Not-For-Profit/Exempt Organizations Blog

Stealth Can Be Good: New Procedure Allows Governmental Entities to Relinquish Section 501(c)(3) Tax-exempt Status

Elizabeth M. Mills — Thu, 05 Jan 2012 16:48:01 -0500

A new provision which was slipped in to the annual announcement of procedures for exempt organization determinations and letter rulings provides a way for governmental entities to voluntarily terminate their Section 501(c)(3) status. This is important for governmental hospitals that otherwise could be faced with new exemption requirements and penalties.

In the past, many local governmental entities, such as hospital authorities or hospital districts, obtained determinations from the IRS that they were tax-exempt organizations described in Section 501(c)(3) of the Internal Revenue Code. A common reason for obtaining recognition of Section 501(c)(3) status (in addition to their sovereign immunity as governmental entities from federal income tax) was so that the governmental entity’s employees could take advantage of Section 403(b) tax-sheltered annuities. (A government entity may not establish or maintain a Section 401(k) plan unless it adopted the plan before May 6, 1986. While governmental entities are permitted to maintain Section 457(b) plans, which are defined contribution plans providing for employee contributions similar to Section 401(k) plans, Section 457(b) plans are subject to lower contribution limits than the overall contribution limits for Section 401(k) plans and Section 403(b) annuities).

Section 501(c)(3) governmental entities were relieved of the burden of having to file a Form 990, which at that time was really the only disadvantage to Section 501(c)(3) status. (Governmental educational institutions were already subject to unrelated business income tax on their income that would have been taxable had they not been governmental institutions.) When the “intermediate sanctions” applicable to transactions with public charities became effective in 2005, imposing potential excise taxes on persons involved in transactions with Section 501(c)(3) organizations that were not public charities, the implementing regulations specifically provided that governmental entities with Section 501(c)(3) recognitions were not covered.

Not only were there no significant disadvantages to maintaining Section 501(c)(3) status, but there appeared to be no way to relinquish the status once obtained. Old general counsel’s memoranda and IRS Continuing Professional Education texts said so, although relinquishment was not apparently prohibited under the Code.

The enactment of Section 501(r) of the Code posed a very real burden on governmental hospital entities holding Section 501(c)(3) status determinations. Section 501(r) imposes specific requirements that hospitals must meet to remain tax-exempt, including a requirement that each hospital conduct a “community health needs assessment” (“CHNA”) every three years . Not only can hospitals lose their tax exemption if they do not conduct a CHNA – which may be a desired outcome for a governmental hospital – but they are also subject to a $50,000 excise tax for each year that each hospital facility does not conduct a CHNA – obviously not a desired result.

The deadline for the first round of CHNAs is coming up. Hospitals that do not have a CHNA in place by the end of their third tax year ending after March 23, 2010 are noncompliant and subject to penalties. For example, a hospital with a June fiscal year end must have a CHNA in place by June 30, 2013.

The IRS has addressed this in a “stealth” but effective manner. The IRS updates its procedures for determinations, private letter rulings, and other matters at the beginning of each year. The new Revenue Procedure 2012-4 addresses procedures for matters under the jurisdiction of the Division Commissioner, Tax Exempt and Government Entities. This year’s procedure added a new type of determination letter that the Exempt Organizations Determinations office will issue. Section 7.05(14) adds a “government entity voluntary termination of Section 501(c)(3) recognition (must include documentation of tax-exempt status other than under Section 501(a)).” Thus, governmental entities with Section 501(c)(3) determinations now have a process for asking the IRS to remove this status.

Governmental entities with Section 501(c)(3) determinations, particularly hospitals, should consider whether to take advantage of this new procedure.

IRS Extends Filing Deadline for Certain Tax-Exempt Organizations

Kathleen E. Gerber — Tue, 20 Dec 2011 07:30:00 -0500

The IRS has granted an automatic extension for certain tax-exempt organizations to file their annual returns electronically. The extension is being provided because the IRS’s electronic filing system (the “Modernized eFile system” or “MeF”) will not be available for filing Forms 990, 990-EZ, 990-PF, and 1120-POL from January 1, 2012 through February 29, 2012 (the “Suspension Period”). The extension is only available for organizations with filing due dates (whether original or extended) during the Suspension Period (“Affected Organizations”). Ordinarily, organizations with a fiscal year ending August 31 or September 30 would have filing deadlines during the Suspension Period. Under Notice 2012-4, Affected Organizations will automatically be granted an extension of time to file electronically to March 30, 2012.

Since the relief is automatic, an Affected Organization does not have to file Form 8868, Application for Extension of Time to File an Exempt Organization Return as long as the organization files its return by March 30, 2012. However, an Affected Organization will still have the option to file a Form 8868 to request an automatic extension of time to file during the Suspension Period. For example, if an Affected Organization’s original deadline to file its Form 990 is on February 15, 2012, the organization may properly complete and file a Form 8868 by such date to receive an automatic three-month extension of time to file ending on May 15, 2012. An Affected Organization that has previously received only one three-month extension of time to file will also continue to have the option to file Form 8868 to request a second automatic three-month extension.

Because a six-month extension of time to file is the full extension permitted by statute, the automatic extension relief provided by the Notice is not available to an Affected Organization that has already obtained two three-month extensions of time to file. However, any such organization will be considered to have reasonable cause for failing to file on time and, therefore, will not be assessed penalties for failure to timely file if the organization files its return by March 30, 2012. These organizations will not have to file a Reasonable Cause Statement in order to obtain such relief, but each such organization should attach a Reasonable Cause Statement to its return in order to avoid receiving a system-generated penalty notice for late filing.

Generally, any Affected Organization that is normally permitted to submit a paper filing will be able to do so during the Suspension Period. Additionally, Affected Organizations that are normally required to file electronically and are not eligible for the automatic extension of time to file granted by the Notice because they already obtained two three-month extensions previously will be permitted to submit a paper filing. The IRS noted that while the Notice provides these organizations with relief from any penalties for failure to file timely, some organizations may not feel comfortable relying on the Notice for such relief.

Notably, small tax-exempt organizations that are required to file Form 990-N (the e-Postcard) will continue to be able to file electronically during the Suspension Period. Accordingly, the extension and penalty relief provided in the Notice does not apply to such organizations.

Treasury Releases Long-Overdue Report on Supporting Organizations and Donor Advised Funds

Elizabeth M. Mills — Fri, 09 Dec 2011 13:37:19 -0500

Along with making significant changes to the rules for supporting organizations (“SOs”) and donor advised funds (“DAFs”) in the Pension Protection Act of 2006 (the “PPA”), Congress directed that Treasury conduct a study on the organization and operation of SOs and DAFs. Congress gave Treasury one year after the enactment of the PPA to submit a report on the study. On December 5th, more than four years past the prescribed deadline, Treasury finally released its long-awaited report to Congress. The report suggests that the current treatment of SOs and DAFs is appropriate and did not recommend any changes. While the report comes as good news to SOs and DAFs, some aren’t so keen. Senator Chuck Grassley (R–Iowa), denounced the study as disappointing, superficial, and a missed opportunity to “advance the ball in closing abusive loopholes.” For more, see his press release. Interested in whether SOs and DAFs should continue to be treated similarly to public charities, Congress asked Treasury to consider three specific questions regarding SOs and DAFs. A discussion of each question and Treasury’s response is discussed below.

Congress asked whether the deductions donors receive, which are more favorable than those donors receive for contributions to private foundations, are appropriate. The study concluded that because donors give up control of the contributed assets and do not have control over the donee organization, the donors to SOs and DAFs are in a similar position to donors to other public charities. Congress also expressed concern over the potential time lag between contributions, which may be used to build or maintain endowments, and the charitable use of those contributions, asking whether there should be a current deduction for such contributions. The report noted that issues relating to timing are germane to all types of charitable organizations, including public charities, and are not unique to SOs and DAFs. The Treasury concluded that the current deduction scheme is appropriate.

Congress asked whether DAFs should have a distribution requirement similar to those of private foundations. The study noted that the average payout rates among DAFs, which ranged from 9.3% to 28.7% in 2006, was higher than those of private foundations, which averaged just above 5%. This data was based on the one and only year of reported data from new questions on Form 990. Because there was only one year of data and because individual DAF information is not collected, the Treasury reported that it would be premature to make a recommendation regarding distribution requirements for DAFs at this time.

Finally, Congress asked if having an advisory relationship in respect of how funds are invested and/or distributed is consistent with the concept of what constitutes a completed gift for tax purposes. The report noted that contributions to SOs and DAFs are irrevocable and non-refundable and that the donor’s advisory relationship is non-binding. In addition, the report noted that just as a donor’s control of a private foundation does not make a gift to the foundation incomplete, it is consistent to treat donations to SOs and DAFs as completed gifts even if the donor retains non-binding advisory rights. Since this study was based on 2006 data, we’ll have to wait and see if the treatment of SOs and DAFs remains “appropriate” as more information becomes available from the redesigned Form 990.

Recaps from Proskauer's 16th Annual Trick or Treat Tax Exempt Seminar

Jacob I. Friedman — Fri, 04 Nov 2011 12:07:59 -0500

Proskauer’s 16^th Annual Trick or Treat Seminar was held on Monday, October 31, 2011.

The Seminar discussed:

Corporate Governance for Not-for-Profit/Exempt Organizations
Maintaining Tax-Exempt Status During Election Season
Investment Management under UPMIFA: What’s Required, What’s Good Practice
Executive Compensation & Employee Benefits Developments

In her introductory remarks, Amanda H. Nussbaum , Partner, highlighted the Congressional hearings on proposals to modify the structure of tax breaks for charitable donations. In addition, she also discussed recent state legislation adopting flexible purpose corporations - - new companies that are part social benefit and part low-profit entities such as the L3C - - and whether these types of companies were really necessary or whether they would just fade away. She also mentioned the IRS monthly updates of the list of the names of organizations whose tax-exempt status has been automatically revoked due to the failure to file a Form 990 for three consecutive years and some of the IRS's recent projects such as its college and university compensation and unrelated business income study and its governance check sheet.

Here are some take-away points from each presentation:

Corporate Governance for Not-for-Profit/Exempt Organizations. Edward S. Kornreich, Partner, described the responsibilities and obligations of the members of the board of a tax-exempt organization, particularly in regard to the unique issues related to conflicts among not-for-profit entities that have overlapping Board members. Recent information requests issued to not-for-profit boards, including those from the New York State Governor’s Task Force on Not-For-Profit Entities, were also discussed.

Maintaining Tax-Exempt Status During Election Season. Stuart L. Rosow, Partner, reminded attendees that Section 501(c)(3) organizations are absolutely prohibited from engaging in any political campaign activity and violation of the prohibition can lead to revocation of tax-exempt status. This prohibition does not preclude Section 501(c)(3) organizations from advocating a specific viewpoint on particular issues (though not legislation) related to an organization's exempt purpose. Mr. Rosow emphasized that issue advocacy is permitted when the organization focuses expressly on issues and indicates no bias towards any particular political candidate. Many tax-exempt organizations have officers and directors who engage in political campaign activities in their capacities as individuals and not as representatives of the organization. Mr. Rosow provided certain guidelines to ensure such activities are not attributable to the organization and would not jeopardize the organization's tax-exempt status. In addition, Mr. Rosow discussed that lobbying activities for Section 501(c)(3) organizations must be limited so as not to constitute a "substantial" activity and he explained the different methods for measuring whether an activity is "substantial." Finally, Mr. Rosow also noted that the restrictions on lobbying and political campaign activity vary depending on the basis for the organization's tax exemption. Section 501(c)(4), Section 501(c)(5) and Section 501(c)(6) organizations may engage in political campaign activity as long as it does not constitute the organization’s primary activity. Section 501(c)(4), Section 501(c)(5) and 501(c)(6) organizations may engage in lobbying (even exclusively), provided that the lobbying activity is in furtherance of the organization’s exempt purpose.

Investment Management under UPMIFA: What’s Required, What’s Good Practice. Elizabeth M. Mills, Senior Counsel, described the investment provisions of the new Uniform Prudent Management of Institutional Funds Act (UPMIFA) and investment best practices for exempt organizations. The UPMIFA provisions concerning endowment spending and modification of gift restrictions have received the most attention. This is especially true in New York, where special provisions require contacting endowment donors to ask permission to operate under the new spending rules. However, UPMIFA also lays out specific fiduciary duties for boards and committees in managing investments. These include the duty of care (including the duty to use the special skills of the persons involved), the duty to minimize investment costs, the duty to investigate, the duty to diversify, and the duty to dispose of unsuitable assets. UPMIFA elaborates on the duty to invest with the care a prudent person would exercise by listing eight "prudence" factors a board or committee should consider, including, for example, the expected tax consequences of investment decisions. An exempt organization can delegate investment management functions to a professional or firm outside the organization so long as the organization exercises care in selecting and overseeing the agent and reviewing the agent's performance. Best practices include having a dedicated investment committee with a detailed charter outlining its duties and responsibilities, a written investment policy describing the investment goals and risk tolerance of the organization as well as such matters as asset allocation (required in New York), and regular oversight of investment advisors.

Executive Compensation & Employee Benefits Developments. Peter Marathas, Partner, reminded attendees that the IRS will soon release guidance on Code Section 457(f) "ineligible plans" that is intended to "synchronize" the rules for these plans with the rules under Code Section 409A. These rules will, among other things, establish strict standards for so-called severance plans under Code Section 457(f). In addition, Mr. Marathas discussed the enhanced fee disclosure rules applicable to ERISA-governed 403(b) arrangements and also explained the IRS's new guidance on the rules for terminating 403(b) plans. He reviewed some of the requirements of the Patient and Protection and Affordable Care Act (PPACA) for 2012, noting that the cost of coverage will be required to be reflected on Form W-2 for 2012 for all employers with more than 250 W-2 employees and that all health plans must issue a summary of benefits coverage in addition to summary plan descriptions starting in 2012. Mr. Marathas also noted that plan sponsors will have to being to report on the "quality of care" provided under their group health plans to both participants and Health and Human Services in 2012 and all plans will be required to pay a fee based on the number of members in the plan to fund research of comparative treatment, also beginning in 2012.

A replay of the seminar is available by following the instructions below:

Go to: https://university.learnlive.com/login.aspx?data=95lteOCcxJE47lfCNcK0DtkZNdraabwVhSTEu8hVkGBVJEMjqdMJtzrQcjM%2b3cZCQOLbcBsEAlc%3d

Login with your existing user name and password.
If you do not have a user name and password, please select the "New Student Registration" button to create a new account. You will need to enter the Proskauer Company Code: 9736529.
Select the "Catalog" tab at the top of the page. Select the "Enroll" button to the right of the course titled "Trick or Treat Seminar 10-31-11."
Select the "Continue" button in the pop up.
Select the "Launch" button to open the course and begin watching. Please be sure to allow pop-ups and click the boxes that appear on the screen to receive CLE credit.

Recent Changes in Delaware Law Governing Not-for-Profit Corporations

Kathleen E. Gerber — Wed, 05 Oct 2011 11:49:08 -0500

Incorporating under Delaware law can be an attractive option for a not-for-profit organization because Delaware law often grants greater flexibility with respect to the governance and structuring of the organization. For example, under Delaware law, a corporation (whether organized for profit or not) is only required to have one director, whereas the majority of states require a not-for-profit organization to have at least three directors, and Delaware law does not require a corporation to have officers.

Unlike many other jurisdictions, Delaware does not have a separate code governing not-for-profit corporations. Instead, not-for-profit corporations are governed by the same Delaware General Corporation Law (the “DGCL”) that applies to for profit corporations. Typically, although other entity options are available for forming a Delaware not-for-profit organization (such as a trust or a limited liability company), most Delaware not-for-profit entities choose to incorporate as a nonstock corporation (i.e., a corporation that is not authorized to issue capital stock and that has “members” and a “governing body” rather than “shareholders” and a “board of directors”).

In the past, the proper application of the DGCL to not-for-profits was not entirely clear, because most provisions of the DGCL use terms specific to stock corporations, such as the terms “shareholders” and “board of directors.” As part of a comprehensive revision of the DGCL to clarify its application to nonstock corporations generally, Section 114 was added to the DGCL in August 2010 to specifically “translate” the terms in the DGCL applicable to stock corporations into terms applicable to nonstock corporations (e.g., references to “shareholders” are now deemed to refer to the “members” of a nonstock corporation).

The 2010 amendments also revised the DGCL to require nonstock corporations to have members. Previously, there was no such explicit statutory requirement and the Delaware Department of State’s Division of Corporations had taken the position that a nonstock corporation could choose to exist without members by providing in the bylaws that the corporation would not have members. However, the 2010 amendments also added a savings clause in Section 102(a)(4), which provides that neither a nonstock corporation’s existence nor any of its actions will be invalidated by virtue of its failure to have members and where the certificate of incorporation and bylaws are silent regarding the requirements for membership, the persons who are entitled to elect the governing body will be deemed to be the nonstock corporation’s members.

The 2010 amendments distinguish between for profit and not-for-profit nonstock corporations, making it explicitly clear in Section 114(d)(3) that members of a not-for-profit nonstock corporation cannot take an equity interest in the corporation. Accordingly, there should be no concern that having members will necessarily cause a Delaware not-for-profit nonstock corporation to run afoul of the prohibition against private inurement under federal tax law that applies to Section 501(c)(3) organizations (for more on the prohibition against private inurement, see our prior blog post).

IRS Tutorial Explains the Special Rules for International Activities of U.S. Charities

Jacob I. Friedman — Sun, 02 Oct 2011 19:00:17 -0500

The IRS presents webinars on a variety of subjects. In August, the IRS presented a webinar conducted by two IRS representatives on the special rules affecting charities that make grants to foreign organizations or engage in activities in foreign countries.

In a fairly comprehensive course, the following significant points were made:

1. A U.S. charity can do anything in a foreign country that it can do here, provided that the activity is consistent with the charity’s exempt purposes.

2. For purposes of the rule that a charity may not devote a substantial part of its activities to legislative lobbying:

a. lobbying includes action by the public in a referendum, ballot initiative, constitutional amendment or similar procedure;

b. actions by executive, judicial or administrative bodies are not considered legislation;

c. legislation includes foreign laws; and

d. in certain countries ruled by authoritarian or theocratic regimes, it is questionable whether the governing body is a legislature or if a legislative process even exists.

3. A charity is prohibited from directly or indirectly participating in a political campaign of a candidate for a foreign public office, and may not make a contribution to any such campaign.

4. In a country ruled by a dictatorship, a charity’s criticism of the regime in the course of advocating for democracy, the rule of law or human rights would not ordinarily be regarded as intervention in a political campaign.

5. The operation of a foreign school must meet the same non-discrimination requirements that are mandatory for domestic schools.

6. A charity must exercise reasonable care to ensure that its assets are used for charitable purposes. A charity can demonstrate that it exercised this care by:

a. maintaining procedures for properly vetting a foreign grantee, such as requiring a written application from the grantee and conducting background checks;

b. entering into an agreement with the foreign grantee that sets forth the purpose of the grant; and

c. exercising oversight of the grant to ensure that the grant is used as intended.

7. Proper documentation may include periodic reports, accounting of expenses, copies of receipts, reports of on site visits by agents of the granting charity and photos and videos showing the charitable program.

8. The charity should review the reports and take corrective action, where appropriate.

9. A charity’s exempt status can be revoked if the charity makes grants to foreign organizations and it cannot demonstrate that the grants were actually used for exempt purposes.

10. If a corporation makes a contribution to a charitable trust, the funds must be used within the United States in order for the contribution to be tax deductible.

11. Contributors may not earmark funds for the use or benefit of any specific organization or individual.

12. Contributors may designate their contributions to go to a specific purpose such as earthquake relief. A charity may also accept non-binding recommendations or advice from donors.

13. “Friends of” charities must exercise discretion and control over the funds they raise. The IRS looks at the following positive factors:

a. whether the charter provides that the board has discretion to allocate funds raised to any charity;

b. whether the bylaws provide that the board will review all requests for funds, require that the requests specify the proposed use of the funds and require a periodic accounting of funds granted;

c. whether the bylaws allow the charity to solicit funds for a specific project or purpose approved by the charity, but retain the charity’s right to withdraw approval of the grant and use the funds for other purposes; and

d. whether the charity makes these policies known to donors upon request, and refuses to accept contributions earmarked so that they must go to the foreign organization.

14. A donor-advised fund may not make a grant to individuals or make any grant for non-charitable purposes.

15. A Type III supporting organization may not support an organization that is not organized in the United States.

16. A charity may distribute funds to foreign organizations that are not charities. The U.S. charity must be sure that the funds are used for specific projects that further its own exempt purposes. It must keep records and show it controls the distribution of the funds. The charity can demonstrate that it exercises such control by implementing the following procedures:

a. engaging in an independent decision-making process (with no requirement that the charity listen to the donor’s direction) about whether it will provide funds to a foreign organization;

b. conducting a pre-grant inquiry to be reasonably sure that the grant will be used for exempt purposes;

c. entering into a written agreement with the recipient regarding the use of the funds; and

d. obtaining reports that the funds were used for approved exempt purposes.

17. Charities, in conducting their foreign activities and grantmaking, should be mindful of the sanctions programs of the Treasury Department’s Office of Foreign Asset Control known as OFAC. OFAC has programs that ban a broad range of programs in or with certain countries. In some cases a charity may need to obtain a license from OFAC in order to conduct the activity.

18. OFAC has a program that forbids transactions with specific named individuals and organizations. A list of names is available on the OFAC website. Violations of these programs can lead to civil fines and criminal penalties.

19. The Commerce Department’s Bureau of Industry and Security (BIS) also restricts export of certain equipment and technology to certain countries. Information in this program is available on the BIS website.

20. Charities that have foreign investments may have to file certain information returns (besides the 990) such as:

a. Forms 926 and 5471 relating to foreign corporations;

b. Forms 3520 and 3520-A relating to foreign trusts and foreign gifts;

c. Form 8621 relating to passive foreign investment companies and qualified electing funds; and

d. Form 8865 relating to foreign partnerships.

21. Under the income tax withholding rules, a charity that makes a payment to a nonresident alien or a foreign organization, such as compensation for services performed in the United States, may need to withhold tax on a portion of the payment and pay it over to the IRS.

22. If a charity has a financial interest in or signature authority over a foreign financial account, such as a bank account, brokerage account, mutual fund or trust and the aggregate value in the accounts exceeds $10,000 at any time, then the charity may be required to file Form 90-22.1, popularly known as FBAR.

23. Failure to file an FBAR when required to do so may result in civil penalties and criminal penalties. If a charity failed to file an FBAR for earlier years, it should file the delinquent reports and attach a statement explaining why the reports are late.

Treasury Releases its Priority Plan and the Form 990 Implementation Regulations

Jacob I. Friedman — Tue, 13 Sep 2011 08:15:35 -0500

Treasury just released the 2011—2012 Priority Guidance Plan. The Plan lists 317 projects that are priorities for Treasury resources through June 2012. Included in these projects are 13 projects directly related to Exempt Organizations. Many of the other projects such as the 66 employee benefits, executive compensation and employment taxes projects may affect Exempt Organizations.

Among the projects directly relating to Exempt Organizations are:

Updating grantor and contributor reliance criteria;
Regulations on additional requirements for charitable hospitals;
Final regulations on the new supporting organization requirements;
Update on guidance for distributions by private foundation to foreign charities;
Guidance on excess business holdings and program-related investments rules;
Regulations on new donor advised funds rules; and
Final regulations on church tax inquiries and examinations.

Treasury also released final regulations under various Code Sections to implement the redesigned Form 990 . According to Treasury "All tax-exempt organizations required to file [990s] are affected by these regulations."

The final regulations:

allow for new threshold amounts for reporting compensation;
require reporting on a calendar year basis;
modify the scope of organizations subject to reporting upon a substantial contraction;
eliminate the advance ruling process;
change the public support computation to five year; and
clarify that support must be reported using the organization's overall method of accounting.

New Form 8940 for Miscellaneous Exempt Organizations Determination Requests

Christopher T. Bird — Sun, 14 Aug 2011 21:39:04 -0500

The IRS released a new form last week for tax-exempt organizations to request determinations about their tax-exempt status (other than an initial application for exemption). There was previously no form for making such requests. The one-page Form 8940 , Request for Miscellaneous Determination, can be used to make a request for:

advance approval of private foundation scholarship procedures;
advance approval of certain private foundation set-asides;
advance approval of private foundation voter registration activities;
exemption from Form 990 filing requirements;
advance approval that a potential grant or contribution constitutes an "unusual grant" excluded from certain public support calculations;
change in type (or initial determination of type) of a Code Section 509(a)(3) supporting organization;
reclassification of foundation status, including a voluntary request from a public charity for private foundation status;
termination of private foundation status under Code Section 507(b)(1)(B)　(advance ruling request); and
termination of private foundation status under Code Section 507(b)(1)(B)　(60-month period ended).

However, organizations applying for recognition of exemption under Section 501(c)(3) and simultaneously requesting either an advance approval of scholarship procedures or exception from filing Form 990 should include their request with their Form 1023, rather than file Form 8940.

Organizations must also submit with their Form 8940 a user fee and information to support their request, as detailed in the instructions to the form. More information, including a user fee schedule, can be found on the IRS website.

IRS Releases New FAQ Guidance on Reporting Governance Practices on Form 990

Kathleen E. Gerber — Wed, 29 Jun 2011 14:59:21 -0500

The IRS recently released a new list of FAQ and tips for Part VI of Form 990, which requires an exempt organization to provide certain information about its governing board and management, as well as its governance policies and disclosure practices.

Of particular interest is the clarification that questions in Section B (about whether an exempt organization has adopted certain governance policies such as a written conflict of interest policy and a written whistleblower policy) may be answered affirmatively if a committee of the board with the power to do so has approved such policies by the close of the tax year. This should come as welcome news to those exempt organizations that reacted negatively to a 2010 revision to the instructions, which stated that an organization should only answer yes to these questions if its entire governing board adopted the policies. Some exempt organizations complained that requiring full board approval was in contrast to their usual practice of delegating the authority to adopt such policies to a committee of the governing board. An IRS official indicated earlier this week that in addition to making this point clear in the new FAQ, the IRS will be revising the 2011 instructions to Form 990 accordingly.

Some of the other key points of guidance in the new FAQ are highlighted below:

Clarification on whether the policies and practices described in Part VI of Form 990 are required by law: The response to FAQ 2 acknowledges that generally, these policies and practices (for example, a written conflict of interest policy) are not required by the Code, but warns exempt organizations that the IRS will use the information reported to assess an exempt organization’s noncompliance and risk of noncompliance with federal tax law, and also reminds them that the Code requires exempt organizations to make certain items described in Question 18 publicly available (such as an exempt organization’s Forms 990 for its three most recent tax years).
No requirement of receipt and review of the Form 990 by the governing board: The response to FAQ 6 acknowledges that the Code does not require an exempt organization to provide a copy of its Form 990 to the governing board or require review of the Form 990 by the governing board prior to its filing. However, the response reminds exempt organizations that they are required to answer Question 10 of Part VI, which specifically asks if the exempt organization took either of these actions prior to filing the form.
Deadline for adopting a policy for Form 990 reporting purposes: The response to FAQ 3 provides that where a question specifically asks whether the exempt organization adopted a particular policy as of the close of its tax year, the organization must answer no if the policy was not in place by that time; however, if an exempt organization adopted the policy after the close of the tax year, but prior to filing the Form 990, it may include this information in Schedule O of the form.
Extent of due diligence efforts required when evaluating director independence and certain relationships of board members, officers and key employees: The response to FAQ 8 clarifies that an exempt organization need not engage in more than a “reasonable effort” to obtain the information necessary to answer Questions 1 and 2 of Part VI, which request information about director independence and business and family relationships among board members, officers and key employees. The response also provides that an example of a “reasonable effort” would be the annual distribution of a questionnaire to each of these persons asking the necessary information. Importantly, the response states that an exempt organization may rely on the information it obtains in response to such a questionnaire when answering these questions.

URGENT: Treasury Must Receive FBAR Filings by June 30 - for Most Filers

Amanda Nussbaum, Robert Projansky, Pamela Onufer — Mon, 27 Jun 2011 16:33:55 -0500

As reported in our prior blog entry, the Report of Foreign Bank and Financial Accounts, Form TD-F 90-22.1 (“FBAR”) must be filed by a U.S. person that holds a financial interest in, or signature or other authority over, a foreign financial account if the aggregate value of all such U.S. person’s foreign financial accounts exceeds $10,000 at any time during the year. These reporting requirements apply to a tax-exempt organization even if the organization is not required to file an annual return on Form 990.

On June 16, 2011, the Internal Revenue Service released guidance (Notice 2011-54) stating that persons having signature authority over, but no financial interest in, a foreign financial account in 2009 or earlier calendar years for which the reporting deadline was extended by Notice 2009-62 or Notice 2010-23 will now have until November 1, 2011 to file FBARs with respect to those accounts. However, the deadline for reporting signature authority over, or a financial interest in, foreign financial accounts for the 2010 calendar year remains June 30, 2011. For further coverage of recent FBAR guidance, please see our March 14, 2011 Client Alert and our June 9, 2010 blog entry.

Click here to access the link to the IRS notice.

275,000 Nonprofits Lose Tax-Exempt Status

Christopher T. Bird — Mon, 20 Jun 2011 11:28:48 -0500

The IRS announced June 8, 2011 that approximately 275,000 organizations lost their tax-exempt status because they did not file annual returns for three consecutive years. The IRS has published on its website separate lists of affected organizations for each state; OpenData also provides on its website a searchable combined list.

While Section 6033(a) of the Tax Code requires most tax-exempt organizations to file annual information returns, the Pension Protection Act of 2006 imposed a filing requirement on small organizations for the first time in 2007. Despite the IRS’s information campaign over the last several years, it appears many organizations nevertheless remained unaware of their filing obligations and that, under Code Section 6033(j), organizations will lose their exempt status if they do not file for three consecutive years.

What does automatic revocation mean for organizations and their donors? An organization that loses it tax-exempt status must pay corporate income tax on its annual revenues and file the appropriate income tax return. The organization may also lose its state tax exemption if such exemption is dependent on federal tax-exempt status. In addition, the organization will no longer be eligible to receive tax-deductible charitable contributions.

Organizations subject to automatic revocation that wish to have their tax-exempt status reinstated must file an application for exemption and pay the appropriate user fee. In a show of heart, the IRS is allowing small organizations (i.e., those with annual gross receipts of $50,000 or less for 2010) applying for reinstatement to pay a lesser application fee of $100 instead of the usual fee of $400 or $850. And in an even grander gesture, the IRS will treat eligible small organizations applying for reinstatement before December 31, 2012 as having established “reasonable cause” for their filing failures, meaning their tax-exempt status will be reinstated retroactive to the date it was automatically revoked.

Eligible small organizations should consult IRS Notice 2011-43 to take advantage of retroactive reinstatement. Other organizations seeking retroactive reinstatement should review IRS Notice 2011-44. More information on automatic revocation, including a helpful FAQ, can be found on the IRS website and our previous posts on April 5, 2010 and July 27, 2010.

Type II Supporting Organizations Must Have Readily Identifiable Beneficiaries

Jacob I. Friedman — Wed, 11 May 2011 09:19:24 -0500

In a tightly written plain English opinion, the D.C. Circuit Court of Appeals in Polm Family Foundation v. U.S. explained an important requirement of Type II supporting organizations.

To be a Type II supporting organization, a charity must satisfy three tests:

1. the organizational test set forth in IRC Section 509(a)(3)(A),

2. the relationship test set forth in IRC Section 509(a)(3)(B)(ii), and

3. the control test set forth in IRC Section 509(a)(3)(C).

While the district court concluded that the charity failed both the relationship test and the control test, the Court of Appeals based its decision on the failure to satisfy the organizational test. The Court said that this test was the most straightforward.

All supporting organizations must satisfy the organizational test – to be organized and operated exclusively for the benefit, functions and purposes of one or more “specified” public charities.

The regulations permit a Type II supporting organization to satisfy the specification requirement by designating a “readily identifiable” class of supported charities, but need not identify them by name.

The problem with this charity was that its certificate of incorporation designated as supported organizations,

“the class of organizations . . . which support, promise and/or perform public health and/or Christian objectives, including but not limited to Christian evangelism, edification and stewardship.”

The court agreed with the IRS that this formulation does not make the supported organizations “readily identifiable” – there is no limit on geographic area and no limit on types, such as churches or seminaries. Therefore, it is not a public charity but a private foundation.

It is not clear what level of specificity would have been satisfactory. It is clear, however, that charities should attempt to iron out the parameters with the IRS rather than go through the expense and agony of litigation.

IRS Warns that Fringe Benefits Trigger Intermediate Sanctions

Kathleen E. Gerber — Tue, 03 May 2011 16:46:10 -0500

At a recent conference on nonprofit governance sponsored by Georgetown Law Center, an IRS official stated that fringe benefits have become the most common trigger of intermediate sanctions under Section 4958 of the Code.

As most of you know, or should know, Section 4958 of the Code, enacted in 1996, imposes excise taxes on both “disqualified persons” who receive an “excess benefit” from an exempt organization and any organization manager who knowingly participates in an excess benefit transaction.

When an economic benefit is not treated as compensation by the organization, the benefit is presumed to constitute an excess benefit transaction in its entirety, unless the disqualified person can establish that it was properly excludable from income for income tax purposes, or involved a legitimate non-compensatory transaction with the organization.

In February of 2010, the IRS began its first Employment Tax National Research Project in 25 years. This three-year “study” focuses on uncollected taxes in the area of employment for both taxable and exempt entities. As part of this study, 2,000 taxpayers are being selected each year for a comprehensive audit. Fringe benefits are one of the main areas of focus in these audits, making this a priority issue for the IRS.

Exempt organizations should take note. While executives of charitable organizations often receive fringe benefits as part of their compensation package, organizations may fail to include the value of those benefits when calculating the total compensation paid to executives and may fail to report them on the executive’s W-2. If taxable fringe benefits are not included on the executive’s W-2, the omitted amount is an “automatic” excess benefit transaction.

Conference attendees report that Peter Lorenzetti, a manager in the Exempt Organizations division of the IRS, warned exempt organizations that for excludable working condition fringe benefits, organizations must put in place a comprehensive plan that provides guidance on reimbursements and requires employees to substantiate the expenses. A panelist at the conference noted that employees must present original receipts, rather than credit card statements, in order to meet these substantiation requirements. The panelist recommended that the board of an exempt organization should routinely review the CEO’s expense reimbursements to insure that they are appropriate. The IRS manager also reminded exempt organizations that with respect to any taxable fringe benefits, an organization must make its intent to treat such benefits as compensation clear in order to avoid the presumption that the provision of such benefits constitutes an excess benefit transaction.

Charity Loses Tax Exemption Because of Private Inurement - Is Your Charity Immune?

A. Nicole Spooner — Thu, 07 Apr 2011 09:00:00 -0500

In PLR 20113041, the IRS revoked the tax exemption of a public charity based on excess benefit and private inurement issues. This ruling highlights practices that charities should avoid in order to maintain their tax-exempt status.

The charity's primary purpose was to pursue the study of how the interaction of land use, disturbance, and climate impact the structure and biodiversity of a particular region, and publish papers relating to such study. The charity had only one staff member who also functioned as the President. The charity's governing board consisted of three immediate family members - the President, his father (Vice President), and his wife (Secretary/Treasurer).

The IRS noted that the President had no employment contract with the charity and the charity itself had no Conflict of Interest Policy in place to determine how any conflicts, potential or actual, would be addressed.

The charity's records demonstrated that the President "consistently utilized" the charity's income for private purposes. Among the most egregious examples, the charity's records established that:

1. The President routinely made "loans to officers," but never fully substantiated the purpose of these loans. Moreover, the charity's board approved these loans, which were withdrawals from the charity's checking account and payments for the President's personal expenses, "after the fact." Note that since the charity had no Conflict of Interest Policy, the President who made these loans in the first place, then approved these "loans" with his wife and father. All of these amounts went into a "Loans to Officers" account and inadequate records were kept on how this money was spent to further the charity's exempt purposes.

2. The President sold luxury vehicles to the charity, but never transferred title, and performed upgrades without being able to prove that the vehicle even existed or was owned by the charity. Similarly, the charity paid for the President's car expenses without asking for business substantiation for these expenses.

3. The charity paid the President's personal legal expenses.

Interestingly, the IRS focused on the President's withdrawals from the charity's accounts that could not be substantiated as being for the furtherance of the charity's exempt purpose and also touched on ways in which the governing board was not providing proper oversight. In fact, the IRS noted that the charity's inurement issues and excess benefit transactions "resulted from the organization being under the control of one-person with a family-based governing board."

Moreover, the IRS noted that because of the charity's structure, "sufficient safeguards ha[d] not been put in place to prevent future violations...." Charities should be aware that governing procedures and policies, including a Conflict of Interest Policy and a recordkeeping policy, can provide these types of safeguards and help an organization function more efficiently and effectively. In fact, this ruling is a staunch reminder that these policies should be used where appropriate and tailored to the needs of each organization.

This ruling should force each charity to examine its organizational and governing structures to ensure that its board constitutes an independent body so that, unlike the charity here, its governing board has no "inherent conflict of interest when placed in a position to approve financial transactions...."

The amount of compensation paid was also at issue here because the President's salary was considered excessive based on the size of the organization's budget. Accordingly, charities, particularly smaller charities, should use comparability data, to the extent possible, in determining the salaries of its various officers and other staff. Also, having a well-written employment contract with senior employees or officers may help a charity better defend the terms and scope of an employee's or officer's employment and compensation.

This ruling confirms that the IRS is paying close attention to what charities are doing in their "back" offices. Consequently, charities that are not exercising good governance practices will certainly be at risk for revocation of their tax-exempt status.

For additional information on good governance practices for charities, please see our Good Governance, Getting Back to Basics, and Lessons Learned blog entries.

Attorney General Issues Guide on the New York Prudent Management of Institutional Funds Act

Yafang Deng — Fri, 25 Mar 2011 18:36:47 -0500

On March 17, 2011, the New York State Attorney General’s Charities Bureau published “A Practical Guide to the New York Prudent Management of Institutional Funds Act” (the “Guide”). The Guide provides a summary of the New York Prudent Management of Institutional Funds Act (“NYPMIFA”) as well as practical guidance on its application. Although the Guide is not an official regulation, since the Charities Bureau is tasked with enforcement of NYPMIFA, not-for-profit institutions are well advised to take this guidance into serious consideration.

As we have previously reported, NYPMIFA was enacted into law on September 17, 2010. It updates the Uniform Management of Institutional Funds Act, which had governed charitable endowment funds since 1978, with New York’s unique version of the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”). By doing so, New York became the forty-seventh state to have enacted a version of UPMIFA.

NYPMIFA makes several important changes to prior law. Most importantly, NYPMIFA drops the requirement that institutions maintain the “historic dollar value” or original dollar amount of a gift. Instead, NYPMIFA sets forth certain investment and expenditure standards to ensure that endowment funds are used and maintained in a prudent manner. To balance this grant of broader discretion to charitable institutions, NYPMIFA also imposes new notice, decision-making, and corporate governance requirements on institutions and their boards.

Prior Donor Notice

In the Guide, the Charities Bureau highlights several key issues. First, the Guide addresses questions regarding the required notice to donors of gifts made prior to September 17, 2010. NYPMIFA provides that an institution must give 90-days prior written notice to “available” donors (those who are living and can be found with reasonable efforts) before exercising its new power to invade the historic dollar value of the gift. The notice grants each donor an opportunity to opt-out of appropriations below the historic dollar value of the gift. If a donor chooses to opt-out of appropriations below historic dollar value, the prudent investment and expenditure standards enacted by NYPMIFA still apply to the gift. During the 90-day notice period, an institution can continue to appropriate from these funds as long as no expenditure below historic dollar value is made until the donor has granted his or her approval or the 90-day period expires.

The statute (N-PCL § 553(e)(1)) requires that the notice contains language substantially as follows:

Attention, Donor:

Please check Box #1 or #2 below and return to the address shown above.

( ) #1 The institution may spend as much of my gift as may be prudent.

( ) #2 The institution may not spend below the original dollar value of my gift.

If you check Box #1 above, the institution may spend as much of your endowment gift (including all or part of the original value of your gift) as may be prudent under the criteria set forth in Article 5–A of the Not-for-Profit Corporation Law (The Prudent Management of Institutional Funds Act).

If you check Box #2 above, the institution may not spend below the original dollar value of your endowment gift but may spend the income and the appreciation over the original dollar value if it is prudent to do so. The criteria for the expenditure of endowment funds set forth in Article 5–A of the Not-for-Profit Corporation Law (The Prudent Management of Institutional Funds Act) will not apply to your gift.

Institutions may wish to add an assurance to donors that their gift will still be subject to the prudent use standards enacted by NYPMIFA even if they opt out of below historical value appropriations by checking Box #2.

The statutory language describing the notice requirement raised the question of whether notice is required if the institution has no present plans to appropriate below historic dollar value. The Guide answers this question definitively, stating that notice is required to all prior donors, regardless of the institution’s expenditure plans. There are only three exceptions to the notice requirement: (1) the gift instrument already permits spending below historic dollar value; (2) the gift instrument expressly prohibits spending below historic dollar value; (3) the donor made the gift in response to an institutional solicitation but did not include a separate statement restricting use of the funds.

Expenditure Decisions

NYPMIFA provides eight prudent use factors to be considered, if relevant, in all endowment fund appropriation decisions:

The duration and preservation of the endowment,
The purpose of the institution and the fund,
General economic conditions,
The possible effect of inflation or deflation,
The expected total return from income and appreciation of investments,
The institution’s other resources,
The alternatives, where appropriate, to spending and due consideration to the impact of those alternatives on the institution,
The institution’s investment policy.

The Guide clarifies that an institutional board must either consider each factor or make a specific determination that the factor is not relevant. The consideration of the factors and any determinations that a factor is irrelevant must be documented in a contemporaneous record. The record must describe the substance of the consideration rather than making a conclusory statement. The form of the record is not important; meeting minutes are sufficient, but a board can choose to develop a separate record. The record may, but need not, incorporate any written advice the board receives from professionals in making its decisions.

The seventh factor, the consideration of alternatives to spending, is unique among the states that have adopted UPMIFA. The Guide explains that the factor is intended to ensure that boards do not automatically turn to endowment expenditure when alternatives such as fund-raising, expense reductions, sale of assets, staff reductions, or deferred expenditures would better serve the institution and the fund. All considered alternatives should be documented in the record of the decision.

While these factors are meant to be applied on a fund-by-fund basis, the Guide indicates that a single decision can be made regarding multiple endowment funds provided the funds are “similarly situated.” Written procedures for determining when a group of funds is similarly situated should be developed and may include factors such as the purposes, restrictions, financial condition, investment status, and duration of the funds. Even if a group appropriation decision is made, the decision should be justified if the prudent use factors were applied to each fund individually.

Investment Policy

NYPMIFA requires that charitable institutions have a written investment policy that applies to their endowment funds. While the statute provides a list of factors that should be considered in making investment decisions, NYPMIFA does not prescribe the contents of an institution’s investment policy. The Guide indicates that there is no ideal investment policy; however, it gives examples of subjects a policy may wish to address, such as:

General investment objectives,
Permitted and prohibited investments,
Acceptable levels of risk,
Asset allocation and diversification,
Procedures for monitoring investment performance,
Scope and terms of delegation of investment management functions,
The investment manager’s accountability,
Procedures for selecting and evaluating external agents,
Processes for reviewing investment policies and strategies,
Proxy voting.

Regular review and revision of the policy is recommended.

An institution’s investment policy also must set forth guidelines for any delegation of management and investment functions. The Guide advises institutional boards to be diligent in assessing the independence of outside investment agents both before and after retaining them. While NYPMIFA does not prohibit business or personal relationships between the board and its agents, the Guide cautions against the use of agents who may interfere with a board member’s ability to make independent decisions and provide proper oversight. The best course of action may be to adopt a policy requiring all outside agents to be independent. The Guide advises boards ideally to adopt a policy of full disclosure of relationships with outside agents. At a minimum, boards should adopt and follow a conflict of interest policy in making decisions about outside agents.

Releasing Gift Restrictions

NYPMIFA expanded on existing options for an institution to seek the release of donor-imposed restrictions on an institutional fund. The preferred and easiest method is a release granted through the donor’s written consent. If consent is not possible or not granted, an institution may seek judicial release of the restriction after notifying available donors and the Attorney General. The Guide advises institutions to submit a draft of any judicial petitions to the Charities Bureau prior to filing in order to resolve potential issues.

For “small, old” funds (funds that are less than $100,000 in value and have been in existence for more than 20 years) NYPMIFA also creates a non-judicial method for releasing fund restrictions. The institution must provide notice to the Attorney General and to available donors of the intent to modify or release the restriction. If the Attorney General does not respond within 90 days of the notice, the institution may proceed without further requirements.

The statutory language provides a limited exception to the donor notice requirement for the release of a “small, old” fund. As drafted, NYPMIFA states that notice to the donor is not required when the gift instrument limits the institution’s ability to appropriate below historic dollar value (as set forth in N-PCL § 553(e)(2)(B)). However, the Charities Bureau believes that the exception provision contains a drafting error and should in fact refer to funds received as a result of an institutional solicitation without a separate statement by the donor expressing a restriction on the use of the funds (N-PCL § 553(e)(2)(C)). Regardless, the Guide advises institutions to always provide notice to available donors.

For more information about investment management rules affecting not-for-profit organizations, please see our December 29, 2010 blog entry.

Proposed Regulations Expand IRS Authority to Disclose Charitable Organization Information to State Officials

Kathleen E. Gerber — Thu, 17 Mar 2011 16:42:07 -0500

On March 15, 2011, the Treasury published proposed regulations providing guidance on the IRS’s expanded authority to disclose information to appropriate state officers (“ASOs”) under Section 6104(c) of the Code, as amended by the Pension Protection Act of 2006 (the “Act”) . Section 6104(c) of the Code governs when the IRS may disclose certain information to an ASO about Section 501(c)(3) organizations (“charitable organizations”), organizations that have applied for recognition as charitable organizations (“applicants”), and certain other exempt organizations. Prior to the Act’s enactment, the IRS was only permitted to disclose a final determination denying an applicant exempt status, a final determination revoking a charitable organization’s exempt status, the issuance of a notice of deficiency of tax under Section 507 (the termination tax) or chapter 41 or 42 (which relate to excise taxes on prohibited activities), and, upon request of an ASO, returns and other information relating to any of these aforementioned disclosures.

The Act amended Section 6104(c) of the Code to expand the scope of information that the IRS may disclose to ASOs. Specifically, the amended provision permits the IRS to disclose the following additional information:

The issuance of certain proposed refusals to grant an applicant exempt status and proposed revocations of exempt status prior to administrative appeal and a final denial or revocation;
The issuance of a letter of proposed deficiency of tax under Section 507 or chapter 41 or 42;
The names, addresses and taxpayer identification numbers of organizations that have applied for exempt status under Section 501(c)(3); and
Returns and return information related to the proposed determinations and the identifying information of applicants noted above.

Generally, the IRS is only permitted to make these expanded disclosures upon written request from an ASO and only as necessary to administer state laws regulating charitable organizations. In contrast, the previously permitted disclosures relating to final determinations and notices of deficiency were automatic. However, the Act made the disclosure of returns and return information under Section 6104(c) of the Code subject to the disclosure, recordkeeping, and safeguard provisions of Section 6103 of the Code, which are designed to protect the confidentiality of such information. The proposed regulations provide that the IRS will not give automatic notification of any determinations or other information that may be disclosed under Section 6104(c) unless the disclosure, recordkeeping and safeguard provisions of Section 6103 of the Code have been met by the requesting ASO. The proposed regulations also state that the IRS may require an ASO to execute a disclosure agreement or similar document specifying the procedures, terms, and conditions for the disclosure or inspection of information, and provide that such an agreement will satisfy the written request requirement.

There is an exception from the written request requirement under Section 6104(c) of the Code, as amended by the Act, which permits the IRS to disclose returns and return information to an ASO on its own initiative if the IRS determines that such information might constitute evidence of noncompliance under the laws within the jurisdiction of the ASO. The proposed regulations take an expansive view of the IRS’s authority to disclose this information on its own initiative and without an ASO request and clarify that these discretionary disclosures may be made before the IRS issues a proposed determination (i.e. denial of recognition, revocation, or notice of deficiency), or takes other action. However, the proposed regulations limit the IRS’s ability to make these voluntary disclosures to an organization’s potential noncompliance with state laws that specifically regulate charitable organizations, rather than an organization’s potential noncompliance with more general state laws, and also require the IRS to determine when state laws may have been violated.

The proposed regulations also define key terms for purposes of Section 6104(c) of the Code, including “appropriate state officer”, “return”, “return information”, and “taxable person.” The IRS and the Treasury Department have requested general comments on the clarity of the proposed regulations, and have made a specific request for comments on whether the description in the proposed regulations of organizations to which these disclosures will apply lists all the organizations with respect to which ASOs might legitimately need information.

IRS Releases 2010 Schedule H and Grants Automatic Three-month Extension of Time to File

Elizabeth M. Mills — Thu, 24 Feb 2011 14:13:10 -0500

As we have previously reported, the Affordable Care Act (the "Act") included additional requirements for tax-exempt hospitals to maintain their tax-exempt status; these changes are effective for tax years starting after March 23, 2010, the enactment date of the Act. 　

These additional requirements included Form 990 reporting obligations for hospitals, which required some adjustments to Form 990 and the corresponding instructions. Late yesterday, the IRS released the 2010 Schedule H and instructions. The IRS also announced that hospitals should not file 2010 Forms 990 requiring Schedule H before July 1, 2011 and granted an automatic three-month extension to all such organizations whose Forms 990 would otherwise be due on or before August 15, 2011.　

This announcement does not affect the ultimate due date for such returns, but simply means that the three-month automatic extension will be granted without filing a request. Although the IRS has not yet issued guidance on the new hospital requirements, the new Schedule H and instructions will shed some light on their interpretations.

PPACA Emergency Room Reminder

Peter J. Marathas, Jr. — Wed, 16 Feb 2011 16:23:31 -0500

Federal legislation often includes provisions that lead to unintended consequences. One such provision in the Patient Protection and Affordable Care Act (the “Act”) likely has left some hospital benefits managers scratching their heads: a requirement that certain group health plans may not impose greater restrictions on out-of-network emergency care services (Section 10101(h) of the Act).)

Specifically, under the Act, starting in 2011, non-grandfathered plans must provide coverage for emergency services without regard to whether the provider is in-network or out-of-network.

In other words, a hospital that offers an incentive to its employees to use its own emergency room and not its competitors’ emergency room may not provide that incentive through the group health plan because the Act forbids it to impose greater restrictions on out-of-network emergency services.

While the regulations permit a group health plan to balance bill out-of-network emergency care, the bottom line is that straightforward incentives to use the hospital’s emergency room may be difficult to maintain in a group health plan.

We’ve heard that some hospitals are considering whether to drop the incentive rather than pay more for a competitor’s service under its group health plan. The provider’s logic is sound: rather than underwrite a competitor’s product, they’ll remove the subsidy from their own. Any reasonable business person would make the same choice. Some others are considering whether to offer some reimbursement through a health reimbursement account (“HRA”), a Band-Aid, at best and one that may or may not work under the Act.

Time will tell. For now, the intent of this provision in the Act—to provide participants with equal access to in-network and out-of-network emergency services—seems antithetical to the Act’s over-arching goal: to provide affordable health care to individuals.

Medical residents conclusively determined to be subject to FICA tax beginning April 15, 2005 under new U.S. Supreme Court decision

Elizabeth M. Mills — Fri, 11 Feb 2011 13:48:05 -0500

In Mayo Foundation for Medical Education and Research v. United States , the U.S. Supreme Court upheld the validity of a Treasury Regulation that states that the student exception from FICA (Social Security and Medicare) tax does not apply to medical residents because they work at least 40 hours per week. Applying the deferential two-part standard of review from Chevron the Supreme Court concluded that the relevant statutory provision was ambiguous and the regulation was a permissible interpretation of the statute.

For background on the medical resident FICA issue, click here.

As we have previously reported, since the 1990’s many academic medical centers and individual medical residents have filed claims with the IRS seeking refunds of FICA taxes paid on medical resident salaries based on the argument that the residents are students and thus exempt from FICA. In March 2010, the IRS announced that it would concede and pay outstanding claims for periods before April 1, 2005. April 1, 2005 is the date the new FICA regulation precluding student status for full-time workers went into effect.

In June of last year the Supreme Court agreed to hear an appeal of a decision by the Eight CircuitCourt of Appeals in which the Eight Circuit held that the regulation was valid and denied the taxpayers’ refund claims. The Supreme Court affirmed that decision. The Supreme Court stated that the statute does not define the term “student” or otherwise directly address whether medical residents are subject to FICA tax, and concluded that the full-time employee rule is a “reasonable interpretation” of the statute.

While the legal standard applied by the Supreme Court in determining the validity of tax regulations is of great interest to tax practitioners, the significance of this decision for most of us is that the debate about whether medical residents are exempt from FICA tax will finally be put to rest. All timely-filed claims covering periods before the regulation took effect are being paid by the IRS (see here for IRS information and frequently asked questions on this payment process). Medical residents will not be exempt from FICA tax for periods after the regulation took effect – regardless of whether refund claims were filed for post-4/1/2005 periods. Unless there is federal legislation, this multi-decade discussion seems to have come to an end.

National Taxpayer Advocate Recommends Statute of Limitations on Revocation of Tax-Exempt Status

Jacob I. Friedman — Wed, 12 Jan 2011 17:22:26 -0500

On the last day of 2010, the National Taxpayer Advocate, in its tenth annual report to Congress, recommended that Congress enact a statute of limitations on revocation of a charity’s tax-exempt status, to run concurrently with the current period of limitation on assessments. That period generally is (absent fraud, tax evasion or non-filing) either three or six years. (This specific recommendation appears on page 391 of the report).

Under current law, a charitable organization could face revocation of its tax-exempt status and a corresponding assessment in current years based on an audit of years that are closed for purposes of assessment (even though the charitable organization may have met all the requirements to maintain its tax-exempt status in the years open for assessment).

The National Taxpayer Advocate concluded that in light of the far-reaching impact that revocation has on charitable organizations and third parties, such as donors, it would only be fair to institute the protective safeguard of a statute of limitations on revocation.

The report includes an interesting quote from a 1922 Supreme Court case, United States v. Oregon Lumber Co., 260 U.S. 290, 299-300: “Statutes of limitation are vital to the welfare of society, stimulating activity, punishing negligence, and protecting parties from the prosecution of state claims, when, by loss of evidence from death of some witnesses, and the imperfect recollection of others, or the destruction of documents, it might be impossible to establish the truth.”

The Office of the National Taxpayer Advocate was established by Congress in 1996 to help taxpayers resolve problems with the IRS and recommend changes that will prevent the problems in the future.