News / Resources

There are a number of developments involving tax-exempt organizations and charitable giving, many of which stem from the complex and technical changes enacted as part of the Pension Protection Act of 2006.

IRS Joins Congress in Emphasizing "Good Governance"

For the last several years, the Senate Finance Committee has shown a keen interest in ensuring that tax-exempt organizations are operated in a manner which is transparent and responsive to the needs and responsibilities of their tax-exempt missions.The IRS joined the discussion in 2007 by issuing a preliminary staff discussion draft of possible good governance practices for charitable organizations. The discussion draft was expanded and released in February 2008 as "Governance and Related Topics -- 501(c)(3) Organizations." This guidance is available online. It provides an important view of IRS expectations regarding the governance of tax-exempt organizations and includes a discussion of topics such as board size and composition, executive compensation, conflict of interest, audited financial statements and policies on investments, codes of ethics and whistleblowers.

Tax-Exempt Organizations and Prohibited Tax Shelter Transactions

The IRS has issued proposed and temporary regulations to implement Code Section 4965. That Code Section targets tax-exempt organizations that serve as "accommodation parties" in tax shelter transactions by facilitating a benefit for a taxable party, and it was enacted in part as a reaction to promoters of tax shelters who took advantage of tax-exempt organizations. The regulations impose penalties on tax-exempt organizations that become parties to "prohibited tax shelter transactions" and on "entity managers" who knowingly approve an organization's participation in such transactions. Tax-exempt organizations and their managers should become familiar with these rules so they are not unwittingly exposed to these penalties.

Regulations Clarify Relationship Between Excess Benefit Transactions and Tax-Exempt Status

Recently issued final regulations clarify the relationship between maintaining tax exemption under Code Section 501(c)(3) and the imposition of excise taxes on "excess benefit transactions" under Code Section 4958. The final regulations adopt proposed regulations issued in 2005 with minor modifications.

The final regulations provide guidance on the factors the IRS will consider in determining whether an organization that engages in one or more excess benefit transactions should retain its tax-exempt status. Such revocation factors include (i) the size and scope of the organization's activities that further exempt purposes before and after the excess benefit transaction(s), (ii) the size and scope of the excess benefit transaction(s) in relation to the size and scope of the organization's regular and ongoing activities, (iii) whether the organization has been involved in multiple excess benefit transactions, (iv) whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions, and (v) whether the excess benefit transaction has been corrected or the organization has made good faith efforts to seek correction from the insiders who benefited from the transaction.

An example added to the final regulations illustrates the revocation factors and the emphasis the IRS will place on the safeguards to prevent excess benefit transactions. That example involves an excess benefit transaction that was not significant in comparison to the size and scope of an organization's exempt activities or de minimis. However, the IRS noted that the organization implemented written procedures to prevent the occurrence of excess benefit transactions, followed such procedures and amended them after an excess benefit transaction occurred. Such safeguards were a factor noted by the IRS in determining that the tax-exempt status of the organization in the example should not be revoked. The example in the final regulations underscores the importance of having carefully written policies and procedures to ensure compliance with the myriad of technical rules, such as those that apply to excess benefit transactions, governing the operation of tax-exempt organizations.

IRS Revises Tax-Exempt Organization and Charitable Remainder Trust Returns

• Substantially Revised Form 990 for Tax Years Beginning in 2008. Form 990, which is the annual information return filed by most tax-exempt organizations, has been substantially revised. Calendar-year organizations will be required to file the new Form 990 during 2009, while fiscal year organizations must use the new form in 2010 (for fiscal years commencing in 2008). A copy of the revised Form 990 can be found at the IRS website.
  
  The format of the new Form 990 is similar to a draft released in June 2007. It includes an 11-page "core" form together with 16 schedules. The core form includes a summary page with a "snapshot" of information regarding the organization's mission and activities, together with financial information. The core form also includes additional sections which require reporting on program service accomplishments, other IRS filings, governance, management and disclosure, compensation, revenue, functional expenses, balance sheet and financial statements. The various schedules are completed based on responses to questions in the core form.
  
  The new forms generally apply to all types of charities. However, for the 2008 tax year, hospitals will only be required to complete items concerning identifying information about hospital facilities; the entire schedule must be completed for tax years beginning in 2009. Similarly, only identifying information about bond issues is required for the 2008 tax year after which the entire Schedule will be required for tax years beginning in 2009.
  
  Many of the questions on the new Form 990 are self-explanatory. However, the new form was released without instructions, which will be important to understand the scope of questions and the definition of key concepts. The IRS released draft instructions on April 7, 2008. The Tax-Exempt Team at Baker Hostetler has reviewed the draft instructions and is prepared to assist organizations with their newly expanded reporting obligations.
  
  
• New Form 990-N "e-Postcard" for Smaller Tax-Exempt Organizations. Prior to the 2006 Act, tax-exempt organizations with $25,000 or less in gross receipts were not required to file any return with the IRS. Now, if an organization is not required to file a full return, it is required to file an electronic form annually.
  
  In order to implement this change the IRS released Form 990-N, commonly called the e-Postcard. The e-Postcard must be filed electronically for tax years that began in 2007. If an organization fails to file Form 990-N for three consecutive years, its tax-exempt status will be revoked. Churches or their integrated auxiliaries, conventions or church associations are not required to file.
  
  
• IRS to Make Form 990-T Available to the Public. Tax-exempt organizations that have unrelated business taxable income are required to file with respect to that income a Form 990-T. The 2006 Act requires that such forms must be available to the public upon request. However, a recent technical correction to the 2006 Act makes clear the IRS is now required to make Form 990-T publicly available. In Announcement 2008-21, the IRS indicated that Forms 990-T that were filed after August 17, 2006, now may be requested by filing Form 4506-A with the IRS. Moreover, it is anticipated that the IRS will provide Forms 990-T to Guidestar (www.guidestar.org), a website that posts information returns filed by tax-exempt organizations, disclosing only information relevant to the calculation of unrelated business taxable income, but not any other forms typically attached to Form 990-T.
  
  
• Revised Tax Return for Charitable Remainder Trusts, Pooled Income Funds and Charitable Lead Trusts. Form 5227 is filed by charitable remainder trusts, pooled income funds and charitable lead trusts. The IRS has released a revised Form 5227, Split-Interest Trust Information Return, which reflects changes enacted by the 2006 Act. In a related development, Form 1041-A is no longer required to be filed by charitable remainder trusts, pooled income funds and charitable lead trusts.

Charitable Giving Update

There have been a number of key developments in the area of charitable giving in recent months.

• Expiration of Certain Charitable Giving Incentives. The 2006 Act included many incentives for charitable giving that expired on December 31, 2007. They included an IRA charitable rollover, favorable treatment of contributions by S corporations, gifts of inventory (such as food and books) and gifts of conservation restrictions. Those incentives have not been extended to date although President Bush's recent budget proposal included a request that Congress consider such extensions.
  
  
• Gifts of Appreciated Property by S Corporations. As noted, the 2006 Act included favorable treatment of contributions by S corporations. In Revenue Ruling 2008-16, the IRS addressed the treatment of charitable gifts of appreciated property by an S corporation during 2006 and 2007 and determined that the intent of the 2006 Act provision was to permit an S corporation shareholder to deduct his or her pro rata share of the fair market value of the contributed property just as a partner does in a partnership. Under prior law, the charitable contribution deduction for an S corporation shareholder was limited to his or her basis in the S corporation stock.
  
  
• Charitable Lead Annuity Trust Samples. In Revenue Procedure 2007-45 and Revenue Procedure 2007-46, the IRS issued sample testamentary and inter vivos grantor and nongrantor charitable lead annuity trusts. Taxpayers who create trusts that are substantially similar to the samples or that integrate alternative provisions found in the samples are assured the trusts qualify as Charitable Lead Annuity trusts.
  
  
• Excise Tax on Unrelated Business Taxable Income of Charitable Remainder Trusts. The IRS has released proposed regulations providing that charitable remainder trusts with unrelated business taxable income in taxable years beginning after December 31, 2006, are exempt from federal income tax, but are subject to the new 100 percent excise tax on the unrelated business taxable income earned by the trust. The proposed regulations make it clear that the excise tax is treated as paid from corpus or principal of the trust and does not reduce net income which is otherwise taxable in the hands of the private beneficiary as it is distributed to the beneficiary.

Tax-Exempt Organization Update

The 2006 Act made a number of changes impacting the organization and operation of tax-exempt organizations. Tax-exempt organizations are still adapting to these changes.

Among other things, the 2006 Act included a number of changes to the Internal Revenue Code concerning "supporting organizations" -- public charities described in Code Section 509(a)(3). These organizations must operate for the benefit of, perform the functions of, or carry out the purposes of (i.e., "support") one or more public charities in certain categories described in Code Section 509(a)(1) or (2). The IRS has provided additional guidance regarding such supporting organizations.

• Guidance for Type III Supporting Organizations. The 2006 Act amended Code Section 509(a)(3) to designate three types of supporting organizations: Type I,"controlled by" one or more supported organizations (e.g., a parent/subsidiary relationship); Type II, "controlled in connection with" one or more supported organizations (e.g., where the same persons control the supporting organization and a supported organization); and Type III, "operated in connection with" one or more supported organizations (where the supported organizations do not control the supporting organization but have a "significant voice" in its operations, e.g., through representation on the governing body). In addition, the 2006 Act defined a "functionally integrated" Type III supporting organization (a more favorable classification) as an organization which performs a function of or carries out the purposes of a supported organization and, but for the supporting organization, the supported organization would normally engage in those activities directly.
  
  In Announcement 2007-87, the IRS indicated that it anticipated proposing requirements for Type III supporting organizations. For example, it is anticipated that functionally integrated supporting organizations will be required to satisfy two tests in addition to demonstrating that performance of functions or carrying out activities that the supported organization would have engaged in but for the supporting organization. Such tests are an "expenditure test" and an "assets test" that currently apply to private operating foundations and would ensure that a supporting organization expends sufficient resources on activities that further its supported organization(s). In addition, it is anticipated that Type III supporting organizations that are not functionally integrated will be required to expend at least 5 percent of the value of their assets annually to or for the benefit of their supported organization(s).
  
  
• Transitional Relief for Charitable Trusts Classified as Type III Supporting Organizations . Under the 2006 Act, if a Type III supporting organization is in trust form, the power of a beneficiary-supported organization to enforce the trust will not be sufficient in itself to meet the responsiveness test under the Code Section 509(a)(3) supporting organization regulations, which requires that the supporting organization demonstrate that it is responsive to the needs of the supported organization. Under the 2006 Act, if such a trust could not otherwise meet the responsiveness test it was reclassified as a private foundation on August 17, 2007.
  
  In Notice 2008-6, the IRS provided transitional relief to trusts impacted by these changes. Specifically, if a trust is able to demonstrate that officers or trustees of the supported organization(s) have a significant voice in investment policies, grant making and direction of the use of income or assets, then such trust may retain its Type III supporting organization classification. Otherwise, such supporting organizations must establish a Type I or Type II supporting organization classification described above or become a private foundation and be subject to a 2 percent tax on its investment income and to the limitations imposed on private foundations with respect to minimum payout, self-dealing, business holdings, etc. Such former Type III supporting organization may file Form 990 for taxable years that began before January 1, 2008, but must file Form 990-PF for taxable years beginning on or after January 1, 2008.

Continued Interest by IRS in Political Activities by Tax-Exempt Organizations

During each election cycle, the IRS reminds charitable and religious organizations of the statutory prohibition against engaging in political activity in support of, or in opposition to, a candidate for public office. Such prohibition is absolute and the most recent reminder was issued in November 2007. In addition, in Revenue Ruling 2007-41, the IRS set out a number of factual situations in which charitable organizations have, or have not, engaged in prohibited political activity. Because the penalty for violating the prohibition against political activity is the loss of tax-exempt status, it is critical that organizations not violate the prohibition.

Baker Hostetler is ready to help.

Baker Hostetler's Tax-Exempt Team advises a wide range of public charities, private foundations and other tax-exempt organizations with respect to obtaining and maintaining their tax favored status. Regularly, we work with clients on ways to best avoid violating the many technical and intricate penalties associated with the regulation of tax-exempt organizations and charitable giving vehicles. Our team is available to review and revise governance policies or to tailor new policies to the specific needs and operations of any given tax-exempt organization. In addition, we are available to counsel individual donors on how best to secure optimum benefits from the charitable giving programs.