly everyone in the tax-exempt sector.

2012 Highlights:

  • Exchange of Information with States.  EO continued to see an increase in the number of referrals from state charity regulators and tax agencies regarding potential exempt organization tax law violations.  In FY 2011, EO received 104 referrals from 19 different states.  Some of the most common issues that are referred to the IRS from the charity regulators involve private benefits and inurement, nonfilers, political activities by § 501(c)(3) organizations, employment tax issues and organizations not operated as required by their exempt status.  Conversely, under recently expanded authority, the IRS is allowed to disclose to certain state charity regulators significantly more information about exempt organizations, including proposed and final revocations of tax exemption for § 501(c)(3) organizations, proposed and final notices of deficiency for Chapter 42 excise taxes, § 501(c)(3) exempt organizations applications in process and proposed or final denials of these applications.  At present, only eight state tax and charity agencies in seven states have met the requirements to receive these disclosures; nonetheless, these agencies received approximately 27,000 disclosures in FY 2011.
  • Hospital Community Benefit Reviews.  As we have previously noted, EO is required under the Affordable Care Act to review the community benefit activities of all tax-exempt hospitals every three years.  This work continued in the past year.  EO will use the information from the reviews for research, reporting and compliance purposes, as well as to identify areas where additional guidance, education or Form 990 changes are needed.

The IRS continues to implement the “three years and you’re out” rule for Form 990 non-filers added by the Pension Protection Act of 2006 (the “PPA”).  That legislation amended Section 6033 of the Internal Revenue Code to provide that exempt organizations required to file a Form 990-series return (i.e., a Form 990, Form 990-EZ or Form 990-N) that do not file the return for three consecutive years will have their tax-exempt status automatically revoked going forward.  Organizations subject to automatic revocation are required to file exemption applications with the IRS to regain exempt status, even if they were not originally required to file an application for recognition of exempt status.  Further, exempt status will not be restored retroactively unless the IRS finds there was reasonable cause for the failure to file.

Many practitioners have been anxious to leaf through regulations to confidently determine whether an organization is a “functionally integrated” or “non-functionally integrated” Type III supporting organization, and the implications of either classification.

On December 28, 2012, the Internal Revenue Service released the long-awaited final regulations for Type III supporting organizations, as well as temporary regulations addressing annual distribution requirements.  The text of the temporary regulations also serves as the text of the proposed regulations.  The final regulations describe all of the other requirements (outside of the annual distribution requirement explained below) of a Type III supporting organization’s relationship with its supported organization.

The American Taxpayer Relief Act of 2012 (“TRA”) (H.R. 8) passed by the Senate on January 1, 2013, passed by the House of Representatives early on January 2, 2013 and signed by President Obama, in large part addresses income and other tax rates without direct effect on tax-exempt organizations. Several provisions, however, will be of interest to tax-exempt organizations: the extension of several incentives to make certain charitable donations; the return of deduction limitations for certain individuals, including the charitable deduction; the absence of new limitations on tax-exempt financing; and the end of grants and loans to co-op nonprofit insurers exempt under the new provisions of Section 501(c)(29) of the Internal Revenue Code.

Two new bills recently introduced in the California State Legislature would increase the disclosure requirements applicable to certain nonprofit organizations participating in California political campaigns and would strengthen the enforcement authority of the California Fair Political Practices Commission.  Under current California regulations that went into effect this past May, nonprofit organizations such as Section 501(c)(6) trade associations, Section 501(c)(4) social welfare organizations and Section 501(c)(3) charities are already required to disclose the identity of any donor making a contribution of $100 or more within the reporting period who requests or knows that the organization will use the donor’s payment to make a contribution or independent expenditure to support or oppose a candidate or ballot measure in California.  If the donor knows or has reason to know that only a portion of the donor’s payment will be used to make such contribution or independent expenditure, the payment is apportioned on a reasonable basis in order to determine the amount of the contribution.  Both of the two recently introduced bills, Senate Bill 3 and Assembly Bill 45, would codify this relatively new regulation.

New York Attorney General Eric T. Schneiderman has issued proposed regulations that would require many nonprofit organizations to annually disclose certain information about their political spending and their donors’ identities.  According to the Attorney General, the proposed regulations are in response to nonprofit organizations, in particular Section 501(c)(4) social welfare organizations, that have engaged in political campaign activity and do not disclose their sources of funding.  While Section 527 organizations are required to publicly disclose certain information relating to their political expenditures and their donors’ identities, other nonprofit organizations are generally exempt from such reporting requirements.