Diara M. Holmes Michael W. Durham. Caplin & Drysdale, Chartered

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1 Diara M. Holmes Michael W. Durham Caplin & Drysdale, Chartered

2 Education J.D., cum laude, Harvard Law School, 1998 M.P.P., Harvard University's John F. Kennedy School of Government, 1994 B.A., University of Pennsylvania, 1992 Bar and Court Admissions District of Columbia California (inactive) New York (inactive) Diara M. Holmes is a member of Caplin & Drysdale, practicing in its Exempt Organizations group since She advises a broad range of nonprofit organizations including colleges and universities, U.S. affiliates of foreign charities, churches, trade associations and large public charities on both tax planning and tax controversy matters. She has represented prominent organizations before the IRS in private letter ruling requests and complex audits involving a range of issues -- including lobbying, alleged campaign intervention, executive compensation, UBIT, private foundation excise taxes, and structuring transactions. 2

3 Education J.D., Yale Law School, 2002 M.A., Yale University, 2001 B.A., Brigham Young University, 1997, summa cum laude Bar and Court Admissions District of Columbia District of Columbia Court of Appeals Michael W. Durham is a member of Caplin & Drysdale, practicing in its Exempt Organizations group since Michael regularly advises clients on the tax laws governing nonprofit advocacy organizations, particularly those affecting political speech and lobbying. Other areas of focus include the rules governing private foundations, grantmaking, international tax rules applicable to U.S. charities, religious organizations, and complex structures among affiliated entities. In addition to his tax planning and advising work, he represents clients before the IRS and has written extensive comments to Treasury and Congress regarding various issues of concern to his clients. 3

4 Exempt Organizations 2013 in Review and Looking Ahead to FY 2014 Guidance from Treasury and IRS OMB Guidance re Grants Noteworthy State Nonprofit Law Developments (MA and NY) Noteworthy Case 4

5 The 2013 Exemption Application Controversy IRS announcement The TIGTA Report Hearings Investigations Administrative response 5

6 The Statute (1913) provides for exemption for organizations not organized for profit but operated exclusively for the promotion of social welfare. 6

7 Current Regulations (adopted 1959) An organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. An organization embraced within this section is one which is operated primarily for the purpose of bringing about civic betterments and social improvements. The promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office. 7

8 Revenue Ruling (1981) When an organization s primary activities promote social welfare, its lawful participation or intervention in political campaigns on behalf of or in opposition to candidates for public office will not adversely affect its exempt status under section 501(c)(4). 8

9 On Nov. 26, IRS and Treasury published Prop. Regs. addressing certain requirements for qualifying for exemption as a social welfare organization under IRC section 501(c)(4). Proposal would amend 501(c)(4) regulations to replace the reference to political campaign intervention with a new term candidate-related political activity and specifies that such activity does not promote social welfare. Definition of CRPA imports key concepts from FEC rules and IRC section 527. Comments on the proposed rules are due by Feb. 27,

10 Proposal takes a bright line approach. The drafters acknowledge that: the approach taken in these proposed regulations, while clearer, may be both more restrictive and more permissive than the current approach, but believe the proposed approach is justified by the need to provide greater certainty to section 501(c)(4) organizations regarding their activities and reduce the need for fact-intensive determinations. 10

11 Voter-registration drives. Get-out-the-vote ( GOTV ) drives. Voter guides. Advocating for or against the appointment or confirmation of executive-branch officials or judicial nominees. 11

12 Public communications referring to a candidate (or party) close in time to an election. Within 30 days of a primary, any public communication referring to one or more clearly identified candidates. Within 60 days of a general election, any public communication referring to one or more clearly-identified candidates one or more political parties in that election Suggestion of more protection outside these windows Candidate can be clearly identified in several ways, even by reference to a distinguishing issue or characteristic. 12

13 Public communications referring to a candidate (or party) close in time to an election. A public communication is defined broadly to include a communication by whatever means, including broadcast, Web site, publications, advertising, or a communication that reaches, or is intended to reach, more than 500 persons. Similar to FEC electioneering communications, but applies more broadly. 13

14 Hosting or conducting an event within 30 days of primary or within 60 days of general election at which one or more candidates in such election appears as part of the program For example, traditional candidate forums and debates. 14

15 Grants Any grant or contribution to a 527 Any grant or contribution to a 501(c) that engages in candidate-related political activities UNLESS it represents that it does not engage in such activities, and the grant is subject to a prohibition on use in such activities Includes non-fair-market exchanges Does this mean no grants to 501(c)(3) affiliates that conduct permissible, nonpartisan activities? 15

16 Election-law expenditures or contributions Any other expenditure reportable to the FEC Any contribution, loan, or deposit that under applicable law is treated as a campaign contribution to a candidate (including in-kind gifts) 16

17 Organization s activities include those: paid for by the organization conducted by an officer, director, or employee acting in that capacity, or conducted by volunteers acting under the organization s direction or supervision Communications include: anything published by the organization in an official publication anything posted by the organization on its website anything that is part of the program at an official function of the organization communications by employees, volunteers, or other representatives who are not officers and directors, but only to the extent such person is authorized to communicate on behalf of the organization 17

18 Citing criticism of the primarily standard, Treasury and the IRS request comments on these threshold issues: What proportion of an organization s activities must promote social welfare? How should those activities be measured (time, expenditures, revenue)? Should additional limits should be imposed on any non-social-welfare activities? 18

19 Should the proposed definitions be extended to 501(c)(3) organizations, either as they are or as a safe harbor/presumption? 501(c)(5) and 501(c)(6) organizations? the definition of exempt function expenditures under section 527 and/or the section 527(f) tax? What about attribution via hyperlinks or third-party comments posted on a website? Should there be other permitted activities, and if so, how can they be drafted to avoid fact-intensive analysis? 19

20 Activity Old Treatment New Proposed Treatment Voter Registration, GOTV Voter Guide Hosting an event at which a candidate appears Issue advocacy communications Grants Political if biased or selective on the basis of individual ideology Political if biased or perhaps if focused on a narrow range of issues OK if no mention of candidacy and there is a non-electoral reason for appearance, or if all candidates have equal opportunity All the facts and circumstances determine whether they are political; express advocacy not required, but even within the 30- or 60 day window, it is sometimes possible to maintain ongoing issue advocacy or influence a legislative vote during the window, even if a candidate is mentioned. Grants to 527s probably political; others less clear. (candidates include only elected officials) 20 Automatically political Automatically political if it references a clearly defined candidate or (in the general election) a political party Automatically political within 30 days before candidate s primary, 60 days before general election Automatically political if there is express advocacy or there is no other reasonable interpretation; within 30- or 60-day window, public communications referring to a clearly defined candidate (or, in the general election, a political party) are political, as is any expenditure reportable to the FEC. Any grant to a 501(c) that does any candidaterelated political activities is political; exception if grantee represents it doesn t do any and there is an agreement not to use the money for such purposes. (candidates include others such as appointed, selected, and nominated officials such as judges)

21 Section 501(r) imposes a variety of new requirements for exemption on hospitals Community health needs assessments every 3 years Financial assistance/emergency medical care policies Limitations on charges Restriction on extraordinary collection actions before making reasonable efforts to determine if person is eligible for financial assistance Facility can lose exemption for violations $50,000 excise tax for CHNA failure 21

22 New proposed regulations in 2013 on CHNAs Joint CHNAs and implementation strategies possible for facilities in the same community, provided there is sufficient clarity about individual facility s participation Facility can determine its community served, but can t exclude underserved or take into account patients on the basis of ability to pay CHNAs must take into account input from at least one public health department Underserved, low-income, and minority groups public comment on previous CHNA Input must include information on barriers to access Standards for adoption and publicizing of CHNA & implementation strategy 22

23 Proposed regulations also address enforcement IRS can take into account seriousness of violation in deciding whether to revoke exemption; no revocation if error is minor, inadvertent, due to reasonable cause, and promptly corrected Expected safe harbor for non-willful, non-egregious violations that are corrected and disclosed Calculation of tax for entities with some noncompliant facilities facility by facility approach Facility operated by partnership where lack of control makes the activity subject to UBIT will not be subject to 501(r) requirements 23

24 Proposed regulations also address enforcement IRS can take into account seriousness of violation in deciding whether to revoke exemption; no revocation if error is minor, inadvertent, due to reasonable cause, and promptly corrected Notice proposed revenue procedure to provide a safe harbor for non-willful, non-egregious violations that are corrected and disclosed on the 990 Calculation of tax for entities with some noncompliant facilities facility by facility no offsetting of profits from one with losses from the other proximate and primary test for deductions 24

25 509(a)(3) organizations Public charities by affiliation with another public charity (often a church) Exclusively serve the supported organization s purposes Not controlled by private donors / related parties Some sponsored entities integrated auxiliary status may depend on 509(a)(3) Restrictions on donations from anyone controlling supported org & related parties, and on transactions with substantial contributors and other insiders Type 1 Controlled by appointment Type 2 Controlled by overlap Type 3 Operated in connection (usually some board overlap, other standards to show close ties) functionally non-functionally integrated integrated New rules limit qualifying activities (not grantmaking, investment, or fundraising); other changes starts 2014 Limit on business holdings New tighter rules 5% required payout starts

26 Extends provisional qualification as functionally integrated until at least 2016 to organizations that: Meet the old functionally integrated test Support at least one government supported organization Perform the functions of or carry out the purposes of that supported organization. Notice also modifies Notice by providing interim guidance to grantors in determining which type of SO a potential grantee is, for purposes of excise taxes under 4942, 4945 and 4966 (requiring use of the new functionally integrated standards. Relevant for PFs and sponsoring organizations of DAFs. 26

27 Five-year study concluded in June 2013 with the Final Report. Report is based on audits of only 34 organizations not a statistically valid sample. However, as a result of the compliance project, IRS plans to look at UBI reporting more broadly, especially at recurring losses and the allocation of expenses, and to ensure, through education and examinations, that tax-exempt organizations are aware of the importance of using appropriate comparability data when setting compensation. 27

28 The IRS reported four primary reasons for UBIT-related adjustments. 1. Lack of Profit Motive: "a pattern of recurring losses indicates a lack of profit motive. 2. Misallocation of Expenses: Most organizations failed to allocate mixeduse expenses on a reasonable basis or improperly allocated expenses that were not directly connected to the unrelated business activity errors resulted in excessive expense allocations which offset (understate) UBI. 3. Errors in Computation or Substantiation of NOLs: organizations either could not substantiate their NOLs or miscalculated their NOLs in a manner that improperly increased the NOL amounts. 4. Misclassification of Related Business Activities: The IRS reported that nearly 40% of the colleges and universities it examined incorrectly treated unrelated business activities such as fitness centers, recreation centers, and golf courses as exempt activities. 28

29 Clearly, UBIT issues will remain a major issue for IRS education and enforcement (i.e., audits). In-house counsel and 990/990-T preparers should ask: What steps do you take to determine whether business activities are "related" or "unrelated"? Be sure to observe the fragmentation rule and examine each activity (i.e., each revenue stream) separately. Can you articulate a reasonable basis for determining which expenses are "directly connected" to unrelated business activities? How do you determine the allocation of expenses between mixed-use activities for example, facilities that are used both for exempt function activities and for commercial purposes (e.g., rented to the public)? Can your organization demonstrate a profit motive for unrelated business activities particularly those activities that produce recurring losses (e.g., during their start-up years)? Do you keep records to substantiate the NOLs claimed on your organization's Form 990-T? 29

30 The Report documents the IRS's first large-scale effort to look not only at whether comparability data was used but whether the data was "appropriate." In the C & U audits, the IRS criticized comparability data as inappropriate because: it included data from schools not similarly situated based on the appropriate factors including, location, endowment size, revenues, total net assets, number of students, and selectivity; it failed to document why schools were selected as comparable to the school doing the study; and it failed to state whether compensation reported reflected only salary data, or whether it reflected total compensation as required by section

31 On August 9, 2013, Treasury and IRS released the PGP, which lists the 324 guidance projects that will be priorities for the allocation of resources during the FY ending in June of the guidance projects are focused on exempt organizations: 1. Revenue Procedures updating grantor and contributor reliance criteria under I.R.C. 170 and Revenue Procedure to update Revenue Procedure for EO Select Check. 3. Guidance under 501(c)(4) relating to measurement of an organization's primary activity and whether it is operated primarily for the promotion of social welfare, including guidance relating to political campaign intervention. 4. Final regulations under I.R.C. 501(r) and 6033 on additional requirements for charitable hospitals as added by 9007 of the ACA. (Proposed regulations were published on June 26, 2012 and April 5, 2013). 5. Additional guidance on I.R.C. 509(a)(3) supporting organizations. 6. Guidance under 4941 regarding a private foundation's investment in a partnership in which disqualified persons are also partners. 31

32 7. Final regulations under 4944 on program-related investments. (Proposed regulations were published on April 19, 2012). 8. Regulations regarding the new excise taxes on donor advised funds and fund management under I.R.C added by 1231 of the Pension Protection Act of Regulations under I.R.C and 6071 regarding the return and filing requirements for community health needs assessments failures by charitable hospitals as added by 9007 of the ACA. 10. Regulations under I.R.C on returns of exempt organizations. 11. Final regulations under I.R.C. 6104(c). (Proposed regulations were published on March 15, 2011). 12. Final regulations under I.R.C relating to church tax inquiries and examinations. (Proposed regulations were published on August 5, 2009). 32

33 In her annual report to Congress, released last week, National Taxpayer Advocate Nina Olson criticized the IRS-EO Function: EO usually receives 60,000 applications each year - for initial applications and reinstatement. Its inventory backlog now stands at about 66,000 cases, more than the number of routine applications it usually receives in an entire year, four times the 2010 level, and more than triple the 2011 level. EO also erroneously treated thousands of organizations as no longer exempt, and programming conditions will cause more erroneous revocations in the future. 33

34 Expedited Handling of Determination Letters still possible, despite confusion generated by Rev. Proc New procedures for seeking reinstatement following auto-revocation under IRC section 6033(j) (Rev. Proc ) 1. Streamlined Retroactive Reinstatement -- for orgs eligible to file Forms 990-EZ or 990-N. 2. Retroactive Reinstatement Process (Within 15 Months of auto-revocation notice) 1023/ establish reasonable cause for failure to file return for at least one of the three consecutive years. 3. Retroactive Reinstatement (After 15 Months of auto-revocation notice) 1023/ establish reasonable cause for failure to file returns for all three consecutive years. 4. Post-Mark Date Reinstatement. 34

35 Q: What about pending applications for reinstatement? A: New procedures apply if they benefit your organization s ability to be retroactively reinstated. So, for example, if your affiliate was previously reinstated from the post-mark date of the application, but you would have satisfied the new retroactive process requirements (#2 or #3 above), you may reapply under Revenue Procedure on or before May 2,

36 Notice delayed implementation schedule FATCA withholding begins July 1, 2014 New W-8 forms; drafts released For some payments, foreign payees may need to provide additional information or certifications to avoid withholding; navigating W-8BEN-E will be a challenge Certain nonfinancial payments excluded 36

37 On December 26, 2013, OMB released welcome guidance on federal grants: 10% Floor on Overhead ( Indirect ) Costs nonprofits may elect an automatic indirect cost rate of 10% OR negotiate a higher rate. pass-through entities (e.g., state & local govts receiving federal funding) must honor a nonprofit s existing negotiated indirect cost rate OR negotiate a rate in accordance with federal guidelines. Direct Costs in certain circumstances, program admin (e.g., secretarial staff dedicated to a specific program) can be reported as direct, rather than indirect. Single Audit Threshold new threshold for a single audit (A-133) requirement will be $750,000 (up from $500,000). Consolidated OMB Guidance consolidates 8 OMB circulars related to charities, so applications and reporting will be standardized and streamlined for consistency across federal agencies. 37

38 Released in December, the Report: analyzes the CEO compensation-setting practices at 25 of the largest MA charities (mostly universities and hospitals), recommends additional criteria beyond federal tax guidelines that charity boards should consider in setting CEO compensation, and introduces a new form ( Schedule EC ) that certain MA charities will need to complete as part of their annual state reporting. AG Martha Coakley hopes that requiring more detailed disclosures will moderate the rate of increase in executive compensation. Opines that IRS requirements alone may not assure reasonable compensation. Boards should consider additional factors, including: impact of the compensation on the charity s mission; impact of the compensation on the charity s reputation; level of financial risks imposed by certain types of compensation arrangements; whether the charity is paying more than necessary to secure the executive talent; relative magnitude of the CEO s total compensation package in relation to that of the charity s non-executive workforce; and tax subsidy received by the charity due to its tax exemptions. 38

39 New Schedule EC & EC-1 intended to increase transparency and timeliness of reporting on charity executive compensation 25 MA charities completed the prototype as part of the study (for tax years ) Requests information beyond Form 990 Sched J requirements, including: describe the nature of each component of compensation reported; explain how/when any forms of contingent compensation (e.g., deferred compensation, incentive compensation, and retirement) accrue, vest, and are (or will be) paid; list loans and loan guarantees initiated or existing between the organization and the CEO; identify the compensation consultant used in establishing the compensation; and describe how the CEO s comp-setting process differs from the process for other members of the organization s senior mgmt team. 39

40 Non-501(c)(3) entities nationwide that register or should register with the NY AG Charities Bureau must disclose election related expenditures : Dollar totals and percentages spent on election related expenditures For those spending more than $10,000 on New York State elections: Itemization of expenses over $50 Disclosure of donors giving more than $1,000 whose moneys are available for use in New York elections 40

41 What is an election related expenditure? Money spent on qualifying communications paid ads over radio/tv/cable/satellite/billboard/periodicals paid placement on internet & similar networks paid telephone communications to 1,000 or more printed materials with more than 5,000 copies or mailings sent to 5,000 or more recipients that qualify as express election advocacy OR election targeted issue advocacy. Also grants and similar contributions made to support such activities 41

42 Express election advocacy : express words or no other reasonable interpretation Election targeted issue advocacy : communication referring to or depicting a clearly identified candidate, political party, or ballot question within 45 days before a primary/run-off election or 90 days before a general/special election Exceptions for neutral debates and membership communications. 42

43 States attempting to intervene where IRS has not. Note complication of tracking activities against multiple thresholds. Note imperfect convergence toward FEC-like standards. 43

44 On December 18, 2013, NY Gov. Cuomo signed the Nonprofit Revitalization Act of 2013 into law. The Act overhauls longstanding legal requirements that affect the operations, governance, and oversight of nonprofit corporations and charitable trusts organized in NY and, to a lesser extent, other nonprofit organizations operating in the state. Most provisions will take effect on July 1, Some provisions relevant to out-of-state entities registered to fundraise in New York. 44

45 Elimination of Types The Act replaces the NPCL s current type classification scheme with a simpler distinction between charitable and non-charitable corporations. Requires notice to the Department of Education rather than consent for many organizations For all but certain organizations (schools, libraries, museums, historical societies), the Act replaces the requirement of obtaining the DOE s written consent for corporate filings with an easier requirement to merely provide notice to DOE. 45

46 Act modifies financial reporting requirements in connection with NY charitable solicitation Required Information Old Law Gross Revenue Unaudited < $100K < $250K Independent CPA Review Report Independent CPA Audit Report New Law Gross Revenue $100K-$250K $250K to $500K (2014) $250K to $750K (2017) $250K to $1M (2021) $250K+ or lower if paid third party fundraisers $500K+ (2014) $750K+ (2017) $1M+ (2021) 46

47 New standards for approving compensation Person must be absent except to answer questions prior to deliberation and vote Employees cannot be board chairs New standards for approving related party transactions the board must determine that the transaction is fair, reasonable, and in the best interests of the organization. AG given new power to police these standards. New requirements for audit committees Orgs with 20+ employees and $1M+ in revenues must have a whistleblower policy 47

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49 Freedom from Religion Foundation v. Lew (W.D. Wisconsin Nov. 22, 2013) A. Petitioner: parsonage cash allowance under 107(2) is discriminatory because it favors religion in violation of 1st Amendment (Court agreed.) B. Government: law as written today is nondiscriminatory because it allows for the possibility of atheistic or nonreligious individuals to qualify as "ministers of the gospel." 49

50 A. What did the court decide? It is unconstitutional for the government to favor religion by not taxing tax ministers on housing allowances provided by their churches. B. When does the ruling take effect? This ruling does not take effect until after any appeals are complete, so it should not affect any ministers for the time being. C. Who will be affected? The ruling addresses only cash housing allowances; ministers living in church-provided housing are not affected. D. Standing? 50

51 Diara M. Holmes / dholmes@capdale.com Michael W. Durham / mdurham@capdale.com Disclaimer This communication does not provide legal advice, nor does it create an attorney-client relationship with you or any other reader. If you require legal guidance in any specific situation, you should engage a qualified lawyer for that purpose. Prior results do not guarantee a similar outcome. Attorney Advertising It is possible that under the laws, rules, or regulations of certain jurisdictions, this may be construed as an advertisement or solicitation Caplin & Drysdale, Chartered All Rights Reserved. 51