Over the past few months the Internal Revenue Service (IRS) has indicated several areas of interest and possible audit activity, as well as several interesting announcements on a variety of topics. The article provides a summary of some of these areas.
Tax Exempt Bonds
A spokesman with the Tax Exempt Bonds division recently said that the IRS is conducting a limited number of examinations of outstanding bonds issued by 501(c)(3) organizations. The examiners are focusing on the Schedule K exempt bond disclosures from Forms 990 in making selections of organizations to be audited. Noncompliance with the bond rules could include uses of the bond-financed property that are different than outlined when the bonds were issued originally. This points out the importance of regular monitoring of exempt bond compliance by organizations and the need for very careful completion of the many disclosures on Schedule K.
Group Exemption Compliance
In its current year work plan, the IRS had announced that it would be taking a look at subordinate groups which are exempt under the group exemption process and do not have to individually apply for exempt status. Group rulings are applied for by a central or umbrella organization and cover all the local organizations/chapters that agree to be covered under the group ruling. An organization that is part of a group exemption may also be eligible to be included in the central organization’s group return if one is filed. However, many groups do not file group returns and there is confusion in this area.
The rules for obtaining and maintaining group exemptions are complex and there is concern about transparency and compliance in this area, especially with regard to filing returns. In fact, some organizations under group rulings have lost exempt status because of not filing Form 990 for three years, perhaps thinking that the return was being taken care of by the central organization. Recently, the IRS sent out questionnaires to some 2,000 central organizations with subordinate groups. The questionnaire can be accessed at http://www.irs.gov/pub/irs-tege/F14414.pdf. At this point, the IRS is using this process to gather data on these groups which have come under scrutiny in recent years on a number of fronts. We may see new regulations on groups as a result and quite possibly see a number of them subjected to IRS audits
The IRS announced that 3,377 hospitals will be reviewed this year under provisions of the Affordable Care Act, which calls for every tax-exempt hospital to be reviewed every three years primarily in the area of community benefit. This will be a “stealth” review: organizations will not know they are being reviewed and information will primarily be gathered from the hospital’s Form 990. Note that the Form 990 also has information about unrelated trade or business income, which the IRS may take the opportunity to review at the same time.
The IRS has been paying particular attention to political activity by 501(c)(3) organizations in this election year and investigating organizations based upon complaints received. 501(c)(3) organizations, including churches, are prohibited from all political activity including political speech.
Although the IRS has received many complaints about churches being involved in political activities, all church audits are on hold for now, according to an IRS
spokesman. This has been ongoing for a few years and will not be resolved until the IRS finalizes rules giving the IRS the authority to begin a church audit.
Section 501(c)(4) Social Welfare Organizations
These organizations are allowed to engage in political activity but not as a primary activity. Since the Citizens United decision by the Supreme Court, it appears that there may be some social welfare organizations where political activities are the primary or sole activity. The IRS has gotten many complaints and will be investigating those organizations about which complaints have been issued. The state of New York is also actively looking at this issue.
Most non-charitable organizations (e.g., 501(c) (4) and 501(c)(6)) are not required to formally apply to the IRS (with a Form 1024) in order to be tax-exempt. However, it is highly recommended that they obtain the assurance of a determination letter from the IRS. Now, the IRS is conducting an examination project of such “self-declared” exempt organizations to determine if they are, in fact, operating as tax-exempt organizations under their “self declared” code section. Although such organizations do not have to file an exemption application, they are required to file the appropriate Form 990 series information return. Not filing Form 990 for three years in a row will cause automatic loss of exempt status. In order to reinstate exempt status, the IRS will require an exemption application even in cases where the organization did not originally have to file one.
Many organizations with offshore activities or investments are required to file a number of forms, such as the Foreign Bank Account Report (FBAR), Form 5471, Form 926 and Form 8865. This is an area of high interest to the IRS and the penalties for noncompliance can be draconian. There have been two Offshore Voluntary Disclosure Initiatives (OVDIs) from the IRS in the past which are
now closed. Currently, however, the IRS has a third OVDI now open. It does not have an end date set, but could be closed without much notice. This is an excellent opportunity for tax-exempt organizations to file past due forms without penalty in most instances. Organizations that may have delinquencies in this area should consult a qualified international tax expert to see if they should consider the OVDI.
Private foundations may not make qualified distributions to foreign organizations unless the organizations have a 501(c)(3) public charity determination letter or an opinion from an attorney saying that the organization is the equivalent of a U.S. public charity. Under proposed regulations, equivalency opinions may be issued by CPAs and enrolled agents.
There are currently four bills in Congress to expand states’ ability to tax Internet sales. Such an expansion could certainly affect many nonprofit organizations. Since states are experiencing severe deficit problems, expect them to be pushing the envelope on sales tax issues. Even without the pending congressional legislation, if an organization has nexus with a state and sales in the state, there may be sales taxes due. Organizations should stay abreast of developments in this area and may wish to consider having an assessment done by a qualified expert before the state arrives with an audit notice. Sales tax audits can be very expensive.
The Supreme Court recently denied hearing a case where a minister had taken the parsonage allowance for a second home, effectively upholding a lower court verdict denying the allowance on multiple homes. Churches and their advisors should be sure that clergy are not taking the allowance on a second home.
This article was written by Michael Sorrells, National Director, Nonprofit Tax Services at BDO USA, LLP
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Winter 2013). Copyright‚© 2012 BDO USA, LLP. All rights reserved. www.bdo.com