UBI: What are the IRS and States Up To? April 13, 2017

Transcription

1 UBI: What are the IRS and States Up To? April 13, 2017 Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International.

2 Discussion Topics > Overview of Unrelated Business Income > IRS Audit Activity IRS 2016 Compliance Activity Results > Form 990 Audit Triggers > State and Local Government Attack on Charities > IRS Priorities

3 Overview of Unrelated Business Income 2

4 UBIT s Reach > UBIT rules were designed to level the playing field when an exempt organization conducts a trade or business on a regular basis but cannot demonstrate that the trade or business has a substantial relationship (other than generating income) to the organization s exempt purpose 3

5 Implications of UBIT > All organizations described in 401(a) and 501(c) > Exception: 501(c)(1) organizations: Organized under Act of Congress which is an instrumentality of the U.S. & exempt from Federal income taxes, includes U.S. Territories or possessions, any state, and DC Churches have been subject to UBIT since

6 Statutory Framework of UBIT > An activity will be subject to unrelated business income tax if it meets ALL three requirements*: Trade or Business; Regularly carried on; and Not substantially related to the exempt purpose of the organization *and there are no statutory exclusions available 5

7 Statutory Framework of UBIT > Trade or Business Same meaning as under IRC Section 162 Generally, includes activity carried on for the production of income from sale of goods or services Trade or business identity is NOT lost because activity takes place within the context of exempt operations > (e.g. catering department sales could include a related and an unrelated component) 6

8 Statutory Framework of UBIT > Regularly Carried On Frequency and Continuity of activity given particular consideration Viewed with regard to a similar activity in a for-profit context One-time, annual or intermittent activity does not rise to regularly carried on status > Operation of a snack stand every day for two weeks at the State Fair is generally deemed a casual sale and is NOT considered regularly carried on 7

9 Statutory Framework of UBIT > Not substantially related There must be a causal relationship between the activity and the accomplishment of the organization s tax-exempt purpose Income producing activity MUST contribute importantly to the exempt purpose Production of income (e.g. fundraising) that is used for taxexempt purposes is NOT automatically a related activity 8

10 Statutory Framework of UBIT > Common Statutory Exclusions Activities substantially performed by volunteers Activities carried on primarily for the convenience of students, patients, residents, employees, visitors Sale of merchandise substantially all of which was donated Passive income sources (interest, dividends, gain, rents, royalties) Income from debt-financed facility where substantially all of the facility used for exempt purposes 9

11 Statutory Framework of UBIT > Passive Income (interest, dividends, gain, rents, royalties) things to watch for Debt-financed property Passive income from related party Active royalties Rent provision of substantial services that aren t customary Rent rental of personal property Gain depreciation recapture, gains on debt-financed property 10

12 UBI General > Form 990-T general topics Method of accounting for expense allocations Tax rate Tax Credits Alternative Minimum Tax Consolidated returns not permitted Tax Bracket Allocation requirement for component members of a controlled group of corporations (Section 1561) Net operating losses 11

13 UBI Things to watch for > New sources of revenue > Expansion of programs > Debt financed income > Related party activities > Corporate sponsorship payments > Website content > Investment partnerships > S Corporation ownership > Foreign reporting requirements 12

14 Strategies to Minimize UBIT > Take a fresh look at your trial balance particularly at the other revenue detail > Analyze the activity > Document the basis for any conclusions > Research areas of exposure 13

15 Form 990 Audit Activity 14

16 Exempt Organizations (EO) FY 2016 Compliance > FY 2016 Compliance Results (general breakdown by primary issues examined) Primary Issue Area Total Filing, Organizational, Operational 2,109 Discontinued Operations Modifications/Revocation 195 Inurement/Private Benefit 192 Political, Legislative, Governance 59 Unrelated Business Income 611 Employment Tax Issues 1323 Other 495 Total 4,984 15

17 IRS Audit Activity > Increase in audit activity of tax-exempt organizations over past 24 months > IRS audits have generally fallen into three categories: General compliance and worker classification Comprehensive reviews, UBI, compensation, employee benefit plans, and fringe benefits Hospital compliance with ACA reporting requirements 16

18 Exempt Organizations (EO) FY 2016 Compliance > Employment Tax Gap Examination: Review of Forms 941 and 990 > Deferred Compensation Audit of Worker Classification Compliance > Employee versus Independent Contractor analysis > Review of Forms 1099 > Review of Form W-9 file Required for all vendors Backup withholding compliance 17

19 Exempt Organizations (EO) Examinations > 2014 Treasury Inspector General report revealed pockets of payroll noncompliance Approx. 3.8% (62,400) had some current tax delinquency 1,200 organizations owed more than $100,000 in federal tax Report recommended the IRS & Treasury draft enforcement legislation for tax-exempt organization compliance with payroll/other underreported taxes > Don t wait to be caught - review payroll tax collection and reporting procedures to mitigate any adjustments related to these issues interest and penalties accrue! 18

20 IRS Audit Activity > Unrelated Business Income Tax Gap Examination: Review of Revenue Sources on Form 990 > Rental Activity/Use of Facilities > Advertising Versus Sponsorship Income > Parking > Catering > Sale of Merchandise and Publications > Partnership/Alternative Investment Activity > Other or Miscellaneous income > Expense allocations Review of loss activities 19

21 IRS Audit Activity > Fringe benefits Is there an accountable plan in place? Is expense substantiation sufficient? What fringe benefits were provided to employees? Review loans, deferred comp, meals/housing, no cost services (especially for officers and key employees) > Employee benefits Review personnel manual/handbook Review policy for employer-owned vehicles Review of other policies (e.g., tuition, life insurance) 20

22 Exempt Organizations (EO) FY 2016 Compliance > EO Final Revocations of exempt status of NFP entities (as of June 30, 2016): Not operating for an exempt purpose - 28 Inurement - 6 Other - 6 Self-declared disqualification of exempt status

23 Form 990 Audit Triggers 22

24 Form 990 Audit Triggers > Board member independence > Compliance and governance > Compensation > Lobbying and political activities > Foreign activity > Tax-exempt bonds 23

25 IRS Activity IRS Data Mining Data mining with respect to responses on Form 990 Form 990 allows for comparability of answers IRS can select from both sides of the Bell Curve Audits are issue specific, but can expand if IRS has findings Allows for more, shorter audits TNT Oct. 5, 2015 IRS will begin publishing select information from Forms 990 for public research and inspection starting Jan. 1, 2016 this is happening 24

26 Board member independence > No mandatory requirement for all board members to be independent > However, number of board members lacking independence raises red flag > Should be representative of the community 25

27 Compliance and governance > Governance Policies not required by Internal Revenue Code, but IRS strongly recommends as best practice Generally improve tax compliance Absence can lead to excess benefit transactions, private inurement, or activities inconsistent with exempt purpose Absence of recommended policies raises red flag 26

28 Compensation > Does the organization s process for determining compensation of officers/key employees meet the Rebuttable Presumption Of Reasonableness? Is comparable salary information used? Are the board members charged with setting compensation independent? Are the compensation deliberations/decisions documented? > Excessive compensation = excess benefit transaction 27

29 Financial information > Form 990-T filings Do you even file a Form 990T? Do you have any activities that consistently report net losses? How does your reporting compare to your peers? 28

30 Lobbying and political activities > Political Activity Prohibited by a public charity Permitted for some other non-profits > Lobbying Activity Public charity can engage in insubstantial lobbying Other non profits (trade associations, etc. have greater flexibility) Media attention may alert IRS of possible political activities 29

31 Political Activity Potential Changes > Repeal of the Johnson Amendment President Trump vowed to get rid of this restriction 1954 legislation prohibiting churches and other nonprofit organizations from directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for elective public office 30

32 Foreign activity > Possible foreign activity triggers Do you have employees working or traveling outside the U.S.? Did you make any payments outside the U.S.? Do you have investments in any foreign entity? Are there any media reports of your organization working with foreign organizations? Does the website discuss foreign operations, joint ventures with foreign organizations, etc.? 31

33 Tax exempt bonds > Private Use > Rebate obligations > Written procedures for post-bond issuance compliance IRS will intensely scrutinize organizations that do not have these policies in place 32

34 IRS Scams > IRS scams are increasing in frequency and getting more sophisticated > Have you or someone you know received an or voic purported to be from the IRS? > How about a letter from the IRS that turned-out to be a scam? 33

35 State and Local Government Attack on Charities 34

36 Non-Profits in the News 35

37 Non-Profits in the News Property Tax Exemption Denied June 30, 2015 a NJ court denied appeal of Morristown Medical Center of its property tax exemption The judge stated that if nonprofit hospitals operate like this one modern non-profit hospitals are essentially legal fictions. > Substantial loans, capital and subsidies to for-profit entities including physician groups > Salaries of top executives and physicians Decision based upon operating structure, not community benefit or charity care 36

38 Non-Profits in the News Other examples Princeton University just settled a lawsuit brought by a small group of local residents that challenged its property tax exemption. Other recent examples include Provena Medical Center (Illinois) 37

39 Non-Profits in the News California Study - No Difference Between Nonprofit and For-profit Hospitals > Recent report of uncompensated care at for-profit and nonprofit California hospitals show no difference in charity care between the non-profit and for-profit hospitals > Study found a similar level of operational expenses devoted to charity care > In March 2015, Blue Shield of California lost its tax exempt status > Watchdog groups urge similar approach by other states across the country 38

40 Other State Tax Issues > Registration in all states in which fundraising is conducted > Alternative investments / UBI (K-1s received for activity in states) > Sales and use tax issues > Real estate tax > Unclaimed property 39

41 IRS Priorities

42 Exempt Organizations (EO) FY 2017 Priorities Guidance Plan > Five Strategic Issue Areas Exemption: Issues include non-exempt purpose activity and private inurement Protection of assets: Issues include self-dealing, excess benefit transactions, and loans to disqualified persons Tax Gap: Issues include employment tax and unrelated business income tax liability International: Issues include oversight on funds spent outside the U.S., exempt organizations operating as foreign conduits, and FBAR requirements Emerging Issues: Issues include non-exempt charitable trusts and IRC 501(r) 41

43 Questions? 42

44 Contact Information > Jane Williams, former Director of Reporting & Compliance/ Controller > The Science Museum of Minnesota > Larry Mohr, Partner > Baker Tilly Virchow Krause, LLP 43