Tax-Exempt Organizations Update

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Brittney Washington
6 years ago
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1 Tax-Exempt Organizations Update Katherine E. ( Katy ) David katy.david@strasburger.com R. Bradley Fletcher brad.fletcher@strasburger.com Rev. Proc Provides Procedures for Reinstatement of Tax-Exempt Status Following Automatic Revocation Permits streamlined retroactive reinstatement for small organizations (Form 990-EZ and Form 990-N filers) that have not had exempt status revoked previously, if requested within 15 months of revocation. 1

2 Rev. Proc Provides Procedures for Reinstatement of Tax-Exempt Status Following Automatic Revocation Permits retroactive reinstatement for organizations that do not qualify for streamlined retroactive reinstatement if requested within 15 months of revocation (requires reasonable cause for failure to file in any one year). Rev. Proc Provides Procedures for Reinstatement of Tax-Exempt Status Following Automatic Revocation Permits retroactive reinstatement if requested after 15 months of revocation (requires reasonable cause for failure to file for all three years). 2

3 Rev. Proc Provides Procedures for Reinstatement of Tax-Exempt Status Following Automatic Revocation Abates failure-to-file penalties where reinstatement is retroactive. Affirms that organizations may continue to apply for reinstatement from date of postmark of reinstatement request. New Form 1023-EZ: Streamlined Application for Exemption Under I.R.C. 501(c)(3) Available for domestic organizations with: Annual gross receipts of $50,000 or less, for past three years and projected for next three years Total assets of $250,000 or less Not available for churches, conventions or associations of churches, schools, colleges, universities, hospitals, supporting organizations, private operating foundations, and certain other excluded organizations. 3

4 New Form 1023-EZ: Streamlined Application for Exemption Under I.R.C. 501(c)(3) Can be used to apply for reinstatement following automatic revocation by: Small organizations ( Form 990-EZ and 990-N filers) requesting retroactive reinstatement within 15 months of revocation; Organizations seeking reinstatement by postmark date of reinstatement request. Cannot be used to apply for: Retroactive reinstatement by Form 990 filers; Retroactive reinstatement after 15 months following revocation. New Form 1023-EZ: Streamlined Application for Exemption Under I.R.C. 501(c)(3) Benefits: Shorter and less burdensome than Form Permits faster processing of exemption applications. Efficiency of Form 1023-EZ expected to help IRS reduce the backlog from 60,000 cases to 30,000 cases and process all exemption applications within six months of receipt. 4

5 New Form 1023-EZ: Streamlined Application for Exemption Under I.R.C. 501(c)(3) Drawbacks: Does little to encourage applicant organizations to think through their plans or understand the responsibility associated with taxexempt status. Relies on certification regarding organizational and operational provisions in organizing documents and does not require documents to be attached for IRS verification. Reduces the amount of information available to donors and the general public. Eliminates scrutiny that state taxing authorities rely on when premising state tax exemptions on federal exemption. Reflects IRS s shift of resources from front-end compliance to backend enforcement. IRS Colleges and Universities Compliance Project Resulted in more than $170 million in losses and NOLs due to: computational errors; lack of profit motive; improper expense allocations; unrelated activities classified as exempt or excluded. IRS disagreed with approximately 40% of organizations that got outside opinions on unrelated business activities. Major areas of disagreement include fitness/rec centers, sports camps, golf courses, advertising, arenas. 5

6 Current UBIT Initiative IRS is examining a sample of organizations that have significant gross unrelated business income but no taxable income. May occur where: Activity without a profit motive generates losses that are used to offset unrelated business taxable income from other activities; Expenses are improperly allocated. Current UBIT Initiative No Profit Motive Continual losses may result where: a business is in start-up phase; where actual costs exceed anticipated budget; where business cycle is in a downturn or wind-down phase. Absent special circumstances, however, IRS will disallow losses from activities with continual losses. Organizations should carefully document reasons why an unprofitable activity is expected to turn around. 6

7 Current UBIT Initiative Improper Expense Allocations Expenses from related activities cannot be used to offset unrelated business income. Allocation of expenses that support related and unrelated activities must be reasonable. Expenses must be deductible for tax purposes (e.g., 50% of meals and entertainment expenses). IRS Considers Governance Relevant to Tax-Exempt Status Small, Family-Controlled Board An organization with a small governing body controlled by its founders may qualify for exemption. A board of three or four family members, standing alone, is not enough to deny exemption (PLR ), but the organization needs to be open and candid (PLR ). An organization controlled by related individuals creates an obvious opportunity for abuse and calls for an open and candid disclosure of [the] organization and operations." (PLR ) 7

8 IRS Considers Governance Relevant to Tax-Exempt Status Lifetime Board Positions Lifetime appointments may justify denial of exempt status because they create potential for private inurement (PLR ) and private benefit (PLR ). IRS Considers Governance Relevant to Tax-Exempt Status Director and Officer Qualifications IRS disparaged qualifications of applicant organization s director. (PLR ) President of conservation easement donee organization held to "not possess the knowledge, training or experience to make educated decisions on whether each conservation easement serves a conservation purpose." (PLR ) 8

9 Lack of Activity An organization s tax-exempt status may be revoked for failure to satisfy the operational test of I.R.C. 501(c)(3) where the organization is dormant. (e.g., PLR ; PLRs ; ; PLR ). I.R.C. 501(c)(4) Controversy Continued Developments IRS offers optional expedited process for organizations that had exemption applications pending for 120 or more days since filing as of May 28,

10 Expedited Processing To receive expedited processing, organization must represent, under penalties of perjury, that it will spend 60% or more of its time and expenses on activities that promote social welfare and will not spend more than 40% of its time and expenses on direct or indirect intervention in any political campaign in favor of or in opposition to any candidate for public office. Standard is a safe harbor and is stricter than otherwise applicable facts-and-circumstances inquiry. TE/GE has consolidated into one document prior memoranda on optional expedited process. TEGE (July 28, 2014). I.R.C. 501(c)(4) Controversy Continued Developments Proposed regulations governing political activity of I.R.C. 501(c)(4) organizations released in November Over 150,000 written comments, expressing near universal dislike of proposed regulations, were received. This reflects the most comments ever received by Treasury and IRS on a proposed tax regulation. In May 2014, IRS announced that it will abandon the original proposed regulations and publish revised proposed regulations. 10

11 National Labor Relations Board Northwestern University Ruling In March 2014, a regional office of the National Labor Relations Board ( NLRB ) ruled that college athletes who receive athletic scholarships to play football at Northwestern University are employees under the National Labor Relations Act and thus are allowed to unionize. Implicit in the ruling is the notion that scholarship payments are compensation for the services athletes render by participating in the University s lucrative football program. National Labor Relations Board Northwestern University Ruling NLRB ruling is not binding on IRS, but IRS uses same common law test for employment relationship. On same facts, IRS could find that athletic scholarships are compensation for services. In such case, student athletes have taxable income, payors have reporting and withholding obligations and employment tax liability, and scholarships paid by private foundations may become taxable expenditures. 11

12 National Labor Relations Board Northwestern University Ruling Commissioner Koskinen affirmed the long-standing IRS position that athletic scholarships can be considered qualified scholarships. National Labor Relations Board Northwestern University Ruling The IRS position is based on a 1977 revenue ruling, which addresses the tax treatment of athletic scholarships where: The scholarship does not exceed expenses for tuition, fees, room, board, and necessary supplies; The university expects, but does not require the student to participate in a particular sport; The university requires no particular activity in lieu of participation in the sport; and The scholarship is not cancelled for a particular academic year if the student opts not to participate in the sport or is unable to participate due to injury during the year. In such cases, the IRS takes the position that although students who receive athletic scholarships do so because of their special abilities in a particular sport, the athletic scholarships are awarded primarily to aid the recipients in pursuing their studies. 12

13 National Labor Relations Board Northwestern University Ruling Changes in college athletic landscape since 1978 may prompt IRS to revisit issue. The changes to NCAA scholarship rules (as well as the changed landscape of college sports) affect the technical (and policy) underpinnings of Rev. Rul and provide a basis upon which the IRS could reverse its long-standing position. QUESTIONS/DISCUSSION SPSA/

14 Disclaimers This document is not intended to provide advice on any specific legal matter or factual situation, and should not be relied upon without consultation with qualified professional advisors. Any tax advice contained in this document and any attachments was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under applicable tax laws, or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter. 14

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