IRS INITIATIVES What’s Going on in Washington

Mike Sorrells, BDO USA United Way Financial and HR Forum

Atlanta 2013

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Your Presenter

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The BDO Institute for Nonprofit Excellence

• Check out our new nonprofit blog at www.nonprofitblog.bdo.com

• And . . . we tweet!

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Agenda• IRS EO Annual Report and Workplan—released

January 25, 2013-www.irs.gov/pub/irs-tege/FY2012_EO_AnnualRpt_2013_Work_Plan.pdf

• Final Report—Colleges and Universities Compliance Program—What this Means for Everyone Else—released April 25, 2013-- http://www.irs.gov/pub/irs-tege/CUCP_FinalRpt_042513.pdf

• Congressional Focus

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IRS 2013 EO Workplan Highlights

• EO is developing an interactive version of the Form 1023 Exemption Application featuring pop-up explanations—this product should be available in 2013

• 200 examinations of executive compensation based upon information gathered in 2012

• Completion of about 2,500 payroll examinations from 3rd and last year of national project

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IRS Payroll Examination Focus:Employee versus Independent ContractorFY 2013 is the third and final year of the National Research Program

(NRP) IRS looks to three main factors in determining employment status:• Behavioral Control• Financial Control• Relationship of the Parties

• Just because the individual works part-time does not make him or her an independent contractor.

• If the person is doing the same job as an individual who is classified as an employee the person is most likely an employee.

• The new healthcare law is focused on employee health coverage and this issue becomes even more important.

• How many hours per week does a person work? Example of Adjunct professors

• For more information see: http://www.irs.gov/pub/irs-pdf/p1779.pdf

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2013 IRS EO Workplan--Group Rulings

• Questionnaire developed in 2012 for central organizations with group rulings (http://www.irs.gov/pub/irs-tege/L4953.pdf)

• Distributed to some 2,000 such organizations early in 2013• Data to be analyzed to learn about relationships between

central and subordinate organizations and ways that filing requirements can be satisfied

• Central and subordinate organizations should understand their responsibilities under the group ruling to be sure they are in compliance

• Rev. Proc. 80-27 Requirements

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IRS 2013 EO Workplan--International

• Continue to examine organizations who operate overseas to ensure activities are consistent with exempt purpose

• Examinations include number of large private foundations with international activities and assets/revenue greater than $500M

• Continue to look at organizations who report foreign bank accounts• Focus primarily on use of charitable assets internationally (private

foundations and public charities)• Concerns over tax shelters, adequate books and records, discretion

and control over funds that have left the US

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2013 IRS EO Workplan—Self-Declarers• Unlike 501(c)(3) organizations, there is no determination letter

requirement for 501(c)(4), 501(c)(5), and 501(c)(6) organizations, although most apply for exemption for assurance

• IRS will review them to ensure they are classified properly and complying with rules

• Recent focus on 501(c)(4) political activities appears to be one cause for heightened IRS scrutiny

• IRS also issued Rev. Proc. 2013-9 that indicates these organizations must apply within 27 months of formation to get retroactive recognition of 501(c) status.

• Questionnaire developed in 2012 has been distributed to 501(c)(4), (5) and (6) organizations who self declared on 2010 or 2011 Form 990 (http://www.irs.gov/pub/irs-tege/Letter4953.pdf)

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2013 IRS EO Workplan-Political Activities

Political activities are allowed, but:• Cannot be primary purpose• Subject to income taxes on lesser of political activities or investment

income (IRS Form 1120-POL)• Look at $$ and activity (time sheets are very important records)• Be careful to avoid substantial private benefit• The current 501(c)(4) Political Organization debacle—my take on it!

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IRS 2013 IRS EO WorkplanGovernance Form 990 Questions--Checklist results (only audited charities)--IRS

to do larger survey with all types of nonprofits—Findings:

• Organizations with a written mission statement are more likely to be compliant,

• Organizations that always use comparability data when making compensation decisions are more likely to be compliant,

• Organizations with procedures in place for the proper use of charitable assets are more likely to be compliant, and

• Organizations where the 990 was reviewed by the entire board of directors are more likely to be compliant.

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IRS 2013 IRS EO Workplan UBIT

• EO will continue on its Unrelated Business Income Project begun in 2012

• Statistics of Income- 2006 tax year, less than 50% of returns filed showed positive amounts of UBTI

• This year IRS will be examining a “statistically valid” sample of nonprofits that have reported “substantial” UBI for 3 consecutive years but have reported no income tax due

• We see a lot of organizations in exactly this situation- May be legitimate (e.g., LLC/LP investments and/or business

activities that will eventually turn around)- May be result of aggressive expense allocations- May be caused by netting a perennial loss activity (that does not

qualify as a trade or business) with other activities which do produce UBI

- Sometimes, all of the above

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IRS 2013 Exempt Organization Workplan College and University Compliance Program(CUCP)• The Project was begun over 4 years ago in 2008 when the IRS

sent a 33-page questionnaire to 400 colleges and universities that included public, private, small, large and medium sized institutions. An interim report was issued in 2010.

• As a result of the answers to the questionnaire, IRS decided to examine 34 of the schools and waited until those examinations were completed to come out with the final report

• April 25, 2013—IRS issued the CUCP Final Report

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CUCP Final Report—UBIT

Underreporting of UBTI resulted in an increase in UBTI for the schools totaling approximately $90 million in the aggregate and disallowance of more than $170 million in losses and net operating losses (NOLs)

• Disallowance of losses due to lack of profit motive;• Improper expense allocations, such as where expenses for related

activities were used to offset unrelated income or where an allocation of overhead to unrelated activities was unreasonable;

• Errors in computations or substantiation of NOLs; and• Misclassification of an activity as exempt when it was really unrelated.Main areas of focus:Fitness and recreation centers and sports camps, arenas and golf

courses; and advertising and facility rentals

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CUCP Final Report--Compensation

• Compensation of the most highly paid was also under the microscope, especially, coaches, investment managers, highly paid faculty and administrators.

• Employment Taxes--The IRS also reviewed employment taxes of the colleges and universities. As a result of the project there were wage adjustments totaling about $36 million and resulting taxes and penalties of $7 million.

• Retirement Plans--Also, with regard to retirement plan adjustments there were increases in wages of more than $1 million and the assessment of more than $200,000 in taxes and penalties.

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CUCP Final Report--Compensation

• In the compensation area, organizations such as colleges and universities cannot pay more than reasonable compensation to individuals who can substantially influence the organization or the Intermediate Sanctions provisions could apply (IRC 4958).

• Organizations can establish the “rebuttable presumption of reasonableness” that shifts the burden of proof to the IRS to prove that compensation is unreasonable.

• 20% of the colleges and universities that attempted to establish the rebuttable presumption of reasonableness failed to do so because of problems with comparability data.

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The Rebuttable Presumption for 501(c)(3) and 501(c)(4) Organizations (and a recommended process for others) Three requirements:1. Advance approval by an independent Authorized Body2. Reliance on Comparable Data3. Concurrent Documentation of Terms and date approved:

• Members of body present for discussion and who voted• Comparability data relied on and how obtained• Reasons for any variance from comparability data• Actions by any member with a conflict

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Executive Compensation Comparables– Similarly Situated Organizations • For-profit comparables

• How many organizations were used?

• Is the position functionally comparable?

• If an organization reviews the Form 990 of other organizations, the Forms relied upon should be in the files and the answers to the questions posed above documented as well.

• IRS is looking for a process and even though the rebuttable presumption will not apply to a 501(c)(6) organization, for example, the process should be conducted as well. IRS is also looking for transparency.

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CUCP Comparability Data Shortfalls

The Final Report indicates that although most of the private institutions attempted to establish the rebuttable presumption, the comparability data fell short of what was required because:

• Schools were not similarly situated based on factors such as location, size of endowment, revenue, total net assets or number of students;

• Compensation studies did not document the selection criteria for the schools compared or why the schools were deemed comparable;

• The compensation studies relied upon did not specify whether the compensation amounts included benefits other than salaries, which must be taken into account for purposes of IRC 4958.

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Congressional Focus on Nonprofits

• Sector has seen tremendous growth—One in ten persons works for a nonprofit

• Congress may look at sector as a source of revenue

• Congress is concerned about abuses in the tax exempt arena and is reviewing IRS enforcement of the current tax laws

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Tax Reform: Revenue Loss from 501(c)(3) OrganizationsFederal• Income Tax Exemption• Charitable Deduction• Tax Exempt Bonds

State• Sales and Use Tax Exemptions• Property Tax Exemptions• Income Tax Exemptions (some states do not even tax UBI)

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Hearings

Three hearings by the House Ways and Means IRS Oversight Subcommittee (so far)

• Form 990, UBIT, Categories of exemption, Complex organizations and Exemption process

• Charitable Deduction• Colleges and UniversitiesSenate Finance Committee• Complex structures• Education tax benefits• The Grassley Factor11 Working groups have been formed to provide input on various areas of

the IRC

Of course, the 501(c)(4) political organizations have gone to the front with a number of hearings!

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Legislative Outlook—The Issues

• Tax exemption• UBIT• Postage rates• Mileage rates• Internet sales tax• The charitable deduction

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Options regarding Charitable ContributionsCap the value of itemized deductions at 28%Other Options (CBO report May 2011):• Retaining the current deduction for itemizers but adding a floor. • Allowing all taxpayers to claim the deduction, with or without a

floor. • Replacing the deduction with a nonrefundable credit for all

taxpayers, equal to 25 percent of a taxpayer's charitable donations, with or without a floor.

• Replacing the deduction with a nonrefundable credit for all taxpayers, equal to 15 percent of a taxpayer's charitable donations, with or without a floor.

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Summary

• Although IRS EO resources have diminished, they are more focused in areas of perceived abuse and potential revenue.

• Congress is concerned about the abuses and potential revenue loss and could increase the IRS EO budget and enact bright line tests to make enforcement easier and collect more revenue.

• EO will be greatly constrained after the political organization issue is addressed completely

• Documentation is key!• Stay tuned

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Questions & Answers

To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this presentation (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. 

Material discussed in this tax presentation is meant to provide general information and should not be acted on without professional advice tailored to your organization’s individual needs.