Form 990, Schedule K and Tax-Exempt Bonds

Form 990, Schedule K and Tax-Exempt Bonds May 25, 2010 1:00 pm EST DRAFT If you experience any technical difficulties, please contact 888.228.4388 or GTU_support@learnlive.com

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Today s Presenters Stephanie Seroogy Senior Manager, Public Finance Minneapolis Mark Swenson Manager, Public Finance Minneapolis

Objectives Learning objectives Learn how to address Schedule K Questions on Your Form 990 regarding tax-exempt bonds when these questions are no longer optional Gain an overview of the private business use calculation on your institution's tax-exempt debt Determine arbitrage rebate and yield restriction calculations for your institution's tax-exempt debt Learn how quality post-issuance tax compliance processes will ease the burden of completing Schedule K

Agenda Form 990 and Schedule K Private Business Use

Form 990: Return of Organization Exempt From Income Tax Who has to file the Form 990? Most organizations exempt from income tax under Code Section 501(a) must file annual information return, including 501(c)(3) organizations. Given reducing maximums for use of Form 990-EZ, more organizations will be required to face full Form 990 requirements including Schedule K relating to tax-exempt bonds. Filing phase-in for Form 990 continues through 2010 tax year.

The New Form 990: In General The redesigned Form 990 was released on December 20, 2007 and must be used for tax year 2008 and thereafter. Redesign is based on the 3 guiding principals of the IRS: Enhancing transparency Promoting tax compliance Minimizing the burden on the filing organization

Polling Question #1 Does your organization have clearly defined post issuance compliance practices and procedures relating to your tax-exempt bond issues? A. Yes B. No

The New Form 990: Addition of Schedule K The new Form 990 includes the addition of Schedule K Supplemental Information on Tax-Exempt Bonds. The Schedule K encourages tax-exempt organizations to set up post-issuance compliance policies and procedures to ensure compliance with tax-exempt bond related tax requirements. The IRS wants to know: Are issuers and conduit borrowers following the rules set in place at closing after the closing?

The New Form 990: Addition of Schedule K (continued) Detailed reporting requirements on Schedule K provide incentives for borrowers to be more rigorous in record keeping and post issuance compliance monitoring of their tax-exempt bonds. This process is expected to be time consuming and burdensome for the 501(c)(3) organizations, especially for the first few years. Some believe the new schedules, including Schedule K Supplemental Information on Tax-exempt Bonds, were designed to obtain information for IRS audits.

Why did the IRS add Schedule K: Supplemental Information on Tax-Exempt Bonds? IRS believes there is significant noncompliance with recordkeeping and record retention requirements relating to tax-exempt bonds issued by or for the benefit of section 501(c)(3) organizations

Form 13907: Tax-exempt Bond Financings Compliance Check Questionnaire (August 2007) Question 1 1. Do you have written procedures or guidelines to ensure that qualified 501(c)(3) bond financings remain in compliance with the following federal tax requirements after the bonds are issued: a. Proper and timely use of bond proceeds and bond financed property? Yes/No b. Arbitrage yield restriction and rebate? Yes/No c. Timely return filings and other general requirements? Yes/No d. For each yes answer, briefly describe your procedures or guidelines.

Interim Report on Charitable Financings: A Summary of Reported Data and Analysis September 11, 2008 Organizations who received and responded to this questionnaire included hospitals, universities and colleges, senior housing projects and other 501(c)(3) organizations. A significant portion - 94% - of respondents answered yes to all three parts of question 1. However, only 16% provided the IRS with a description or other information that demonstrated that they did have such procedures or guidelines: Further testing through examinations or other field tests may be warranted to further assess compliance in these areas (Internal Revenue Service in Interim Report on Charitable Financings: A summary of Reported Data & Analysis)

Interim Report on Charitable Financings: A Summary of Reported Data and Analysis September 11, 2008 (continued) Per Tax-Exempt Bond Office s FY 2009 Work Plan: Feedback from these compliance initiatives suggests potential problems related to inadequate record retention, failure to pay arbitrage rebate, substantial private use of facilities, and other weaknesses related to debt management and monitoring. 501(c)(3) organizations were specifically cited as at high risk for non-compliance in the Tax-Exempt Bond Office s FY 2009 Work Plan.

Form 990 - Schedule K Beginning in 2008, for tax forms filed in 2009, the IRS requires any organization that answered yes to question 24a of Form 990, Part IV, to complete and attach Schedule K to Form 990. What is Question 24a of the Form 990? Did the organization have a tax-exempt bond issue with an outstanding principal amount of more than $100,000 as of the last day of the year, that was issued after December 31, 2002?

Form 990 - Schedule K (continued) The Schedule K is divided into four parts: Part I Bond Issues Part II Proceeds Part III Private Business Use Part IV Arbitrage

Form 990 - Schedule K (continued) Part I is required for 2008. Parts II through IV are optional for 2008 but required beginning in 2009. This delay provides organizations an opportunity to put in place a system to compile the required data. The Schedule K focuses on 3 areas of compliance (or noncompliance) identified by the IRS. The Schedule K consists of 2 pages, providing room to input information for 5 bond issues, and includes 4 pages of instructions and definitions.

Form 990 Schedule K Part I Part I Bond Issues (Required for 2008): Provide general information for each outstanding tax-exempt bond issue which, both had an outstanding principal amount in excess of $100,000 as of the last day of the tax year (or other selected 12 month period) and was issued after December 31, 2002. (a) Issuer name (b) Issuer EIN (c) CUSIP # (d) Date issued (e) Issue price (f) Description of purpose (g) Defeased (yes or no) (h) On behalf of issuer (yes or no) The information for (a) through (e) above should be on the original Form 8038.

Form 990 Schedule K Part II Part II Proceeds (Optional for 2008, required thereafter) Provide more specific information for the tax-exempt bond issues listed in Part I relating to the proceeds and gross proceeds of the tax-exempt bond issues. 1. Total proceeds of issue 2. Gross proceeds in reserve funds 3. Proceeds in refunding or defeasance escrows 4. Other unspent proceeds 5. Issuance costs from proceeds 6. Working capital expenditures from proceeds 7. Capital expenditures from proceeds 8. Year of substantial completion 9. Were the bonds issued as part of a current refunding issue? (yes/no) 10. Were the bonds issued as part of an advance refunding issue? (yes/no) 11. Has the final allocation of proceeds been made? (yes/no) 12. Does the organization maintain adequate books and records to support the final allocation of proceeds? (yes/no)

Form 990 Schedule K Part III Part III Private Business Use (Optional for 2008, required thereafter): Provide information related to the private business use of the tax-exempt bond proceeds listed in Part I. 1. Was the organization a partner in a partnership, or a member of an LLC, which owned property financed by tax-exempt bonds? (yes/no) 2. Are there any lease arrangements with respect to the financed property which may result in private business use? (yes/no) 3. (a) Are there any management or service contracts with respect to the financed property which may result in private business use? (yes/no) (b) Are there any research agreements with respect to the financed property which may result in private business use? (yes/no) (c) Does the organization routinely engage bond counsel or other outside counsel to review any management or service contracts or research agreements relating to the financed property? (yes/no) 4. Enter the percentage of financed property used in a private business use by entities other than a section 501(c)(3) organization or a state or local government: (enter percentage to nearest 1/10 th of a percent) 5. Enter the percentage of financed property used in a private business use as a result of unrelated trade or business activity carried on by your organization, another 501(c)(3) organization or a state or local government: (enter percentage to the nearest 1/10 th of a percent) 6. Total of lines 4 and 5 7. Has the organization adopted management practices and procedures to ensure the post-issuance compliance of its tax-exempt bond liabilities? (yes/no)

Polling Question #2 Does your organization currently have an arbitrage rebate provider to assist you with arbitrage rebate and yield restriction calculations on your tax-exempt bonds? A. Yes B. No

Form 990 Schedule K Part IV Part IV Arbitrage (Optional for 2008, required thereafter): Provide information with respect to arbitrage for the tax-exempt bonds listed in Part I. 1. Has a Form 8038-T, Arbitrage Rebate, Yield Reduction and Penalty in Lieu of Arbitrage Rebate been filed with respect to the bond issue? (yes/no) 2. Is the bond issue a variable rate issue? (yes/no) 3. (a) Has the organization or the governmental issuer identified a hedge with respect to the bond issue on its books and records? (yes/no) (b) Name of provider (c) Term of hedge 4. (a) Were gross proceeds invested in a GIC? (yes/no) (b) Name of provider (c) Term of GIC (d) Was the regulatory safe harbor for establishing the fair market value of the GIC satisfied? (yes/no) 5. Were any gross proceeds invested beyond an available temporary period? (yes/no) 6. Did the bond issue qualify for an exception to rebate? (yes/no) The IRS had identified arbitrage and arbitrage rebate and yield restriction as one of the key areas of noncompliance. This section was included to enforce compliance.

Form 990 Schedule K What should organizations do now? Create post issuance compliance practices and procedures for taxexempt bond issues. Clearly define the facilities and equipment financed by tax-exempt bond proceeds. Trace and allocate tax-exempt bond proceeds to expenditures. Engage an arbitrage rebate provider to assist in compliance with arbitrage rebate and yield restriction regulations. Isolate each tax-exempt bond issue and bond financed property associated with each tax-exempt bond issue for record keeping purposes.

Form 990 Schedule K Final Remarks The Schedule K may by used by the IRS to identify audit targets. Red flags include: Submission of incomplete form Private business use of 0% Private business use above 5% The information required on the Schedule K will make it easier for the IRS to challenge the tax-exempt status of outstanding tax-exempt bond issues. Consistency throughout the form and over the years is essential.

Private Business Use

Tax-Exempt 501(c)(3) Bonds and Private Activity Bonds 501(c)(3) organizations have access to the tax-exempt bond market. However, there are restrictions on 501(c)(3) organizations and their use of tax-exempt bond proceeds. Examples include: All property financed with tax-exempt bond proceeds must be owned by the 501(c)(3) organization. No more than 5% of the proceeds of tax-exempt bonds may be used for a private business use.

Tax-Exempt 501(c)(3) Bonds and Private Activity Bonds (continued) Tax-exempt bond proceeds are used for a private business use by a 501(c)(3) organization if they are: used directly or indirectly in a trade or business that produces unrelated business taxable income or used by others in any non-governmental trade or business In defining trade or business any activity carried on by a person other than a natural person is treated as a trade or business.

Tax-Exempt 501(c)(3) Bonds and Private Activity Bonds (continued) To measure the amount of private business use of tax-exempt bond proceeds, the use of the tax-exempt financed property is treated as the use of tax-exempt bond proceeds. Section 141 of the IRS Code defines the private activity bond tests. These tests were designed to limit the volume of tax-exempt bonds that finance the activities of non-governmental organizations or persons. They also serve to identify arrangements that have the potential to transfer the benefits of tax-exempt financings.

Tax-Exempt 501(c)(3) Bonds and Private Activity Bonds (continued) One of these tests limits the amount of private business use of a tax-exempt financed property to no more than 5% of the proceeds of each tax-exempt bond issue. This is the test that the Schedule K was designed to monitor. If the 501(c)(3) does not adhere to the restrictions and meets any of the private activity bond tests, the bonds become taxable bonds.

Polling Question #3 How does your organization plan to comply with the Schedule K requirement to calculate private business use to the nearest 1/10 th of 1% for each bond issue annually? A. We already do this B. We plan to do this ourselves C. We plan to hire a consultant to assist us D. We don t know yet

Calculation to Determine if Private Activity Bond Tests are Met Private business use of tax-exempt bond proceeds is allocated to property. The amount of private business use of that property is determined according to the average percentage of private business use of that property during the measurement period. The measurement period of property financed by a bond issue: begins on the later of the date the bonds are issued or the date the property is placed in service and ends on the earlier of the last date of the reasonably expected economic life of the property or the latest maturity date of the bonds financing the property

Calculation to Determine if Private Activity Bond Tests are Met (continued) The percentage of private business use for any one year period is the average private business use during that year. The percentage of private business use for a bond issue is the average of the percentages of the private business use during the one year periods within the measurement period. This average is determined by comparing the amount of private business use during the year to the total amount of private business use and use that is not private business use (governmental use) during that year. Private business use must be calculated as a percent for each tax-exempt bond issue annually for Schedule K reporting requirements.

Certain Uses That Do NOT Give Rise to Private Business Use Generally permitted arrangements include: Incidental uses and services to the extent that those uses do not exceed 2.5% of the proceeds of the tax-exempt bond issue used to finance the facility. Incidental uses include pay telephones, vending machines, advertising displays and kiosks, etc. Contracts for cleaning and janitorial services, office equipment repair, billing services, and other services incidental to the primary function of the tax-exempt bond financed facility. Management or service contacts that meet the safe harbor (per Revenue Procedure 97-13). Research agreements that meet the safe harbor (per Revenue Procedure 2007-47). Granting of admitting privileges by a hospital if those privileges are available to all qualified physicians in the area. A contract to provide for services if the only compensation is the reimbursement to the service provider for actual and direct expenses paid by the service provider to unrelated parties.

Certain Uses That Do NOT Give Rise to Private Business Use (continued) Certain permitted short term uses of 50 or 100 days including all renewal options may not result in private business use. Use of tax-exempt bond financed facilities is not private business use by individuals if those individuals are not using the facilities in a trade or business and the use is substantially related to the exempt purpose of the 501(c)(3) organization.

Certain Uses that DO Give Rise to Private Business Uses Costs of issuance are treated as private business use. This means the amount of tax-exempt bond proceeds used for costs of issuance is counted against the 5% limitation. The use of tax-exempt bond proceeds or tax-exempt bond financed facilities by a 501(c)(3) organization in an unrelated trade or business is treated as a non-qualifying use counting against the 5% limitation. Use of tax-exempt bond proceeds or tax-exempt bond financed facilities by any person other than a natural person, a 501(c)(3) organization for its exempt purpose or a governmental unit is counted against the 5% limitation.

Certain Uses that DO Give Rise to Private Business Uses (continued) Ownership of the tax-exempt bond financed property by an entity other than the 501(c)(3) organization. Leases on the tax-exempt bond financed property. Special legal entitlements for the beneficial use of the tax-exempt bond financed property. Management or service contracts related to the tax-exempt bond financed property if the contacts do not meet the safe harbor. Sponsorship of a non-qualifying research agreement relating to the tax-exempt bond financed property if the contact does not meet the safe harbor.

Polling Question #4 Do you currently have your bond or tax counsel or another outside counsel review all management and service contracts or research agreements before you enter into them? A. Yes B. No

Management and Service Contracts, Research Agreements Revenue Procedures 97-13 and 2007-47 offer guidance on if a contract will or will not result in private business use. Criteria include the type of compensation received and the length of the contract. Management and service contracts typically result in private business use if compensation is based in whole or in part on a share of net profits. For example, sharing of net profits of a gift shop located within a hospital and the hospital would result in private business use.

Private Business Use Example Based on Allocation of Square Footage Series 2005 Bonds Calculation for Tax Year 2009 (1) Building 1 Parking Garage Building 2 Building 3 Building 4 Total Total Square Footage 500,000 200,000 50,000 50,000 50,000 850,000 Private Business Use Square Footage 10,000 50,000 2,000 62,000 Percent Private Business Use 2.0% 25.0% 0.0% 0.0% 4.0% 7.3% Use Proceeds PBU % (2) PBU Proceeds Building 1 $75,000,000.00 2.0% $1,500,000.00 Parking Garage 5,000,000.00 25.0% 1,250,000.00 Building 2 10,000,000.00 0.0% - Building 3 4,000,000.00 0.0% - Building 4 4,000,000.00 4.0% 160,000.00 Costs of Issuance 2,000,000.00 100.0% 2,000,000.00 Total $100,000,000.00 $4,910,000.00 Percent Private Business Use for Series 2005 Bonds 4.9% (1) Based on 200 total spaces with 50 reserved. (2) Based on square footage analysis above.

Final Remarks A focus of the IRS FY 2009 Tax Exempt Bonds Work Plan is on 501(c)(3) organizations and the organizations record retention policies and post issuance compliance practices and procedures including arbitrage rebate compliance and private business use monitoring. Make these areas a focus of your organization too! Become familiar with Schedule K! Determine how your organization will address the two most time consuming issues on the Schedule K in advance: calculation of arbitrage rebate and calculation of private business use

Any questions? Please type your questions or comments into the Q&A

Contact Information Please contact any of the following for more information: Daniel Romano Partner-in-Charge, National NFP Tax Practice Phone: 212-542-9609 Email: Daniel.Romano@gt.com Stephanie Seroogy Senior Manager, Public Finance Phone: 612-677-5109 Email: Stephanie.Seroogy@gt.com Mark Swenson Manager, Public Finance Phone: 612-677-5113 Email: Mark.Swenson@gt.com

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