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Form 1023

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Form 1023 Powered By Docstoc
					  National Government and
Not-for-Profit Training Program

    Form 990 and 1023 Revisions

        Frederick H. Rothman
Director of Tax Services, CPA, JD, LLM
    frothman@loebandtroper.com
      Loeb & Troper, New York




           Form 1023




                                         1
                           Overview
Required to be filed by an organization that wishes to be
recognized as Federally tax-exempt under IRC section
501(c)(3). To receive exemption an organization must be
operated exclusively for exempt purposes (charitable,
educational, religious, scientific…)
  If filed within 27 months of organization 501(c)(3) status will be
  effective as of organizational date
Organizations not required to apply are:
  Churches, Associations of Churches, Integrated Auxiliaries
  Organizations other than private foundations that have gross
  receipts of $5000 or less annually




                      IRS Processing
 Checked for EIN, User Fee, and Organizational
 Documents
 If 1023 meets the requirements it is put into the screening
 inventory
    Can request expedited processing if
       Pending grant that if not received might have adverse impact on
       organization’s ability to continue
       New organization created to provide disaster relief
       IRS caused delays with respect to issuance of letter
 Case assigned to screening agent who reviews the
 application and determines if the application needs further
 development or is sufficient to grant exemption




                                                                         2
                   IRS Processing

If the application is sufficient exemption is granted at this
point (within 60 days)
If not “screenable” the application is placed in general
inventory and then assigned to an agent that reviews the
application and contacts applicant and/or the Power of
Attorney to resolve any outstanding issues (Approximately
5 months until assigned and 7-8 months until exempt
status granted)
In certain cases, when the complexity of the application
warrants it, the application is sent to Washington to be
processed




               Why a Form Update?

Educate the taxpayer
Enhance Enforcement
Develop a user-friendly form and a faster process – IRS has
experienced significant processing delays due to the need to
request additional information that has now been added to
the form




                                                                3
                 The Need for Change
The prior Form 1023 (last updated in 1998):
  Included language and questions that were confusing to the
  “common” taxpayer
  Failed to identify common abuses of fraudulent taxpayers
  Did not clearly identify the basic requirements such as the
  organizational language for the Articles of Incorporation
  Commonly required additional Forms to be filed to be a valid
  application
  Included repetitive questioning for some applicants
  Was not “scannable”, and therefore, technologically outdated
  The inefficiency of the application was resulting in an extremely
  large backload for the IRS, delaying application approval




   The Main Differences – What’s Good for
                 Processing
 Checklist section to ensure application is complete
 Organizational document questions ensure appropriate
 items included
 Combines Filing Fee (former 8718) and Advanced
 Ruling Period Statute Extension (former 872-C) into the
 Form
 Requests the applicant to include with the Application
 Form 5768 for the 501(h) lobbying election




                                                                      4
  The Main Differences – What’s Good for
                Processing
Eliminates tax-exempt bond question and IRS internal
bond checklist is now obsolete
Instructions add a plain-language general discussion
about Section 501(c)(3) status and the difference
between private foundations and public charities
   Appendix A – Sample Conflict of Interest Policy
   Appendix B – State information
   Appendix C – Glossary of Terms




                  Other Differences

Longer, longer, longer!
Detailed questions regarding transactions with Officers,
Directors, Trustees and Key Employees
Detailed questions and compensation disclosures
regarding transactions with Independent Contractors
Board resumes and qualifications for the position
Detailed questions regarding foreign grant-making




                                                           5
                 Recurring Themes

Answers must include “Past, present, and planned
activities”
Repeatedly must describe the process for determining
fair market value of compensation and other payments
to both employees and independent contractors, even if
unrelated




                 Recurring Themes

Attempts to identify anywhere there could be an abusive
transaction between related parties
  Questions often require lengthy responses and IRS’ way of
  “casting its net”
  IRS knows the questions are more information than it may need
  for many organizations, but purposefully structured the Form in
  this manner to prevent abuses via education and to act as an
  enforcement mechanism




                                                                    6
                   List of Sections

Checklist
Part I – Identification of Applicant
Part II – Organizational Structure
Part III – Required Provisions in Your Organizing
Document
Part IV – Narrative Description of Your Activities
Part V – Compensation and Other Financial
Arrangements With Your Officers, Directors, Trustees,
Employees, and Independent Contractors




                   List of Sections

Part VI – Your Members and Other Individuals and
Organizations That Receive Benefits from You
Part VII – Your History
Part VIII – Your Specific Activities
Part IX – Financial Data
Part X – Public Charity Status
Part XI – User Fee Information
Schedules A - H




                                                        7
                   Form 1023 Checklist

 Required to be filed with the application, and the
 application may be returned if the checklist is not both
 included and complete. It references:
     List of forms and documents to include
     Sending the correct user fee
     Having already received an EIN (an organization can no longer
     request it as part of application filing)
     Cautions the applicant to ensure answers to questions are
     complete and accurate, and notes that financial information must
     correspond with the proposed activities
     Asks specific questions to ensure that organizational documents
     have appropriate Section 501(c)(3) language and that legal
     name is used for the application




         Part I – Identification of Applicant
Question 8: Did the organization pay anyone (other than an
officer, director, trustee, employee or a person listed on the
Form 2848) to help plan, manage or advise on the structure
of the organization, or about financial and tax matters?
If yes, the name, role and amount paid (or promised to be
paid) must be disclosed
   This is a significant addition in the information requested and is
   aimed at helping the IRS to identify paid preparer tax shelters and
   schemes as well as a excess private benefit transactions




                                                                         8
                     Part I, Continued
Question 9b: An email address can now be included. This
is in anticipation of future electronic security that will allow
agents to communicate electronically. Currently, agents
are not permitted to communicate with applicants
electronically; only written communication via letter or by
facsimile is acceptable
Question 12: Foreign corporations must state where they
were incorporated. This is the first of several new
questions especially for foreign corporations or for foreign
operations




        Part II – Organizational Structure
The organizational documents requested are explained in
more detail than before, based on available legal structures
(Corporation, LLC, Association or Trust)
   Questions 1 - 4 identify each of the four ways a Section 501(c)(3)
   may be formed and request the appropriate organizing document
   for each method
   Question 5 asks for the applicant’s bylaws showing the date of
   adoption or a description of how the officers, directors, or trustees
   are selected in the absence of bylaws
   IRS has added descriptions of each type of document to assist the
   applicant in understanding whether the entity was actually legally
   created, and the type of entity




                                                                           9
   Part III – Required Provisions in Your Organizing
                       Document
Both questions require that the specific language for the
organizing documents be included in such document. The
purpose clause is explained in question One and the
dissolution clause is explained in question Two
   Question 1 - The organization must exhibit clear section 501(c)(3)
   purpose and activities, and upon dissolution, the assets must revert
   to another section 501(c)(3) entity or purpose
   Question 2 – Dissolution clause with assets reverting to another
   section 501(c)(3) entity or purpose




      Part III – Required Provisions in Your
               Organizing Document
Added because of the significant delays in processing
applications due to the lack of conformity in the organizational
documents. Previously applications were often delayed for
months depending on the State of incorporation or the
amendment procedures for a trust document
Requiring a document to include the purpose and dissolution
clauses prior to application submission should allow for a more
efficient approval process. In the prior application, as the
organizational language was supplied in the instructions but not
referenced in the application itself, IRS found that many
organizations were unaware of the requirements




                                                                          10
    Part IV – Narrative Description of Your
                   Activities
 The general direction as to how to answer the question
 has not changed – the description should include past,
 present and planned activities in narrative form
    IRS does not want narrative to include references to possible
    future activities that are currently “hopes and dreams”
 The question allows the narrative to include references to
 other parts of the application. This is, in part, in response
 to the high volume of complaints about the prior
 application requesting redundant information




  Part V – Compensation and Other Financial
  Arrangements With Your Officers, Directors,
    Trustees, Employees, and Independent
                Contractors
Added in an effort to identify transactions resulting in
excessive private benefit and/or inurement
Provides IRS determination agents with the opportunity to
identify such transactions through a detailed review of the
organization at the time of filing for exemption




                                                                    11
                   Part V, Continued
Questions 1a, 1b, and 1c are similar to those asked on the
Form 990, Part V and Form 990 Schedule A, Parts I and II
  Question 1a asks for the a list of the organization's officers,
  directors, and trustees and their total annual compensation “for all
  services to the organization” regardless of the services capacity for
  which they receive it
     Not identical to the Form 990’s 3 columns as the Form 1023 only has
     one
  Question 1b requires the same information for the five highest paid
  employees over $50,000
  Question 1c requires the same full annual compensation information
  for the five highest paid independent contractors over $50,000




                   Part V, Continued
Questions 2 through 9 continue the Compensation
section with a series of questions aimed at identifying
specific prohibited or questionable transactions
These are primarily in yes/no format, with an instruction
to attach detailed descriptions of payment rates and
structures, and the review procedures in place within the
organization when the answer is not clearly within the
IRS-recommended guideline




                                                                           12
                  Part V, Continued
It is not uncommon for many of these policies and procedures
to not yet be in place for a new organization, and this will,
therefore, require a fair amount of narrative disclosure that was
not required on the former application

What is good? The questions serve to educate the organization
about what IRS would like to see included in procedures. In
fact, many are the types of questions that would likely be
addressed by an organization as part of a detailed Intermediate
Sanctions review process




                  Part V, Continued
What is interesting is the addition of questions that include
these same disclosures with regard to independent
contractors (attorneys, bankers, auditors, practicing
physicians at a hospital, etc.)




                                                                    13
                    Part V, Continued

Specifics of which to take note include:
  Question 4, although noting that these practices are not required,
  asks if the organization has certain procedures in place regarding
  determining compensation
     If no, the organization must separately explain its procedures, perhaps
     making it more efficient for the organization to adopt the IRS-approved
     procedures for the “rebuttable presumption of reasonableness”

  Question 5 also notes that, with regard to a Conflict of Interest
  Policy, it is not required but is recommended and the questions also
  require the organization to explain its procedures




            Part V (There’s still more?!)
    Question 6 requests information on the persons who may receive,
    and the specific structure of, any non-fixed payments from the
    applicant as part of compensation, including discretionary
    bonuses and revenue-based payments
    Questions 7 through 9 are similar to the related party transaction
    questions on the prior application, but would require more
    detailed disclosure in most instances that:
       Describe the terms of the arrangement
       Explain how fair market value is determined

    Copies of leases, service agreements and other documents
    referenced in these questions are to be attached




                                                                               14
Part VI – Your Members and Other Individuals and
 Organizations That Receive Benefits From You
    Question 1 - Asks in general if the organization provides goods
    or services to individuals or other organizations, with descriptions
    to be attached
    Questions 2 and 3 - Ask if particular individuals or organizations
    are being assisted, and the questions serve a two-fold purpose
       First, the service is trying to insure that the goods or services are
       being distributed exclusively for a section 501(c)(3) purpose
       Second, IRS again asks if goods or services will be provided to
       anyone with a business or family relationship, thus trying to identify
       transactions resulting in private benefit and/or inurement




                   Part VII – Your History
    Question 1 refers an organization to Schedule G (Successors to
    Other Organizations) if they are a successor organization to either
    a for-profit or not-for-profit organization
       All aspects of the transaction are questioned in detail
    Question 2 refers an organization to Schedule E (Organizations
    Not Filing Form 1023 Within 27 Months of Formation) if they were
    established more than 27 months prior to their application filing
    date. This new schedule is expected to save IRS review time as it
    guides an organization through the options for:
       Good-faith relief and exemption back to the date of incorporation, or
       Prospective section 501(c)(3) status, and retroactive section
       501(c)(4) status




                                                                                15
       Part VIII – Your Specific Activities
This section consists of a wide variety of questions
aimed at identifying other specific activities of the
organization that may not have been covered in the
explanation of exempt purpose, or which may be
problematic
  Question 1 – Political Activities
     While prohibited for a section 501(c)(3) organization, it is interesting
     that the form does not state this
  Question 2 – Influencing Legislation (aka Lobbying)
     References Form 5768 to make an election to measure lobbying
     expenditures against total exempt purpose expenditures and fall
     within the section 501(h) safe harbor




                   Part VIII, Continued
  Question 3 – Bingo and Gaming Activities
     These questions were developed as a result of abuses of law in
     several states where the conduct of bingo games requires a section
     501(c)(3) exemption

  Question 4 – Fundraising Activities
     Replaces the questions asked in Part II of the prior application
     Adds 4e regarding whether the organization will maintain separate
     accounts for any contributor, where the contributor has the right to
     advise on the use or distribution of funds – IRS appears to be
     looking for section 509(a)(3) “type III” organizations
  Question 5 - Affiliation with a Governmental Unit
     This question is aimed at establishing that the organization is not
     already exempt as a governmental unit and is in fact in need of
     exemption as a section 501(c)(3) organization




                                                                                16
                Part VIII, Continued
Question 6 - Economic Development
   This question is included to identify organizations that may be better
   qualified as other than a section 501(c)(3) organization
Question 7 – Development and Management of Activities or
Facilities
   May require significantly more work for complex organizations as it
   seeks information regarding involvement by anyone other than
   employees or volunteers
   Requests information on the parties involved, business or family
   relationships, and the process used to determine fair market value




                Part VIII, Continued

Question 9 – Childcare
   Replaces the old Schedule G, asking for organizations providing
   childcare that are requesting exemption under section 501(k) to
   provide the evidence that requirements are met
Question 10 – Intellectual Property
   IRS requests information regarding any intellectual property that may
   result from the organization's operations, and how any items will be
   produced, distributed, and marketed. Also requested is information
   regarding if fees will be charged and how fees will be determined
   This will be particularly relevant to scientific research organizations
   and organizations that are involved with various forms of art, music
   and literature




                                                                             17
               Part VIII, Continued

Question 11 – Acceptance of Non-Cash Contributions
   Organizations planning to do so are required to provide an attachment
   with detail about the contributions and any donor-imposed restrictions
   that may be part of the arrangement
   Non-cash assets mentioned include closely-held stock, patents, autos,
   real property, collectibles and art
   This question appears to be focused on identifying non-cash
   contributions for which valuation is required, likely for the purpose of
   monitoring and enforcement to ensure donors do not retain
   inappropriate control, and so IRS has a list of organizations engaging
   in such programs
   Rules related to deductibility of car contributions have changed
   effective 1/1/05




               Part VIII, Continued

Questions 12 and 14 – Foreign Activities
   Operations outside of US performed directly by the organization
   Grants, loans or other distributions to foreign organizations –
       Explain the relationship with the foreign entity and/or persons
       Addresses the concept of “earmarking” which precludes US
       deductibility
       Requests the organization to use procedures similar to the expenditure
       responsibility rules of private foundations, which might also be
       considered fiduciary responsibility

These questions replace the follow-up questions that IRS agents
previously had to ask (via their internal procedures) when it was
discovered that such activities occurred




                                                                                18
               Part VIII, Continued

Question 13 – Grants, Loans and Other Distributions to
Organizations
   Requests the organization to use procedures similar to the
   expenditure responsibility rules of private foundations, which
   might also be considered fiduciary responsibility
Question 15 – Close Connection with Any Organizations
   A broad question which appears to be a catch-all in asking if the
   applicant has a close connection with any organization. A
   definition of close connection is given in the instructions, but
   seems quite broad and could be left for room with some
   interpretation




               Part VIII, Continued

Questions 16, 17 and 18 – ask if the organization is applying
under 501(e), (f) or (n), respectively. These were asked in Part I
of the prior application and were often answered in error by
applicants. A code reference and explanation in the instructions
are now provided for each
Questions 19 - 22 reference the specific schedules required for
certain organizations
Question 19 – Schools
Question 20 – Hospitals or Medical Care Providers
Question 21 – Low-income, Elderly or Handicapped Housing
Question 22 – Scholarships, Fellowships, Educational Loans




                                                                       19
              Part IX – Financial Data
It is critical that the financial information presented reflect
the activities of the organization and be consistent with the
narrative description of activities and programs set forth in
other sections, as well as the public charity/private
foundation status requested
Neither the income statement nor the balance sheet format
have any significant changes as compared to the prior
Form 1023.




          Part X – Public Charity Status
This section has been made a bit more user friendly by
combining the sections of the old Form 1023 into a single
section
What is new are the general instructions and their
discussion of public charity v. private foundation status
For the Advanced Ruling Period of section 509(a)(1) or
section 509(a)(2) organizations, this section includes the
signature line of the new integrated Consent Fixing Period
of Limitations Upon Assessment of Tax Under Section 4940
of the Internal Revenue Code, formally known as the 872-C




                                                                  20
          Part XI – User Fee Information

 This section requests the user fee that was previously
 included using Form 8718
 The fee remains at $500 with a reduced fee of $150 for
 organizations with gross income less than $10,000
 The check should be in an envelope on top of the Form
 1023, and unattached to the Form




                 The New Schedules
Like the prior Form 1023, the new Form has many
schedules for specific needs, and have been significantly
updated, are new, and some were eliminated
  Schedule A – Churches
  Schedule B – Schools, Colleges, and Universities
  Schedule C – Hospitals and Medical Research
  Schedule D – Section 509(a)(3) Supporting Organizations
  Schedule E – Organizations not filing within 27 months
  Schedule F – Homes for Elderly or Handicapped and Low-Income
  Housing
  Schedule G – Successors to Other Organizations
  Schedule H – Organizations Providing Scholarships, Fellowships, etc.




                                                                         21
             Changes to the Schedules
The updates to the Schedules are similar to those
that were made to the application itself in that they
are designed to request more specific information
about the organization, reduce redundancy, and be
more user friendly
   In the past, IRS review agents would request this information from
   each applicant, but it was during the review process, therefore
   causing delay




                        Conclusion
The new Form 1023 is longer and requests more data and many
narrative descriptions
A knowledgeable practitioner should find the form to be formatted
more logically, and ask more complete questions
After the IRS and practitioners have had an adequate adjustment
period, IRS expects that the new Form 1023 should significantly
improve the overall time period currently associated with
receiving a Federal Exemption under Section 501(c)(3) by either
eliminating or drastically reducing necessary IRS follow-up
questions after a submission
IRS is evaluating an interactive, electronic Form




                                                                        22
                   Form 990




                Who Looks at 990

Potential Donors
  Foundations

Newspaper Reporters

Competing Agencies

Oversight Agencies

State and Local Authorities




                                   23
        Non-Private Foundation Status

Schedule A, Page 2, Part IV
  Entities exempt by virtue of types/not required to complete
  support schedule
     Churches (Box 5)
     Schools (Box 6)
     Hospital or cooperative hospital service organization (Box 7)
     Federal, state or local government or government unit (Box 8)
     Medical research organization (Box 9)
     Supporting organizations (Box 13)




        Non-Private Foundation Status

Schedule A, Page 2, Part IV
  Public Support Test
     Contributions (Box 10 and 11)
     Contributions/Program Revenue (Box 12)




                                                                     24
       Non-Private Foundation Status

Public Support Test (Cash Basis)
  Schedule A, Page 3, Part IV-A, line 26
     Applicable to Box 10 and 11
     Line 26f must be at least 331/3%to satisfy public support test
     Line 26b - Contributions from non-public and non-governmental
     sources
     Line 28 – Unusual grants
     10% Facts and Circumstances
         Exception to Line 26f
         Required to attach detailed statement of facts. Alternative is to submit letter to
         IRS in Cincinnati




                                                                                              25
       Non-Private Foundation Status

Public Support Test (Cash Basis)
  Schedule A, Page 3, Part IV-A, line 27
     Applicable to Box 12
     Line 27g must be at least 331/3% and line 27h cannot exceed
     331/3%
     Line 27a – Contributions from “disqualified persons” excluded
     from public support
         Disqualified persons include “substantial contributors” (persons who have
         given more than $5,000 if that is in excess of 2% of all contributions
         received by organization since its inception), officers, directors, trustees
         or persons having similar powers or responsibilities, as well as family
         members and corporations, partnerships, estates or trusts in which
         above described persons have more than a 35% interest




       Non-Private Foundation Status

Public Support Test (Cash Basis)
  Schedule A, Page 3, Part IV-A, line 27
     Line 27b – Limits amount of program revenue from any one
     source (including government) includable in public support to
     greater of $5,000 or 1% of support
         Medicare/Medicaid Exception




                                                                                        26
       Non-Private Foundation Status

Public Support Test
  Schedule A, Page 3, Part IV-A
     Satisfaction of support test over four-year period (preceding
     reporting year) results in continued public status for year following
     the reporting year
     Failure to satisfy public support test for 2 consecutive years will
     result in loss of public status. Instructions say to notify IRS in
     Cincinnati if the support test is not met
     Status checked in Part III is the status set forth in IRS determination
     letter
     If current status is not consistent with revenue sources, request
     change of status
         Consider answer to Question 76, Part VI, Page 5 with respect to change of
         activities




                                                                                     27
         Non-Private Foundation Status

Schedule A, Page 2, Part IV, Line 13
   Its all about relationships
      Supporting organizations




                 Revenue and Support
Form 990, Page 1, Part I – Revenue
  Contributions vs. membership dues
  Government grants vs. program revenue
     Impact on non-private foundation status
  Special Events – Line 9
     Contribution portion
     Relationship to Part VI, question 83b
     Quid pro quo disclosure rules
     Gaming
  Sales of inventory – Line 10
     Both exempt function and unrelated business. Where car sales go,
     with gift value of car as part of cost of sale. Contribution value would
     be reflected on line 1




                                                                                28
                Revenue and Support

Form 990, Schedule B
  Special rule for organizations described in Box 11 (public
  support primarily from contributions) – contributions greater
  than 2% of total support
  Excludes governmental sources
  Public inspection copy should have names and addresses of
  donors deleted
     Address of donor to be entered




                            Expenses

Page 2, Part II
  Line 22 – Grants and allocations
     Instructions call for a detailed schedule
     Scholarships granted by schools need not name names, merely
     number of scholarships granted
     Grants to foreign entities
         More scrutiny then ever

  Line 25, 26 and 29 – Compensation
     Failure to report payroll taxes if there is payroll can result in IRS
     inquiry
  Line 30 – Professional fundraising fees
     Subject to reporting on Schedule A, Part II, if more than $50,000,
     and on state filings




                                                                             29
    Program Service Accomplishments

Part III, Page 2
  The place for an organization to tell its story
     Objectives
     Statistics
     Accomplishments




 Reconciliation of Revenue and Expenses
               (Part IV-A/B)
If audit not performed or required not applicable
Introduced at the behest of states
Most common differences
  Unrealized gain(loss)
  Volunteer services (see Form 990, Part VI, Line 82a)
  Investment expense




                                                         30
Officers, Directors, Key Employees, Part V
   Critical part of 990 for “intermediate sanction purposes”
      IRS Tax Exempt Compensation Enforcement Project

   All benefits – whether taxable or not, whether vested or
   not – must be reported
      Written intent required to treat benefits as compensation for
      intermediate sanction purposes except if not includable in
      disqualified person’s gross income

   Can attach explanation of compensation arrangement
   Must enter number of hours for board members as well
   as key employees




           Transactions with “Insiders”

  Schedule A, Page 2, Part III, Question 2
    Seeks disclosure of direct or indirect transactions (with respect
    to both sides of transaction) between organization and officers,
    directors and key employees
       Sales and leases
       Loans
       Furnishing of goods, services or facilities




                                                                        31
                       Relationships

Page 4, Part V, Line 75 – Compensation to Officer,
Director, Key Employee of more than $100,000 from
Reporting Organization and all “Related Organizations”
  Related organization defined as
     Filing entity directly or indirectly owns or controls or that owns or
     controls filing entity
     Owns means 50% or more of voting rights
     Control means appointment of 50% or more of Board or Key
     employees, or overlap of 50% or more
     Supporting organization
     Supported organization




                       Relationships

Page 5, Part VI, Question 80a
  Answer is “yes” if more then 50% or organizations governing
  body, officers, directors or membership are also such with
  respect to any other organization
  Disregard coincidental overlap when membership is one
  organization is not a condition of membership in another
  organization
Page 5, Part VI, Question 88
  Ownership of “50% or greater interest in a taxable corporation or
  partnership, or a disregarded entity (single member LLC)
     If “yes,” must complete Part IX, Page 6




                                                                             32
                      Relationships

Transfers and transactions and relationships with
noncharitable exempt organizations
  Schedule A, Page 6, Part VII
     Line 51 – Applies to both related and unrelated non-charitable
     organizations
     Does not include contributions and grants from non-charitable
     organizations
     Line 52 – Asks for listing of non-charitable organization, that
     reporting organization is affiliated with or related to
     Related refers to common control or a “historic and continuing
     relationship”




                   Other Information

Page 5, Part VI
  Question 76 – Changes in activities
  Question 77 – Changes in organizing documents not reported to
  IRS
  Question 83a – Compliance with public inspection requirements
  Question 83b – Quid pro quo disclosure requirement (see page 1,
  Line 9, special events)
  Question 85 a-h – Lobbying/political expenditures by section
  501(c)(4), (5) and (6) organizations




                                                                       33
                    Other Information

 Page 5, Part VI
   Question 89b – Whether organization engaged in excess
   benefit transaction or became aware of such a transaction
   from a prior year
       NEVER LEAVE UNANSWERED
   Question 91 – If the IRS calls or writes, person you want to
   answer the phone or open the envelope




Non-Key Employees and Professional Services

 Schedule A, Page 1, Parts I & II
   Part I – Same rules as Form 990
   Part II
       Applies to only professionals
       Must describe service
       Utilize professional’s address
       Include fee, not reimbursed expenses (unless unaccounted for)




                                                                       34
                                Lobbying

Schedule A, Page 2, Part III
   Question 1 – If answer yes to lobbying, must complete either
   Part VI-A or VI-B
   Part VI-A – Applicable to electing public charities (file form
   5768)
       Objective standards based on expenditures
       Instructions are extensive and helpful
   Part VI-B – Applicable to non-electing charities
       Subjective
           Includes volunteer activities
           Requires description of lobbying activities
           Scant instructions




Senate Finance Committee Staff Discussion
         Draft Recommendations
“Charity Oversight and Reform: Keeping Bad Things from
Happening to Good Charities,” June 22, 2004
http://finance.senate.gov/hearings/testimony/2004test/062204stfdis.pdf
   Require CEO (or equivalent officer) to sign declaration under
   penalties of perjury that CEO
       Has established procedures to ensure that information and tax returns
       (including 990-T) are in compliance with IRC
       Has been provided with reasonable assurance of the accuracy and
       completeness of all material aspects of the return




                                                                               35
Senate Finance Committee Staff Discussion
         Draft Recommendations
Increase penalties for failure to file or include
required information
Limit extension period to four (4) months




    AICPA Comments on Senate Finance
        Committee Discussion Draft
With respect to failure to file complete and accurate
return, urged clarification of items covered and
reasonable cause exception

Opposed limiting extension period to four (4) months

With regard to requiring signature by CEO,
expressed “serious practical concerns” as to its
impact on smaller organizations




                                                        36
    AICPA Comments on Senate Finance
        Committee Discussion Draft

Comments
  www.cpa2biz.com/resourcecenters/tax/exempt+organization/eo_roundtable.pdf




    Other Commentaries on Government
            Information Returns
Options to Improve Tax Compliance and Reform
Tax Expenditures, Chapter VIII. Exempt
Organizations
   Joint Committee on Taxation, January 27, 2005
       www.house.gov/jct/pubs05.html
   Final Report presented to the Senate Finance
   Committee by the Panel on the Nonprofit Sector
   Convened by Independent Sector, March 1, 2005
       www.nonprofitpanel.org




                                                                              37
              What’s New for 2005

Organization required to check a box if a grant amount
includes foreign grants
Organization required to indicate whether or not it had
an interest in, or a signature authority over a financial
account in a foreign country (Form TD F 90-22.1 may
be required to be filed). Organization also required to
disclose if it maintained a foreign office, and if so,
where (Form 990, Part VI, Questions 91b & c)




             What’s New For 2005

Organization required to indicate whether or not it
received a contribution of qualified real property
interest under section 170(h) (“qualified conservation
contribution”) Schedule A, Part III, line 3c
Compensation of five highest – paid independent
contractors for “other services” over $50,000 –
Schedule A, Part II-B




                                                            38
             What’s New For 2005

Reconciliation of revenue and expenses per audited
financial statements with revenue and expenses per
return – format revised
Officers, Directors, Trustees and Key Employees –
  Part V-A – Current
  Part V-B - Former




             What’s New For 2005

Part V-A – Question 75
  75a – Number of officers, directors and trustees permitted
  to vote on organization business at board meetings
  75b – Whether officers, directors, trustees, key employees
  (Part V-A), five highest paid employees (Schedule A,
  Part I), highest compensated professionals (Schedule A,
  Part II-A), and other independent contractors (Schedule A,
  Part II-B) related to each other either through business or
  family. If so, required to explain relationships




                                                                39
             What’s New For 2005

Part V-A – Question 75
  75c – Whether any persons listed in Part V-A, V-B,
  Schedule A, Part I, Schedule A, - Part II-A and II-B,
  receive compensation from related organizations. If
  so, required to provide such information

  75d – Whether organization has a written conflicts of
  interest policy




        The Shape of Things to Come

IRS Proposed Changes
  First Things First
  The Layered Look




                                                          40
                        Electronic Filing
                   Form                           Applicability Dates
990
File at least 250 returns and if                      Taxable years
have total assets of $100 million or               beginning on or after
more at the end of the year                        December 31, 2005

File at least 250 returns and if                      Taxable years
have total assets of $10 million or                  beginning on or
more at the end of the year                               after
                                                    December 31, 2006
990-PF
                                                      Taxable years
File at least 250 returns                            beginning on or
                                                          after
                                                    December 31, 2006




                        Form 990/990PF

    Electronic Filing IRS Forms and Publications
       Publication 3112 – IRS e-file application and
       participation
       irs.gov/efile
          Click on e-file for charities and nonprofits




                                                                           41
             AICPA

NATIONAL GOVERNMENTAL AND NOT-FOR-
              PROFIT
         TRAINING PROGRAM


          NPO TAX UPDATE




          OCTOBER 19, 2005
           LAS VEGAS, NV
                                1
 FREDERICK H. ROTHMAN
        LOEB & TROPER
 655 THIRD AVENUE, 12TH FLOOR
  NEW YORK, NEW YORK 10017
         212-867-4000
FROTHMAN@LOEBANDTROPER.COM
                                                                                                 1
I. INTERNAL REVENUE SERVICE DEVELOPMENTS
  A. Exempt Organizations Implementing Guidelines

     1. Issued November 2004. The full text is available at www.irs.gov/charities

        a. Examinations

            (1) The TE/GE Strategic Operational Priorities
               (a) Combating abusive tax avoidance transactions (ATAT), with special
                   emphasis on earlier identification of abusive schemes and enforcement in
                   identified transactions;
               (b) Anti-terrorism efforts;
               (c) The excessive compensation initiative;
               (d) Credit counseling; and
               (e) Improving business results and customer service

            (2) Abusive Tax Avoidance Transactions (ATAT)

               (a) IRC Section 501(c)(15) Entities and Producer-Owned Reinsurance Companies
                   (PORC): Section 501(c)(15) of the Internal Revenue Code provides tax
                   exemption for small non-life mutual insurance companies. Although new
                   legislation effective for tax years beginning after December 31, 2003 (calendar
                   year 2004) amended the code to address these abuses, this change does not
                   impact the compliance or enforcement activities for years prior to enactment.

               (b) Donor-Advised funds: Donor-advised funds allow private donors input as to
                   how their charitable contributions will be spent. A number of organizations
                   appear to have abused the basic concepts underlying donor-advised funds.
                   These organizations appear to have provided questionable charitable
                   deductions, providing impermissible economic benefits to the donors and their
                   families. EO Examinations will identify organizations with a high potential for
                   abuse in this area and commence examinations during FY 2005.

               (c) IRC Section 509(a)(3) Supporting Organizations: Will continue to focus on
                   cases where promoters are using supporting organizations in abusive tax
                   avoidance schemes. These schemes include tax-exempt support organizations
                   that do not own or control their assets, have made large loans to the founder or
                   supported organization trustees, do not have independent trustees, and do not
                   provide the support for which they obtained exemption.
                                                                                    2
(3) Anti-terrorism

   Continuing its examination of organization making foreign grants, the IRS
   currently has 100 such examinations underway. The purpose is to see if the
   current rules are working. The primary focus is to ensure that funds are used for
   their intended charitable purpose and not diverted for terrorist activity. The
   “compliance strategy coordinating committee” will utilize the examination results
   to determine whether there is a need for possible guidance or other modifications
   to the laws in this area.

(4) Excessive Compensation Initiative

   The Tax Exempt Compensation Enforcement Project was established to address
   the issue of potentially excessive compensation paid to insiders of charities and
   private foundations. The initiative addresses how compensation is determined and
   reported, loans to employees, “deals” between employees and organizations,
   compensation as compared to assets, and whether the excess benefit box was
   checked on the return or not. Approximately 2000 letters were mailed. A report
   on the initiatives will be published.

(5) Credit Counseling/Consumer Credit Services

   Addressing abuse in the credit counseling industry is one of EO’s highest priority
   projects. It appears that not all of these organizations continue to meet the legal
   standards for tax-exempt status; for example, they are not providing meaningful
   education or counseling.

   In FY 2004, EO began an initiative to address this significant compliance problem.
   Entities accounting for over half of the gross receipts in this market segment were
   under examination at the end of FY 2004. EO examination activity, in
   coordination with state Attorney General offices, the Federal Trade Commission
   and other operating divisions continued into FY 2005.

(6) Business Results and Customer Service

   (a) Hiring and training – 72 new revenue agents were hired in September 2004 and
       were trained during FY 2005.

   (b) Organizational Structure – Exempt Organizations Compliance Unite (EOCU)
       the Data Analysis Unite (DAU), and the Fraud and Financial Transaction Unit
       (FFTU) were developed to enhance return selection, method of taxpayer
       contact and use of data.

       (i)   The EOCU will address those entities with issues that do not initially
             require examinations, through inspection of filed returns and
             correspondence contacts. EOCU hired 18 additional employees.
                                                                                         3
            •   Educational Letters – Issued letters not requiring response
                (fundraising)
            •   Case Building – Initial contract made by EOCU, but it does not
                actually work the case/project. They do mass mailing, solicit the
                information and related follow-up.
            •   Compliance Checks – Ask for clarifying information on the return or
                on the master file.
            •   Review of operations Unit (ROO) – Follow up on new organizations
                3-5 years after determination letter issued to see if activities consistent
                with 1023. Selection criteria either specific issues or statistical
                sampling.
            •   Through June 2005 issued 1600 educational letters, 3500 compliance
                checks and 1000 case building letters.
            •   Unit to conduct correspondence audits is being added.

       (ii) The DAU was designed to provide trend research and analysis to improve
            workload selection for examinations. Its major object will be to support
            compliance through identification of trends, support the compliance
            program in achieving operational efficiencies through the use of improved
            case selection, and identifying trends and/or potential compliance issues
            within the EO sector through the use of the Internet, Return Inventory
            Control System (RICS), and various internal and external databases.

       (iii) The Fraud and Financial Transaction Unit (FFTU) will be established to
             address complex fraud and tax avoidance cases. The unit’s personnel are
             trained to effectively address complex fraud and abusive scheme issues
             and will provide expert assistance and work in conjunction with the
             Criminal Investigation (CI) Division and other stakeholders, as needed.

(7) Compliance Projects

   (a) IRC Section 527 Organizations – EOCU sent letters to noncompliant
       organizations (filed Form 8872 late, did not fully disclose all required data on
       Form 8872, and filed amended Form 8872 materially different from original
       return). Where appropriate examinations may result. Implementation ongoing
       throughout FY 2005.

   (b) Disaster Relief – With respect to pre and post 9/11 organizations, focus is to
       ensure distributions are made in compliance with the Victims of Terrorism Tax
       Relief Act of 2001, that there is no private benefit, inurement or fraud, and that
       the organizations are fulfilling their exempt purpose.

   (c) Gaming – Implementation of multi-year National Charitable Gaming Strategy
       and Action Plan.
                                                                                            4
B. 2005 – 2006 Priority Guidance Plan (August 8, 2005)

   1. Exempt Organizations

       a. Guidance on donee reporting for car donations.

       b. Guidance on down payment assistance organizations.

       c. Regulations under sections 501(c)(3) and 4958 on revocation standards. (Proposed
          Regulations issued on September 8, 2005)

       d. Guidance under section 501(c)(15) on the calculation of gross receipts.

       e. Guidance under section 527(1) with respect to the authority to waive taxes and
          amounts imposed on political organizations for failures to comply with notice and
          reporting requirements.

       f. Regulations under section 529 regarding qualified tuition programs.

   2. Retirement Benefits

       a. Comprehensive final regulations under section 403(b) regarding tax-favored annuities
          purchased by section 501(c)(3) organizations or public schools. Proposed regulations
          were published on November 16, 2004.

       b. Revenue procedure amending and restating the employee plans compliance resolution
          system (EPCRS).

   3. Executive Compensation, Health Care and Other Benefits, and Employment Taxes
       a. Guidance on accountable plans and per diem payments.
       b. Guidance on the impact of providing a 2½-month grace period for dependent care
          assistance offered under a cafeteria plan.
       c. Proposed regulations on cafeteria plans under section 125 updating regulations for
          statutory changes and providing additional guidance.

       d. Guidance under section 132 on debit cards and qualified transportation fringes.

       e. Guidance on the impact of providing a 2 ½-month grace period for flexible spending
          accounts on health savings accounts (HSAs).

       f. Proposed regulations addressing numerous issues with respect to the taxation of
          nonqualified deferred compensation under section 409A as added by the American
          Jobs Creation Act of 2004. Interim guidance was issued as Notice 2005-1. [Issued
          September 29, 2005]
                                                                                               5
   4. General Tax Issues
       a. Revenue ruling regarding the treatment of payments made by a tax-exempt
          organization upon its conversion to a taxable entity to satisfy its public-benefit
          obligations.
       b. Guidance under section 170(f)(11) as added by the American Jobs Creation Act of
          2004 regarding reporting of noncash charitable contributions.
       c. Proposed regulations under section 170(f)(12) as added by the American Jobs Creation
          Act of 2004, and related provisions, regarding contributions of qualified vehicles.
          Interim guidance was issued as Notice 2005-44.
C. Form 990

   1. Electronic filing – For taxable years beginning after December 31, 2005, if organization
      files at least 250 returns and if total assets at end of the year are $100 million or more.

   2. Revisions of Form 990

       a. 2005 – Questions with respect to foreign grants, foreign offices, foreign financial
          accounts, receipt of contribution of qualified property (“qualified conservation”) and
          amounts paid to five highest paid non-professional independent contractors for other
          services over $50,000, and type of supporting organization. Additional information
          with respect to offers, directors, key employees as well as former officers,
          directors, key employees.
       b. Over the horizon – Layered look – Core form with schedules for specific types of
          organizations.
   3. Form 1023 – Revised Form 1023 mandatory as of April 1, 2005

       a. IRS hopes that it can be filed electronically by 2007.
D. Recommendations of the Advisory Committee on Tax Exempt and Government Entities
   (ACT)
   The fourth report of recommendations of the Advisory Committee on Tax Exempt and
   Government Entities (ACT) on four issues addressing: Survey and Review of Existing
   Information and Guidance for Indian Tribal Governments, Tax-Exempt Bonds Record
   Retention Burden, Establishing the Enrolled Retirement Plan Agent Under Circular 230, and
   Project “IMPROVE” – Informative Materials Prescribe Responsibilities and Obligations Very
   Early: Recommendations to Enhance the Compliance of Newly Formed Charities, is
   available. The 18 members of the ACT presented their report to the IRS in a public meeting
   in Washington, D.C. on June 8, 2005.
E. IRS Web Site Addition
   The IRS has enhanced the exempt organizations published guidance pages of its website by
   adding a link to a page of written determinations (www.irs.gov/foia/lists/0,,id=97705,00.html)
F. IRS CPE Text – Not published this year.
                                                                                                6
G. Revenue Rulings

   1. 2004-112 – Qualified convention and trade show activity by trade association involving
      Internet activity (see discussion under Unrelated Business Income).

H. Revenue Procedures

   1. 2005-1 – Procedures for issuing letters rulings.

   2. 2005-3 – Areas of the IRS with respect to which IRS will not rule.

   3. 2005-4 – TE/GE Ruling procedures remain largely unchanged.

   4. 2005-5 – Technical Advice procedures remain largely unchanged with respect to
      Employee Plans and Exempt Organizations.

   5. 2005-6 – Employee plan determination procedure remain largely unchanged.

   6. 2005-8 – Rules updated on user fees for exempt organizations.

   7. 2005-11 – Standards for determining whether services performed by a student qualify for
      the FICA exception.

   8. 2005-24 – Safe harbor procedure with respect to disregarding specific right of election
      against estate that could be satisfied from CRAT or CRUT.

   9. 2005-60 – Guidance issued to inform authorized e-file providers of their obligations to the
      IRS and to combine the rules governing IRS e-file, including the rules regulating
      electronic return originators (EROs) that electronically file various forms specified in the
      guidance.
I. Notices
   1. 2005-1 – Guidance under Section 409A with respect to nonqualified deferred
      compensation.
   2. Notice 2004-67 – Updates list of transactions determined to be “listed transactions.”
      (a) Contingent installment sale of securities by a partnership to accelerate and allocate
          income to tax-indifferent partner, such as a tax-exempt entity. (identified as listed
          transaction 2/28/00).
      (b) Transactions involving distributions described in reg. Sec. 1.643(a)-8 from charitable
          remainder trusts (identified as listed transaction 2/28/00).
      (c) Transaction utilizing S Corporation and exempt organization, in which S corporation
          shareholders attempt to transfer incidence of taxation of S corporation income by
          purportedly donating S corporation stock to exempt organization while retaining the
          economic benefits associated with that stock.
                                                                                               7
J. Conference Policy – Rulings
   The IRS has expressed its intention to curtail the number of conferences it will hold with
   exempt organization representatives seeking private letter rulings. So called “drop-in”
   conferences will be limited to “essential” situations. The IRS is still responding by phone to
   questions about whether particular types of rulings would be issued, time frames for
   processing ruling requests, documents and factual representations that would be helpful if
   submitted with requests, alternative approaches to a particular transaction and similar
   questions. IRS is also considering whether to stop issuing “comfort” rulings on issues clearly
   and adequately addressed by published authorities.
K. Tax Scams – IRS “Dirty Dozen”

   1. In IR-2005-19, February 28, 2005, the IRS unveiled its annual listing of notorious tax
      scams (“the Dirty Dozen”). Three involve exempt organizations.

      a.   Credit Counseling Agencies. Taxpayers should be careful with credit counseling
           organizations that claim they can fix credit rating, push debt payment agreements or
           charge high fees, monthly service charges or mandatory “contributions” that may add
           to debt. The IRS Tax Exempt and Government Entities Division has made auditing
           credit counseling organizations a priority because some of these tax-exempt
           organizations, which are intended to provide education to low-income customers with
           debt problems, are charging debtors large fees, while providing little or no
           counseling.

      b.   Corporate Sole. Since September 2004, the Department of Justice has obtained six
           injunctions against promoters of this scheme and filed complaints against 11 others.
           Participants apply for incorporation under the pretext of being a “bishop” or
           “overseer” of a one-person, phony religious organization or society with the idea that
           religious organization. When used as intended, Corporate Sole statutes enable
           religious leaders to separate themselves legally from the control and ownership of
           church assets. But the rules have been twisted at seminars where taxpayers are
           charged fees of $1,000 or more and incorrectly told that Corporation Sole laws
           provide a “legal” way to escape paying federal income taxes, child support and other
           personal debts.

      c.   Abuse of Charitable Organizations and Deductions. The IRS has observed as
           increase in the use of tax-exempt organizations to improperly shield income or assets
           from taxation. This can occur, for example, when a taxpayer moves assets or income
           to a tax-exempt supporting organization or donor-advised fund but maintains control
           over the assets or income, thereby obtaining a tax deduction without transferring a
           commensurate benefit to charity. A “contribution” or a historic façade easement to a
           tax-exempt conservation organization is another example. In many cases, local
           historic preservation laws already prohibit alteration of the home’s façade, making
           the contributed easement superfluous. Even if the façade could be altered, the
           deduction claimed for the easement contribution may far exceed the easement’s
           impact on the value of the property.
                                                                                                   8
II. OTHER DEVELOPMENTS WITHIN THE BELTWAY
   A. General Explanations of the Administration’s Fiscal Year 2006 Revenue Proposals – Dept. of
      Treasury (February 2005) – The “Blue Book” www.treas.gov/press/releases/js2232.htm(click
      on The “2005 Blue Book” General Explanations of the Administration’s Fiscal Year 2006
      Revenue Proposals)

      1. Tax-free withdrawals from IRAs for charitable contributions

          Individuals would be allowed to exclude from gross income distributions made after age
          65 from a traditional or Roth IRA directly to a qualified charitable organization. The
          exclusion would be available without regard to the percentage of AGI limits that apply to
          deductible contributions. An amount transferred directly to a charitable organization
          would be counted as a distribution for purposes of the required minimum distribution
          rules.

      2. Expansion and enhancement of contributions of food inventory

          The enhancement deduction for donations of food inventory would be expanded to include
          businesses other than C corporations. The amount of the enhanced deduction for
          donations of food inventory would be increased to the lesser of: (1) fair market value, or
          (2) two times basis. The ensure consistent treatment of all businesses claiming an
          enhanced deduction for donations of food inventory, the enhanced deduction for qualified
          food donations by S corporation and non-corporate taxpayers would be limited to 10
          percent of net income from the associated trade or business. Taxpayers with a zero or low
          basis would be allowed to assume a basis equal to 25 percent of fair market value.

      3. Reform excise tax on investment income of private foundations

          This proposal would replace the two rates of tax on private foundations that are exempt
          from federal income tax with a single tax rate of one percent. The tax on private
          foundations not exempt from federal income tax would be equal to the excess (if any) of
          the sum of the one-percent excise tax on net investment income and the amount of the
          unrelated business income tax that would have been imposed if the foundation were tax
          exempt, over the income tax imposed on the foundation. The special reduced excise tax
          rate available to tax-exempt private foundations that maintain their historic level of
          charitable distributions would be repealed.

      4. Modification of tax on unrelated business taxable income of CRTs.

          A levy of a 100-percent excise tax on the unrelated business taxable income of a charitable
          remainder trust, in lieu of depriving the trust of its federal income tax exemption for any
          year in which unrelated business taxable income is received. The unrelated business
          taxable income would be considered income of the trust for purposes of determining the
          character of the distribution made to the beneficiary. The amount of the tax would be
          allocated to corpus.
                                                                                     9
5. Modification of basis adjustment of stock of S Corporation contributing appreciated
   property

   An S corporation shareholder would be allowed to increase the basis of the S corporation
   stock by an amount equal to the excess of the charitable contribution deduction that flows
   through to the shareholder over the shareholder’s pro rata share of the adjusted basis of the
   contributed property.

6. Repeal $150 million dollar limit on qualified 501(c)(3) bonds

   The $150 million limit on the volume of outstanding, non-hospital, tax-exempt bonds for
   the benefit of any one 501(c)(3) organization would be repealed in its entirety, effective
   for bonds issued after the date of enactment.

7. Repeal certain restrictions on use of qualified section 501(c)(3) bonds for residential
   purposes

   The residential rental property limitation would be repealed, effective for bonds issued
   after the date of enactment. As under current law, the use of residential rental property by
   a 501(c)(3) organization would be a qualifying use only to the extent it did not constitute
   an unrelated trade or business.

8. Expand authority to require electronic filing

   The proposal also would expand the Secretary’s authority to require businesses (including
   corporations, partnerships and other business entities) and exempt organizations to file
   their returns electronically. The Administration’s proposal would lower the current 250-
   return minimum for mandatory electronic filing, but would maintain the minimum at a
   high enough level to avoid imposing an undue burden on taxpayers.

9. Impose Penalties on charities that fail to enforce conservation easements

   The proposal would impose significant penalties on any charity that removes or fails to
   enforce a conservation restricted for which a charitable contribution deduction was
   claimed, or transfers such an easement without ensuring that the conservation purposes
   will be protected in perpetuity. The amount of the penalty would be determined based on
   the value of the conservation restriction shown on the appraisal summary provided to the
   charity by the donor.
                                                                                               10
B. Senate Finance Committee

   1. “Charity Oversight and Reform: Keeping Bad Things from Happening to Good Charities,”
      June 22, 2004 – http://finance.senate.gov/hearings/testimony/2004test/062204stfdis.pdf.

          a. Require CEO (or equivalent officer) to sign declaration under penalties of perjury
             that CEO

              (1) Has established procedures to ensure that information and tax returns
                  (including 990-T) are in compliance with IRC and

              (2) Has been provided with reasonable assurance of the accuracy and
                  completeness of all material aspects of the return

              (3) AICPA Response – Supported proposal from a conceptual standpoint, but
                  expressed “serious practical concerns “as to its impact on smaller
                  organizations.

          b. Increase penalties for failure to file or include required information

              (1) AICPA Response – Urged clarification of items covered as well as the
                  availability of a reasonable cause exception and some means of correcting any
                  oversight before penalties are imposed.

          c. Limit extension period to four (4) months

              (1) AICPA Response – Opposed – pointed to circumstances attributable to
                  circumstances beyond organizations’ control, including “alternative
                  investments” (partnerships, LLCs) with respect to which information is not
                  available within proposed time frame.

          d. Require independent audit of its financial statements, including certification
             regarding the organizations’ exposure to UBIT.

              (1) AICPA Response – Proposed threshold too low. California has established $2
                  million threshold. With respect to UBIT, posed question as to what standards
                  would apply and whether material standard would apply.

   2. Chairman Grassley’s letter (May 25, 2005) to 10 major non-profit hospitals asked them to
      account for their charitable activities. The letter poses 21 questions and asks for
      information about issues including charitable activities, patient billing, and ventures with
      for-profit companies and hospitals.          (http://finance.senate.gov/press/Gpress/2005/
      prg052505.pdf)

   3. Social Security and Family Policy Subcommittee Hearing on September 13, 2005 –
      “Charities on the Frontline: How the Nonprofit Sector Meets the Needs of America’s
      Communities.”
                                                                                                11
C. Independent Sector’s Panel on the Nonprofit Sector Final Report

   1. Submitted to Senate Finance Committee on June 22, 2005 (www.nonprofitpanel.org)

   2. Recommendations

       a. Federal and State Enforcement – Increase resources allocated to IRS for oversight and
          enforcement of charitable organizations, fund a program to help states to establish or
          increase oversight, and eliminate statutory barriers that preclude IRS from sharing
          information with state regulations.

       b. Internal Revenue Service Reporting – Amend federal law to require all Form 990
          Series returns be filed electronically, require that Form 990 series returns be signed,
          under penalties of perjury, by the CEO, CFO, or highest ranking officer, and require
          all section 501(c)(3) organizations with less then an average of $25,000 in gross
          receipts file an annual notice with basic contact and financial information. (Tax-
          exempt status for organizations failing to file such notice should for three consecutive
          years be suspended.) Paid preparer penalties should be extended to preparers of Form
          990. Several changes in the format of Form 990 and instructions are also
          recommended.

       c. Periodic Review of Tax-Exempt Status – Congress should not require charitable
          organizations to file an additional report every five years. Rather, additional resources
          should be focused on reporting and reviewing the annual returns filed.

       d. Donor-Advised Funds – Laws defining and regulating donor advised funds should be
          enacted, including aggregate minimum distribution asset balance of all its donor
          advised funds, (5%) percent of aggregate requirements, prohibitions against private
          benefit transactions, and penalties to be imposed on donors, advisors, and managers
          who violate the prohibitions.

       e. Type III Supporting Organizations – (operated in connection with one or more
          supported organizations) should be retained. Minimum distribution requirements
          should be required (5 percent of net assets, excluding assets used directly to support
          charitable purposes of supported organization) and prohibiting a Type III form
          supporting more than five qualified entities.

       f. Abusive Tax Shelters – Congress should make clear that tax-exempt organizations are
          subject to the same reporting requirements as taxable entities with regard to listed and
          other reportable transactions.

       g. Noncash Contributions – Appreciated Property – Congress should strengthen the rules
          for the appraisals utilized to substantiate deductions claimed for such property, as well
          as expanding penalties on taxpayers who claim excessive deductions based on
          overstated values and appraisers who knowingly provide such appraisals.

       h. Noncash Contributions – Conservation and Façade Easements – Congress should
          increase penalties on taxpayers who claim excessive deductions, and impose penalties
          on charities that fail to enforce conservation or historic façade easement agreements.
                                                                                               12
      i. Noncash Contributions – Clothing and Household Items – Congress should not limit
         the deduction to an arbitrary ceiling without a clear basis for establishing the ceiling
         amount and an assessment of the impact of the change on the level of charitable
         contributions. The IRS should establish a list of the value that taxpayers can claim for
         specific items, based on the sole price of such items identified by major thrift store
         operations or similar assessments.
   3. Areas to be covered in Supplemental Report
      a. Financial reporting and transparency, including improvements in Forms 990 and 990-
         PF.
      b. Tax-exempt status of credit counseling organizations.
      c. Rules and reporting requirements for charitable organizations that operate or fund
         programs outside the United States.
   4. See Page 12-A
D. Ways and Means Committee – http://waysandmeans.house.gov (click on 109th Congress
   under Hearings)
   1. Hearing on an Overview of the Tax-Exempt Sector. Hearing Advisory, Witness List and
      Testimony – April 20, 2005
      a. Chairman Thomas in announcing the Hearing stated that “the hearing was one in a
         series of hearings to enable Congress to obtain a better understanding of how vast and
         diverse this sector is today…. …. Congress has a responsibility to oversee and assure
         the American taxpayer that the tax-exempt sector is living up to its legal
         responsibilities.”
   2. Hearing on the Tax-Exempt Hospital Sector – Hearing Advisory, Witness List and
      Testimony – May 26, 2005
      a. Hearing examined three issues
          (1) How the standards for hospital tax-exempt evolved over time
          (2) What criteria are used to assess if hospitals meet the tax-exempt standard
          (3) If tax-exempt hospitals operate principally as businesses selling their services in a
              competitive market
      b. Senate Finance Committee
E. Joint Committee on Taxation Report on Options to Improve Tax Compliance and Reform
   Expenditures (www.house.gov/jct/pubs05.html click on JCS-2-05 (January 27, 2005))
   1. Require five-year review of exempt status of public charities and private foundations and
      annual notice by organizations not required to file information returns.
   2. Impose termination tax on conversion of assets of charities. Would address concerns
      regarding sales/transfers to for-profit entities, would extend a modified version of Section
      507 termination tax applicable to private foundations to conversions and liquidation of
      public charities. Would extend intermediate sanctions (public charities) and self-dealing
      rules (private foundations) to acquirer of charitable organization’s assets.
                                                  12-A

4. Supplemental Report – Draft Recommendations
      www.nonprofitpanel.org/supplemental/list

   a. International grantmaking (see page 33)

   b. Disclosure of unrelated business activity

   c. Consumer credit counseling agencies

   d. Nonprofit conversions

   e. Taxation of sales of donated assets
                                                                                           13

3. Require disclosure by exempt organizations to IRS of participation in a “prohibited tax
   shelter transaction” and disclosure of other parties in the transaction.
4. Reform Intermediate Sanctions and Extend Certain Reforms to Private Foundations (secs.
   4941 and 4958). Proposal eliminates rebuttable presumption, establishes due diligence
   procedures that apply to public charities and private foundations. Instead, procedures that
   now give rise to rebuttable presumption generally will establish that an organization has
   performed the minimum standards of due diligence. Satisfaction of the minimum
   standards would not result in any presumption.
5. Increase the Amount of Excise Taxes Imposed on Public Charities, Social Welfare
   Organizations, and Private Foundations (secs. 4941, 4942, 4943, 4944, 4945, and 4958).
   For acts of self- dealing other than the payment of compensation by a private foundation
   to a disqualified person, the initial tax would be 10% of the amount involved. For acts of
   self-dealing regarding the payment of compensation by a private foundation, the initial tax
   on the self-dealer will be 25% of amount involved with 15% of which is subject to
   abatement. The initial tax on foundation managers would increase from 2.5% to 5% of the
   amount involved. The proposal would also double the dollar limitation on the amount of
   the initial and additional taxes on foundation managers per act of self-dealing to $20,000,
   and double the dollar limitation on organization managers of public charities and social
   welfare organizations for participation in excess benefit transactions to $20,000 per
   transaction.
6. Modify Charitable Deduction for Contributions of Conservation and Façade Easements
   (sec. 170). The proposal eliminates the charitable contribution deduction with respect to
   façade and conservation easements relating to personal residence properties, substantially
   reduces the deduction for all other qualified conservation contributions, and imposes new
   standards on appraisals and appraisers regarding the valuation of such contributions
7. Limit Charitable Deduction for Contributions of Clothing and Household Items (sec. 170).
   The proposal limits the amount that taxpayers may deduct for contributions of clothing
   and household items to $500.
8. Reform Rules for Charitable Contributions of Property (sec. 170). Option 1: This
   proposal contains various options and concepts to limit deductions on donations of
   property, generally to the lesser of basis or fair market value. They do not apply to
   publicly traded securities and certain other property already addressed in previous
   legislation, i.e., intellectual property and vehicles. Form 8282 (filed on disposition
   within 2 years of contribution) would be eliminated. Suggestions for enhanced
   appraiser accountability, limiting the deduction to the disposition amount, and eliminating
   deductions for property altogether are also included. Option 2: Retains current FMV
   deduction but for exempt use property with a value of more than $500 there would
   be a reduced tax benefit if disposed of within three years.
9. Require Public Disclosure of Form 990-T and Related Certification Requirements (secs.
   6104 and 6685). The proposal extends the present-law public inspection and disclosure
   requirements and penalties applicable to the Form 990 to an organization's Form 990-T.
   Organizations that normally have annual total gross revenues or gross assets of at least
   $10 million must include with its Forms 990 and 990T filings a certification by an
   independent auditor or by an independent counsel.
                                                                                                14

  10. Expand the Base of the Tax on Private Foundation Net Investment Income. Proposal
      amends the definition of gross investment income to include income from notional
      principal contracts, annuities, and other substantially similar income from ordinary and
      routine investments. Carry backs of losses from sales or other dispositions of property are
      not included.

  11. Limit Tax-Exempt Status of Fraternal Beneficiary Societies that Provide Commercial-
      Type Insurance (sec. 501 (c)(8)). A fraternal beneficiary society, order, or association is
      exempt from tax as an organization described in section 501(c)(8) only if no substantial
      part of its activities consists of providing commercial- type insurance. In the case of an
      organization that is exempt from tax under the proposal, it is taxed under the rules relating
      to insurance companies rather than under the unrelated business income tax rules
      generally applicable to exempt organizations.

  12. Established Additional Exemption Standards for Credit Counseling Organizations (sec.
      501). Under the proposal, a nonprofit credit counseling agency or other nonprofit
      organization that provides credit counseling, debt management, and similar services, is
      eligible for exemption from income tax only as a charitable or educational organization
      under section 501(c)(4). It also provides additional requirements that must be satisfied by
      a credit counseling organization in order to be an organization described in section
      501(c)(3) or (c)(4), and the requirements supplement, rather than replace the present law
      requirements.

F. Joint Committee on Taxation

   Historical Development and Present Law of The Federal Tax Exemption for Charities and
   Other Tax-Exempt Organizations (prepared in conjunction with Hearing of House Committee
   on Ways and Means on April 20, 2005. www.house.gov/jct/pubs05.html -scroll down to
   JCX-29-05 (248 pages))

G. Other Legislative Proposals

   1. Imposition of excise tax or certain life insurance contracts.

       a. Bill introduced by Senators Grassley and Baucus to “crackdown” on abuses involving
          life insurance, annuity or endowment contract with respect to which a charitable
          organization and a person other than charitable organization had held an interest
          (whether or not at the same time). Contracts are not subject to excise tax if persons
          holding an interest have an insurable interest in the insured independent of the
          organization are a named beneficiary or as beneficiary of trust holding contract. Tax
          imposed would be 100 percent of acquisition costs. Reporting would be required by
          charitable organization and any person acquiring an interest in a policy.

       b. Modify tax on unrelated business taxable income of charitable remainder trusts
          (CRTs). Presently a CRT with any unrelated business taxable income loses its tax-
          exempt status for that year. The proposal is to impose a 100-percent excise on the
          unrelated business taxable income. [See Page 8 #4 – Administration Proposal]
                                                                                                      15
      2. Care Act Redux

          The Senate Finance Committee was scheduled to act on a package of charitable giving
          incentives in September. Included are a charitable deduction for nonitemizers and tax-free
          distributions from IRAs. Other provisions dealt with improvement of oversight of exempt
          organizations. Other proposals to be addressed include donor-advised fund reform,
          supporting organization reform and self-dealing. Many other proposals, including
          recommendations made by the Panel on the Nonprofit Sector.


III. CHARITABLE CONTRIBUTIONS
   A. American Jobs Creation Act of 2004 – Effective June 2005

      1. Qualified vehicles – IRC section 170(f)(12) – Includes automobiles, boats and airplanes

          a. Deduction for a vehicle with a value greater than $500 is limited to gross proceeds of
             sale unless there has been significant intervening use or material improvement. If
             there has been a significant intervening use or material improvement donor may claim
             FMV of donated vehicle.

          b. If claimed value exceeds $500, new substantiation requirements. Acknowledgement
             must be provided to donee within 30 days of contribution or date of sale if no
             significant intervening use or material improvements.

          c. If vehicle sold without significant intervening use or material improvement,
             acknowledgement must include certification vehicle sold in an arms-length transaction
             between unrelated parties, gross proceeds, and statement that deduction may not
             exceed gross proceeds.

          d. If donee organization retains vehicle for its usage, acknowledgement must include
             certification stating intended use or any intended material improvement, and intended
             duration of such use, and certification that it will not be transferred in exchange for
             money, property or services prior to completion of intended use or improvement.
          e. Donee organization required to provide IRS with a copy of acknowledgement (as is
             donor) but guidance has not yet been issued on procedures to be followed.
          f. A penalty will apply if a donee organization knowingly furnishes a false or fraudulent
             acknowledgement, or knowingly fails to furnish an acknowledgement in the manner,
             at the time, and showing the required information. With respect to a qualified vehicle
             sold without a significant intervening use or material improvement, the penalty is the
             greater of (i) the product of the highest rate of tax specified in Section 1 of the Internal
             Revenue Code (currently 35%) and the sales price stated on the acknowledgement, or
             (ii) the gross proceeds from the sale of the vehicle. For all other acknowledgements,
             the penalty is the greater of (i) the product of the highest rate of tax specified in
             Section 1 of the Internal Revenue Code and the claimed value of the vehicle, or (ii)
             $5,000.
                                                                                                16
   g. IRS Notice 2005-44 – 2005-25 IRB1 (June 3, 2005) – Interim guidance
       (1) Qualified vehicle sold at significantly below FMV or gratuitously transferred to
           needy individual in direct furtherance of donee organization’s charitable purpose.
       (2) To constitute a significant intervening use, a donee organization must actually use
           the qualified vehicle to substantially further the organization’s regularly conducted
           activities, and the use must be significant. Incidental use by an organization is not
           a significant intervening use. Whether a use is a significant intervening use
           depends on its nature, extent, frequency, and duration. For this purpose, use by the
           donee organization includes use of the qualified vehicle to provide transportation
           on a regular basis for a significant period of time or significant use directly related
           to instruction in vehicle repair. However, use by the donee organization does not
           include use of the qualified vehicle to provide training in general business skills,
           such as marketing and sales.
       (3) Material improvement includes a major repair or improvement that improves the
           condition of the qualified vehicle in a manner that significantly increases the value.
           Cleaning, minor repairs, and routine maintenance are not considered material
           improvements. To be a material improvement of a qualified vehicle, the
           improvement may not be funded by an additional payment to the donee
           organization from the donor of the qualified vehicle. Services that are not
           considered material improvements include: 1) application of paint or other types of
           finishes (such as rust proofing or was); 2) removal of dents and scratches; 3)
           cleaning or repair of upholstery; and 4) installation of theft deterrent devices.
   h. IRS Publications 4302 (Rev. Aug 2004), A Charity’s Guide to Car Donations, and
      4303, A Donor’s Guide to Car Donations, are in the process of being revised.
      Addenda to the publications highlight the new rules that now apply to donations of
      cars.

   i. IRS released Form 1098-C, “Contributions of Motor Vehicles, Boats and Airplanes,”
      for use by donee organizations to report qualified contributions and to provide written
      acknowledgements to donors. (Announcement 2005-66, 2005-391R.B. 1.)
2. Patents and Similar Property – Effective January 1, 2005 (IRC Section 170(e)(1)(B)(iii)
   and 170(m)
   a. Certain copyrights, trademarks, trade names, trade secrets, know-how, software or
      similar intellectual property or applications or registrations of such property.
   b. Donor’s initial deduction is limited to the lesser of the donor’s basis or the property’s
      fair market value. A donor is also allowed an additional deduction in the year of
      contribution and in later tax years based on a specified percentage of the “qualified
      donee income” received or accrued by the charitable organization from the contributed
      property. Qualified donee income is any net income received or accrued by the
      charitable organization from the contributed intellectual property.
   c. No deduction is permitted with respect to any income received or accrued by the
      donee after the expiration of the legal life of the property, or, if earlier, after the tenth
      anniversary of the contribution.
                                                                                         17
   d. The donee is required to file an annual information return that reports the qualified
      donee income and other specified information related to the contribution.
   e. The additional charitable deduction is not available for patents or other intellectual
      property contributed to a private foundation (other than a private operating foundation,
      common fund foundation or conduit foundation).
   f. IRS Notice 2005-41, 2005-23 IRB 1
      (1) Provides guidance with respect to the additional deduction, the requirement that a
          donor notify the donee in writing at the time of the contribution of the intention to
          treat the contribution as a qualified intellectual property contribution.
          (a) Donor’s written statement must contain the following information
              (i) The name, address, and taxpayer identification number of the donor;
              (ii) A description of the qualified intellectual property in sufficient detail to
                   identify the qualified intellectual property received by the donee;
              (iii) The date of the contribution to the donee; and
              (iv) A statement that the donor intends to treat the contribution as a qualified
                   intellectual property contribution for purposes of §§170(m) and 6050L.
   g. Temporary and Proposed Regulations – 1.6050L-2 and 1.6050-L-2T (May 2005)
      (1) Provides guidance with respect to requirement that donee that receives proper
          notification from the donor that the donor intends to treat the contribution as a
          “qualified intellectual property contribution” files an information report with the
          IRS. Such report is to reflect the amount of qualified donee income.
          (a) No report required if the intellectual property produced no income
          (b) If a report is required it is to be filed (with a copy to donor) on or before the
              first full month following the close of the donee’s taxable year.
          (c) IRS expects to issue new Form 8899 on which donees will report qualified
              donee income.
3. Noncash Donations and Reporting Requirements.
   a. For property valued at more than $500, taxpayer (other than a personal service
      corporation or closely held C Corporation) must include written description of donated
      property.
   b. For property valued at more than $5,000 but less than $500,000, there is no change in
      reporting requirements but the statute provides the IRS with the ability to amend the
      current regulatory requirements.
      (1) Previously C corporations were not required to attach Form 8283 to tax returns
          unless donation was art valued at $20,000 or more.
   c. With the exception of inventory and publicly traded securities, for contributions
      exceeding $500,000 in value taxpayers are required to attach a qualified appraisal to
      their tax return. Applicable to individuals, partnerships and corporations.
                                                                            17-A
4. Katrina Emergency Tax Relief Act Of 2005 (H.R. 3768), Signed Into Law Sept. 23,
   2005.

   a. Individuals making qualified contributions (cash contributions paid during the
      period beginning on August 28, 2005, and ending on December 31, 2005) to
      Section 501(c)(3) organizations will not be subject to percentage limitations.

   b. Contributions for the establishment of a new or maintenance of an existing
      donor-advised fund, or to supporting organizations and private foundations other
      than operating foundations are not eligible recipients for qualified contributions.

   c. Qualified contributions will be allowed to the extent that they do not exceed the
      taxpayer’s AGI over the amount of all other charitable contributions.

   d. Contributions by corporations are not subject to the 10 percent limit during the
      period of August 28 through December 31, 2005.

   e. Contributions by corporations must be for relief efforts related to Hurricane
      Katrina. Individual’s contributions not so restricted.

   f. Individuals and corporations must elect the application of this section.

   g. The standard mileage rate for the charitable use of personal vehicles is 70 percent
      of the standard business mileage rates. (For the period August 25, 2005 through
      December 31, 2006.) This rate was 40.5 cents through August 31, 2005, and was
      increased to 48.5 cents for the period September 1, 2005 through December 31,
      2005.
                                                                                                    18
B.   Regulations

     1. Treasury Decision 9143, 2004-36 I.R.B. 442, and Proposed Regulation Section 208246-
        90,69 Fed. Reg. 44,988 (2004). Temporary and proposed regulations to change the
        method of allocation and apportionment of charitable contributions deductions under
        sections 170, 873(b)(2), and 882(c)(1)(B) between U.S. and foreign – source income. The
        regulations apportion charitable deductions allowed to nonresident alien individuals and
        nonresident foreign corporations against U.S. – source income, maximizing the taxpayer’s
        use of foreign tax credits. The proposed regulations would apportion charitable
        contributions deductions that are allowed only under a tax treaty against foreign source
        income from the other country that is a party to the treaty. This proposed rule would
        apply mostly to contributions to foreign charities.

 C. Cases and Rulings
     1. Addis v. Commissioner, 374 F. 3d 881 (9th Cir. 2004). A charitable deduction was denied
        for a transfer of funds to a charity for the payment of premiums on a life insurance policy
        in which the charity and the taxpayer’s family would share death benefits. Court found
        that the split dollar insurance arrangement provided return benefits to the taxpayers. The
        entire charitable deduction was disallowed because the charity’s acknowledgement did not
        comply with the contemporaneous substantiation requirement of section 170(f)(8). The
        taxable years involved preceded the effective date of section 170(f)(10) which disallows
        charitable deductions and imposes an excise tax on premiums with respect to similar type
        arrangements.

 D. Real Property Easements
     1. In Notice 2004-41, the IRS addressed charitable deduction issues arising from transfers of
        easements to charitable organizations and the purchase of real property from charitable
        organizations. The IRS indicated its intent to disallow inappropriate deductions and
        impose penalties on taxpayers and promoters involved in these transactions, as well as its
        intent to challenge the exempt status of charitable entities that participate in these
        transactions. In the Notice, the Service reviewed the general rule that no charitable
        deduction is allowed for transfer of less than the taxpayer’s entire interest in a property, as
        well as the exception to that rule for qualified conservation easements. It noted that the
        deduction is allowed only where properly substantiated and where the donor and related
        parties do not expect to receive financial or economic benefits greater than those that will
        result to the general public.
        Also commented on were transactions where the charitable organization purchases a
        property, places a conservation easement on the property, and sells the property to an
        individual at a price lower than the charitable organization paid, in order to reflect the
        reduction in value resulting from the easement. In connection with this arrangement, the
        buyer of the property makes a second payment to the organization that equals the
        difference between the price the organization paid for the property and the price at which
        it sold the property to the taxpayer, and deducts the amount as a charitable contribution.
        The IRS noted that it will consider the substance, rather than the form, of these
        transactions as determinative of whether the payments are deductible, and will impose
        penalties and excise taxes where appropriate.
                                                                                        19
      2. Senate Finance Committee Hearing – “The Tax Code and Land Conservation: Report on
         Investigations and Proposals for Reform” – June 8, 2005
         a. Finance Committee Report on The Nature Conservancy
         b. Witness Statements and Reports can be found at http://finance.senate.gov (click on
            hearings)
      3. House Ways and Means Committee, Subcommittee an Oversight – June 23, 2005, Hearing
         to Review the Tax Deduction for Façade Easements http://waysandmeans. house.gov
         (click on oversight under Hearings)
      4. 2005 Schedule A has question with respect to contribution of qualified real property
         interests.


IV. RETIREMENT ARRANGEMENTS
   A. Section 403(b) Plans-Proposed Regulations

      1. The regulations are proposed to be generally applicable to taxable years beginning in
         2006. Special transition rules are applicable to a Section 403(b) contract maintained
         pursuant to a collective bargaining agreement, as well as to a Section 403(b) contract
         maintained by a church-related organization. [Effective date postponed until 2007]

      2. Must be maintained pursuant to a written defined contribution plan which in both form
         and operation satisfies 403(b) and contains all the material terms and conditions for
         benefits under the plan, regarding eligibility, benefits, applicable limitations, the contracts
         available under the plan, and the time and form under which benefit distributions would be
         made. A single plan document is not required. The requirement would be satisfied by
         complying with the plan document rules applicable to qualified plans.

      3. To the extent that a plan document requires an employer to, e.g., exercise control over
         distributions, loans, etc, it is more likely that the plan will be subject to ERISA.

      4. Good faith reasonable standard of Notice 89-23 nondiscrimination rules now applicable to
         employer contributions and employee after tax contributions will not be maintained.
         Rather, such contributions will have to satisfy the nondiscrimination requirements in the
         same manner as a qualified plan.

      5. Loans are permitted.

      6. Contributions are permitted for up to 5 years after employment ends. Contributions are
         subject to nondiscrimination rules and must be permitted or required by plan document.

      7. Plan termination is provided for.

      8. Permits transfer to assets from 403(b) to qualified plan, but not vice versa.
                                                                                                20
B. Interaction of 457(b) and 403(b) Deferral Provisions
   1. For 2005, the combined elective deferral limit under 403(b) and 457(b) is $28,000.
   2. For persons over 50 years of age, the 2005 deferral limit is $32,000 (the age 50 catch-up
      provision is not available to employees of section 501(c)(3) organizations with respect to
      457(b) plans).
   3. For person over 50 years of age, and 15 years of service with the same employer, the
      deferral limit for 2005 is $35,000.
C. Section 457(f) Plans
   1. No limit to annual contributions.
   2. Must be subject to “substantial risk of forfeiture” (substantial future service).
   3. Includible in income when vested.
D. Section 409A – New Requirement for Section 457(f) Plans
   1. Effective date – Generally effective with respect to all compensation deferred under a
      Section 457(f), grandfathered, or church plan that is subject to a substantial risk of
      forfeiture as of January 1, 2005.
       a. Notice 2005-1 provides initial guidance. Outlines scope section 409A. [Proposed
          Regs – issued September 29, 2005]
       b. See 20-A
       c. See 20-A
   2. Substantial risk of forfeiture – Substantial future service. However, IRS is authorized to
      issue regulations “disregarding a substantial risk of forfeiture.”
       a. An example would be if an executive was able to control accelerating or lapse of
          substantial risk of forfeiture.
   3. Compensation for services performed during a taxable year may be deferred at the
      participant’s election only if the election to defer is made no later than the close of the
      preceding taxable year, or at such other time as provided in Treasury regulations. In the
      case of any performance-based compensation based on services performed over a period
      of at least 12 months, the election may be made no later than six months before the end of
      the service period.
   4. Plan can permit a subsequent election to delay the timing or form of distributions only if
      (1) the plan requires that such election cannot be effective for at least 12 months after the
      date on which the election is made; (2) except in the case of elections relating to
      distributions on account of death, disability or unforeseeable emergency, the plan requires
      that the additional deferral with respect to which such election is made is for a period of
      not less than five years from the date such payment would otherwise have been made; and
      (3) the plan requires that an election related to a distribution to be made upon a specified
      time may not be made less than 12 months prior to the date of the first scheduled payment.
                                                                              20-A

b. Notice 2005-1 provided that plan amendments could be made until December 31,
   2005, if plan administrated in “good faith” compliance throughout 2005.
   Proposed regs extend amendment period and “good faith” compliance period to
   December 31, 2006.

c. Proposed regs intended solely as guidance with respect to application of section
   409A to section 457(f) arrangements, and should not be relied upon with respect
   to the application of section 457(f).
                                                                                                   21

     5. Although as a general rule a plan may not permit the acceleration of time or schedule of
        any payment under the plan, the legislative history provides examples of possible
        exceptions including a payment to a participant to pay income taxes due upon a vesting
        event, provided that the amount of such payment is not more than an amount equal to the
        income tax withholding that would have been remitted by the employer if there had been a
        payment of wages equal to the income includible by the participant under Section 457(f)
        at the time of the vesting.
     6. If a deferred amount is required to be included in income, either because the plan fails to
        satisfy the distribution, acceleration of benefits, or election requirements, or because it
        fails to satisfy the funding requirements, the tax for the year is also increased for interest
        and an additional income tax. The interest imposed is equal to the interest at the
        underpayment rate plus one percentage point, imposed on the underpayments that would
        have occurred had the compensation been includible in income for the tax year when first
        deferred, or if later, when not subject to a substantial risk of forfeiture. The additional
        income tax is equal to 20 percent of the compensation required to be included in gross
        income.

     7. The Committee report provides that the total amount of deferrals under a NQDC for the
        year will be required to be shown on Form W-2. Beginning with the 2005 Form W-2, a
        new (Code (Code Y – Deferrals under a Section 409A nonqualified deferral compensation
        plan), for use in box 12, will be added. The IRS is authorized to issue regulations
        establishing a minimum threshold for reporting.
     8. Despite the January 1, 2005 effective date, the IRS announced that Section 457(f) plans
        (which may be a separate plan document, or an employment agreement that includes
        deferred compensation provisions satisfying Section 457(f), do not need to be amended
        before December 31, 2005, provided that the plan is operated in good faith compliance
        with the rules in Section 409A during 2005.


V. UNRELATED TRADE OR BUSINESS
  A. Requirements – IRC Sec. 513(a)
     1. Trade or business – Reg. 513(c) provides that the “term “trade or business” includes any
        activity which is carried on for the production of income from the sale of goods or the
        performance of services, and which otherwise possesses the characteristics required to
        constitute a “trade or business” within the meaning of IRC Section 162.” The regulation
        states that “an activity does not lose identity as a trade or business merely because it is
        carried on within a larger aggregate of similar activities or within a larger complex of
        other endeavors which may, or may not, be related to the exempt purposes of the
        organization.” The foregoing is known as the “fragmentation rule.”
                                                                                             22
2. Regularly carried on

   a. Reg. 1.513–1(c) provides that in determining whether a trade or business from which a
      particular amount of gross income derives is “regularly carried on” within the meaning
      of Section 512, regard must be had to the frequency and continuity with which the
      activities productive of the income are conducted and the manner in which they are
      pursued. This requirement must be applied in light of the purpose of the unrelated
      business income tax to place exempt organization business activities upon the same
      tax basis as the nonexempt business endeavors with which they compete. Hence, for
      example, specific business activities of an exempt organization will ordinarily be
      deemed to be “regularly carried on” if they manifest a frequency and continuity, and
      are pursued in a manner, generally similar to comparable commercial activities of
      nonexempt organizations.

3. Not substantially related to exempt purpose

   a. Reg 1.513-1(d)-1 reads - “In general – Gross income derives from “unrelated trade or
      business,” within the meaning of Section 513(a) if the conduct of the trade or business
      which produces the income is not substantially related (other than through the
      production of funds) to the purposes for which exemption is granted. The presence of
      this requirement necessitates an examination of the relationship between the business
      activities which generate the particular income in question – the activities, that is, of
      producing or distributing the goods or performing the services involved – and the
      accomplishment of the organization’s exempt purposes.”

   b. In determining whether or not an activity is substantially related to the exempt purpose
      of the organization, Reg. 1.513-(d)(1), (2) and (3) provide the following principles:

       (1) An examination of the relationship between the business activities which generate
           the particular income in question…and the accomplishment of the organization’s
           exempt purpose.

       (2) The conduct of the business activities have a causal relationship to the
           achievement of exempt purposes (other than through the production of income),
           and the causal relationship is a substantial one. For the conduct of a trade or
           business from which a particular amount of gross income is derived to be
           substantially related, the production or distribution of the goods or the
           performance of the services…must contribute importantly to the accomplishment
           of those purposes.

       (3) The size and extent of the activities involved must be considered in relation to the
           nature and extent of the exempt function which they purport to serve. Where
           income is realized by an exempt organization from activities which are in part
           related to the performance of its exempt functions, but which are conducted on a
           larger scale than is reasonably necessary for performance of such functions, the
           gross income attributable to that portion of the activities in excess of the needs of
           exempt functions constitutes gross income from the conduct of unrelated trade or
           business.
                                                                                          23
c. Application of principles in determining whether an activity is related

   (1) Disposition of product of exempt functions. – Ordinarily, gross income from the
       sale of products which result from the performance of exempt functions does not
       constitute gross income from the conduct of unrelated trade or business if the
       product is sold in substantially the same state it is in on completion of the exempt
       functions. In the case of an experimental dairy herd maintained for scientific
       purposes, income from sale of milk and cream produced in the ordinary course of
       operation of the project would not be gross income from conduct of unrelated trade
       or business. If the organization were to utilize the milk and cream in the further
       manufacture of food items such as ice cream, pastries, etc., the gross income from
       the sale of such products would be an unrelated trade or business unless the
       manufacturing activities themselves contribute importantly to the accomplishment
       of an exempt purpose of the organization. [Reg. 1.513-1(d)(4)(ii)] What if
       organization’s purpose is to train inner city youth to be pastry chefs?

   (2) Dual use of assets or facilities – In certain cases, an asset or facility necessary to
       the conduct of exempt functions may also be employed in a commercial endeavor.
       The test is whether the activities productive of the income in question contribute
       importantly to the accomplishment of exempt purposes. An example would be a
       museum that has a theater auditorium specially designed and equipped for showing
       of educational films in connection with its program (the theatre is a principal
       feature of the museum and is in continuous operation during the hours the museum
       is open to the public) and the theater is operating as an ordinary motion picture
       theater for public entertainment during the evening hours when the museum is
       closed, gross income from such operation would be gross income from conduct of
       unrelated trade or business. (Expenses would also have to be allocated.) [Reg.
       1.513-1(d)(iii)]

   (3) Exploitation of exempt functions – In certain cases, activities carried on by an
       organization in the performance of exempt functions may generate good will or
       other intangibles which are capable of being exploited in commercial endeavors.
       Where an organization exploits such an intangible in commercial activities, the
       mere fact that the resultant income depends in part upon an exempt function of the
       organization does not make it gross income from related trade or business. In such
       cases, unless the commercial activities themselves contribute importantly to the
       accomplishment of an exempt purpose, the income which they produce is gross
       income from the conduct of unrelated trade or business. Advertising in exempt
       organizations’ periodicals is an example. [Reg. 1.512(a)-1(f)]
                                                                                                24
B. Exclusions from Unrelated Trade or Business

   1. Activities in which substantially all (in excess of 85 percent) is for the organization
      without compensation [Section 513(a)(1)].

   2. Activities carried on by an organization described in Sec. 501(c)(3) or state colleges or
      universities primarily for the convenience of its members, students, patients, officers, or
      employees. [IRC Section 513(a)(2)]

   3. Sale of merchandise substantially all (in excess of 85 percent) of which has been donated.
      IRC Section 513(a)(3). (“Thrift shop exception.”)

   4. Qualified convention and trade show activities of Section 501(c)(3), (4), (5) and (6)
      organizations, and qualified public entertainment activities of Section 501(c)(3), (4), and
      (5) organizations.

      a. A qualified convention or trade show is defined as one in which the purpose is to:

          (1) Stimulate interest in the products of a particular industry.

          (2) Educate those attending about developments, products and/or services related to
              the exempt purpose activities of the organization.

          (3) Demonstrate the aforementioned by the character of a significant part of the show.

          (4) Must be carried on by a qualifying organization and be conducted in conjunction
              with an international, national, state, regional, or local show, convention or annual
              meeting.

C. Commerciality Doctrine

   1. Overview - The doctrine is nonstatutory in nature. Rather, it is judicially generated. The
      essence of the doctrine is that an exempt organization is engaged in a nonexempt activity
      when that activity is engaged in a “commercial” manner. In order to be considered
      commercial, there must be a direct counterpart in the for-profit arena.

   2. Internal Revenue Code and Regulations

      a. Regulations utilize the term “commercial” as one of the factors in determining
         whether or not a “business” is regularly carried on by providing that an exempt
         organization’s business activities will ordinarily be considered to be regularly carried
         on if they “manifest a frequency and continuity, and are pursued in a manner,
         generally similar to comparable commercial activities of nonexempt organizations
         [Reg. 1.513-1(c)(1) and 1.513-1(c)(2)(ii)]. Reg. 1.513-1(d)(3) provides that “...In
         determining whether activities contribute importantly to the accomplishment of an
         exempt purpose, the size and extent of the activities involved must be considered in
         relation to the nature and extent of the exempt function which they purport to serve.
                                                                                            25
3. Judicial Development

   a. Enunciated initially in 1924 by the U.S. Supreme Court (conclusion was that an
      organization’s activities were incidental in relation to its exempt purposes and,
      accordingly, did not adversely affect its exempt status). In 1945, the Supreme Court
      (in a case involving a chapter of the Better Business Bureau seeking exempt status as
      an educational organization) in denying tax-exempt status, concluded that the
      organization had a commercial coloring to it and was in large measure motivated by
      its commercial purpose. Better Business Bureau of Washington, D.C. v. United
      States, 326 U.S. 279(1945).

   b. In Scripture Press Foundation v. United States, 285 F.2d 800 (Ct.1961), the court
      stated that very substantial profits “... is at least some evidence indicative of a
      commercial character...”

      (1) Aspects of commerciality doctrine based on court’s holding.

          (a) Extent of organization’s net profits

          (b) Extent of accumulated surplus

          (c) Amounts expended for tax-exempt functions

   c. Living Faith, Inc. v. Commissioner, 950 F.2d.365 (7th Cir. 1991). Tax-exempt status
      denied to an organization associated with the Seventh-day Adventist Church that
      operated, in accordance with and in furtherance of church doctrine, vegetarian
      restaurants and health food stores. In finding that the facilities were operated in a
      manner similar to other restaurants and food stores, the court held that the activity was
      conducted as a business and was in direct competition with other restaurants and
      health food stores. The court went on to say that “...Competition with commercial
      firms is strong evidence of a substantial nonexempt commercial purpose.”

4. Rulings

   a. In LTR 200051049 (9/26/2000), a hospital purchased a fitness center. As part of its
      overall plan to provide continuing care to its patients and increase wellness awareness
      in the community, it established a rehabilitation center within the fitness center for
      patients who had suffered heart-related illness. A majority of the physical facility was
      occupied by the fitness center. There was a three-tiered membership – general public,
      organization employees and former rehabilitation patients. It was ruled that the
      cardiac rehabilitation program promotes the health of the community, and that the
      fitness center furthered a charitable purpose because it was available to a significant
      segment of the community (based on a survey of income levels of members as
      compared to community).
                                                                                                 26
      b. Rev. Rul. 79-360, 1979-2 C.B. 236, distinguished.
         The Rev. Rul. concluded that the operation of the health club facilities generated
         unrelated business taxable income, because its operation did not contribute
         importantly to the organization’s exempt purpose. The operation of the health club
         was seen to be separate from the organization’s general fitness program inasmuch as
         the commercially comparable annual dues or daily fees were sufficiently high to
         restrict participation in the health club to a limited segment of the community.
   5. Other recent examples of exempt status being denied by the IRS based on
      “commerciality.”
      a. Organization established to provide financial and logistical assistance to the creators
         of low-budget film and theatre productions denied exempt status because it planned to
         help sell commercially viable films, and this has “commercial overtones.” (Citation:
         20044038E, 3/24/04)
      b. Exempt status denied to an organization established to promote and run an annual art
         show and provide an annual art scholarship on grounds that an organization is not
         operated exclusively for exempt purposes, and that its primary activity is running a
         “selling mart for artists.” (Citation: 20144037E, 1/9/04)

      c. Credit counseling agencies
         (1) The IRS, in conjunction with the Federal Trade Commission and state regulations,
             has issued News Release 203-1 20 and Fact Sheet 117, which address concerns
             that such organizations may seek exempt status in order to circumvent state and
             federal consumer protection laws.

         (2) In a legal memorandum (ILM 200431023, 7/13/04), the IRS presented a legal
             analysis of why many credit counseling organizations will not qualify for Section
             501(c)(3) status.
D. The Commensurate Test
   1. Genesis – Reconciliation of insubstantial part requirement of operational test [Reg.
      1.501(c)(3) – 1(c), and the primary purpose test (Reg. 1.501(c)(3) – 1(e)].
      a. Reg. 1.501(c)(3) – 1(c)
         An organization will be regarded as “operated exclusively” for one or more exempt
         purposes only if it engages primarily in activities which accomplish one or more of
         such exempt purposes specified in Section 501(c)(3). An organization will not be so
         regarded if more than an insubstantial part of its activities is not in furtherance of an
         exempt purpose.
      b. Reg. 1.501(c)(3) – 1(e)
         An organization may meet the requirements of Section 501(c)(3) although it operates a
         trade or business as a substantial part of its activities if the operation of such trade or
         business is in furtherance of the organization’s exempt purpose or purposes and if the
         organization is not organized or operated for the primary purpose of carrying on an
         unrelated trade or business.
                                                                                           27
   c. GCM 34682 (1971) is the basis of IRS rulings policy –

      “…to the extent there are any implicit limitations on the business endeavors in which a
      charity may engage for federal income tax purposes, they are limitations which do not
      directly derive from any express statutory directive of tax law but from rules rooted in
      the general law of charity respecting the duties imposed on fiduciaries in the
      administration of charity properties. That is, that charity property must be
      administered exclusively in the beneficial interest of the charitable purposes to which
      it is dedicated. The duties and limitations growing out of that principle, and the
      remedies for their violation, are essentially equitable in nature, and cannot be reduced
      to mechanical rules of application. (Emphasis added.)

      … If an organization is carrying on a real and substantial charitable program
      reasonably commensurate with its resources, that is just about the most conclusive
      evidence one could have as to the charitable purposes of an organization in the
      administration of its properties.
2. Application of “commensurate test”
   a. Although there is no specific percentage limitation, it is common to measure s
      substantiality and nonsubstantiality in terms of percentages of expenditure or time.
      (1) In Orange County Agriculture Society, Inc., 893 F.2d. 647 (2nd Cir. 1990), aff’d 55
          T.C.M. 1602 (1988), exempt status was denied where the organization received in
          excess of 25 percent of its revenue from an unrelated business.

   b. In TAM 2000-21-56 (Feb. 8, 2000), a Section 501(c)(3) organization assisted needy
      women in earning a living by providing a place where they could sell articles and
      foodstuffs prepared by them. The organization operated a consignment shop, gift shop
      and a tearoom in the same facility. Each activity was run both by volunteers and paid
      employees. The consignment shop displays and sells goods made by needy women
      and produces 33% of revenues. The gift shop purchases items from regular for-profit
      vendors, and produces 28% of revenues. The tearoom accounts for 34% of revenues.
      The tearoom and gift shop were held not to be substantially related to the
      organization’s exempt purpose. Notwithstanding that 2/3 of revenue was from UBI,
      the TAM concluded that the regulations do not provide for a quantitative limitation on
      the amount of unrelated business an organization may engage in other than the
      fundamental requirement that the organization must be organized and operated
      exclusively for charitable purposes.

      (1) Although 2/3 of revenue was UBI, the IRS did not consider revocation.
          Organization provided significant charitable services, which apparently weighed
          heavily against revocation. Furthermore, substantial UBI did not mean that a
          commensurate amount of organization’s resources were utilized in producing such
          revenues.
                                                                                                28
E. Internet Activities
   1. In Announcement 2000-84, the IRS stated that “The growing use of the Internet by
      exempt organizations raises questions regarding whether clarification is needed
      concerning the application of the Code to Internet activities.”

       a. Announcement set forth as issues utilization of the Internet with respect to political
          and lobbying activities, advertising and other business activities, and solicitation of
          contributions.

       b. IRS requested comments. In response AICPA (Taxation of Internet Services Task
          Force) submitted comments. (http://tax.aicpa.org/Resources/Exempt+Organizations/
          Regulation+and+Administration/AICPA+Comments+on+Internet+Taxation+for+Exe
          mpt+Organizations.htm)

   2. To date guidance with respect to the Internet and unrelated business income has not been
      forthcoming with the exception of Rev. Rul. 2004-51 (ancillary joint ventures and Rev.
      Rul 2004-112, 2004-51.1.R.B. 985, with respect to virtual trade shows.)

   3. In Revenue Ruling 2004-112, 2004-51 I.R.B. 985, the Service provided guidance with
      respect to when revenues from Internet activities conducted by section 501(c)(6) trade
      associations are within the qualified convention activity exception to unrelated business
      taxable income established by section 513(d)(3)(B). In the ruling, the Service provides
      two scenarios. In the first, a section 501(c)(6) organization conducts semi-annual trade
      shows. During and shortly before and after the trade shows the organization maintains a
      website that provides information about the trade shows and access to information that is
      also available at the trade shows, including product information and listings. In the
      second, an organization makes available a website for a two-week period that does not
      coincide with any convention, annual meeting, or trade show.

       In its analysis, the Service noted that the section 513(d) trade show provision is a narrow
       exception to the general rule that advertising and other promotional activities would
       normally constitute trade or business generating unrelated business taxable income under
       section 513(c). With respect to the first the IRS concluded that the revenue scenario was
       not unrelated business taxable income. The IRS reasoned that, although the Internet
       activities are not conducted at the physical location of the trade shows, they coincide with
       the time of the trade shows and are of a kind traditionally conducted at trade shows.
       Therefore, the Internet activity is ancillary to the trade show and falls within the section
       513(d) exception.

       With respect to the second scenario, the activities are not linked to a trade show or
       convention and do not in themselves constitute a convention, annual meeting, or trade
       show, because the website is not a physical location at which members, suppliers, and
       customers gather in person at a specific time and meet face-to-face, nor do the Internet
       activities coincide with or enhance a specific event that does qualify. Thus, revenues from
       the Internet activities described in the second scenario are not excluded by the section
       513(d)(3)(B) exception.
                                                                                              29
F. Management and Consulting Services
   1. Factors relevant in determining whether an organization has satisfied the substantially
      related test.
      a. Focus on organization’s intent and conduct, rather than on the actual impact of the
         activity.
          (1) In LTR 8422168, one nonprofit organization provided management services and
              facilities to another nonprofit for a fee approximating cost. The service provider
              ruled that the services were substantially related to the exempt purpose of
              increasing the availability of guaranteed student loans.
             (a) In considering intent and conduct with respect to a commercial activity, the fee
                 charged may be very relevant. Limitation on access to services, due to fee
                 charged, may weaken case for furtherance of exempt purpose. Providing
                 services in a charitable context is inconsistent with limiting services to those
                 able to pay the fee.
      b. To overcome presumption in favor of treating commercial activities as not
         substantially related, an organization must show that they are particularly suited in
         connection with the exempt purpose of the organization.
      c. Availability of Commercial Alternative
          (1) Absence as evidence that commercial activity furthered exempt purpose. In
              California Thoroughbred Breeders Association v. Commissioner, 57 TCM (CCH)
              962 (1989) the absence of commercial alternative helped convince court that
              income earned by organizations was not UBTI.
          (2) Presence of commercial alternative as evidence precluding treatment as exempt
              activity. Carolina Farm & Power Equipment Dealers Association v. United States,
              699 F.2d 167, (4th Cir. 1983). Where a service is available in the market place, a
              trade association need not provide it to accomplish an exempt purpose.

      d. Recipients of Services

          (1) Consideration of those benefiting from commercial services can illuminate the
              relationship between the services rendered and the exempt purpose of the
              organization.

             (a) In Hi-Plains Hospital v. United States, 670 F.2d 528 (5th Cir. 1982) operation
                 of a pharmacy was held to further the exempt purpose even though sales were
                 not limited to hospital patients. Sales on an outpatient basis to patients of
                 physicians affiliated with the hospital were found to be related because they
                 helped attract and retain physicians in an area with inadequate medical care.

             (b) Contra. In Carle Foundation v. United States, 611 F.2d 1192 (7th Cir. 1979),
                 there was no evidence that pharmacy sales to non-admitted patients helped to
                 attract and retain physicians, and in Rev. Rul. 68-375 such sales not considered
                 to contribute importantly to exempt purposes.
                                                                                                  30
       e. Relationship Between Service Provider and Service Recipient
          (1) As a general rule, provision of management and other administrative services by
              one tax-exempt organization to another will constitute an unrelated activity.
          (2) Provision of services to a related for-profit entity. In LTR 200132040,
              management services income received by Sec. 501(c)(3) organization from its
              wholly owned subsidiary resulted in UBI. The basis for the findings was that the
              provision of management services to a for-profit organization is not an exempt
              activity.
              (a) IRS position is that the choice of a for-profit entity to conduct activities is
                  inherently not a charitable purpose. An exempt organization could take the
                  position that provision of services to a related for-profit entity does not
                  constitute a trade or business within the purview of Section 162.
       f. Profitability
          (1) The presence of a profit motive is not determinative of whether provision of
              management services is UBTI. While profit motive not necessarily of great
              importance, in appropriate circumstances, it will be one of the factors taken into
              account.
                  (a) In TAM 9608003, where services were provided at cost (exempt status not
                      an issue), it was stated that the “…services, materials, rental space,
                      utilities… are set on a strict recovery basis, with no attempt to make any
                      profit.” In Carle Foundation v. United States, 611 F.2d. 1192, 1198 (7th
                      Cir. 1979), the Court stated that “Although not absolutely conclusive, these
                      substantial profits appear to contribute importantly to a business rather than
                      an exempt purpose and clothe this portion of… the activities with the
                      attributes of a commercial enterprise.”
G. Ancillary Joint Ventures
   1. Development of IRS Position Pre-Rev. Rul. 2004-51
       Plumstead Theater Society v. Commissioner, 74 T.C. 1324 (1980), aff'd per curiam, 675
       F2d. 944 (9th Cir. 1982).
       a. The only court case involving issue of a 501(c)(3) organization as a general partner in
          a limited partnership. Court concluded that an exempt organization could enter into
          such a relationship with for-profit investors and still operate exclusively for charitable
          purposes.
          (1) Exempt status not affected by participation.
              (a) Sufficient safeguards to insulate organization from conflict with exempt
                  purposes which included: (i) exempt organization not obligated to return any
                  capital contributions made by the limited partners out of its own funds; (ii) the
                  sale of the interest in the play was for a reasonable price; (iii) limited partners
                  had no control over the management of the exempt organization; (iv) none of
                  the limited partners was an officer or director of the exempt organization; and
                  (v) the exempt organization exhibited no profit motive.
                                                                                     31
   b. IRS Two-Prong Test – After the ruling in Plumstead, the IRS developed a two-prong
      test to determine the propriety of joint ventures between exempt and nonexempt
      entities.
      (1) The structure of the joint venture should protect the exempt organization from
          potential conflicts between its charitable purposes and its general partnership
          obligations.
      (2) Partnership activities should further the exempt purposes of the organization.

   c. The satisfaction of the so-called “two-prong” test is determinative with respect to the
      retention of Section 501(c)(3) status. However, while the first prong - furtherance of
      exempt purpose - is significant, its importance relates primarily to the characterization
      of the income stream generated by the participation in the joint venture. It is the
      second prong - acting exclusively in furtherance of exempt purposes - and not (other
      than incidentally) for the benefit of the for-profit partners that is key.

   d. While an organization can qualify as a Section 501(c)(3) organization if it conducts
      activities which do not serve a charitable purpose, such activities cannot constitute
      more than an insubstantial portion of the totality of the organization’s activities.
      When the exempt organization’s participation does not represent more than an
      insignificant portion of its assets and/or revenue, there is a commensurate reduction in
      the IRS concern that the exempt organization’s financial interests may be at risk for
      the benefit of its for-profit partners.

2. Rev. Rul. 2004-51
   a. Addresses whether an exempt organization that contributes a portion of its assets to a
      limited liability company formed with a for-profit and conducts a portion of its
      activities through the LLC can still qualify for exempt status. The ruling involves a
      non-health- care ancillary joint venture in which each party (not-for-profit and for-
      profit) each have a 50 percent share and have equal representation on the board. The
      not-for-profit entity is a university and, as part of its educational programs, offers
      summer seminars to enhance the skill level of elementary and secondary
      schoolteachers. To expand the scope of such seminars, the university forms an LLC
      with a company that specializes in conducting interactive video training programs.
      The activities of the LLC represent an insubstantial portion of the university’s
      activities. The video seminars covered the same substantive material as the on-
      campus seminars of the university. Governing documents grant the university
      exclusive right to approve the curriculum, training materials and instructions, and to
      determine the standards for successful completion of the seminars. The for-profit had
      the exclusive right to select locations for video links and to approve other personnel
      (such as camera operators) necessary to conduct such video seminars. All other
      actions required mutual consent.

   b. Rev. Rul. concludes that because the activities the EO conducted through the LLC are
      not a substantial part of its activities, the EO’s participation in the LLC will not affect
      its exempt status. Because activities are substantially related to EO’s charitable
      purposes (education), it is not subject to UBIT on its distributive share of LLC’s
      income.
                                                                                                 32

       c. Ruling implies that, in other circumstances not presented in ruling, even if the activity
          is substantially related, such activity could result in loss of exempt status or unrelated
          business income if the exempt organization cedes control to the for-profit with respect
          to the charitable aspects.

H. Recent Letter Rulings

   1. In LTR 200510030, the IRS rules that income resulting from trade show conducted by a
      single-member LLC of a 501(c)(6) trade group is not UBI because LLC is a disregarded
      entity and because of section 513(d) exception.

   2. In LTR 200506025, the IRS ruled that a section 501(c)(6) business league’s share of net
      revenue from an entity (formed with an unrelated limited liability partnership) that
      delivers an online legal information service to the business league’s members will not be
      UBI. In finding relatedness the keys were the uniqueness of the service (no alternative
      available), and was limited to members and not distributed to the public in a commercial
      manner.

   3. In LTR 200439043, the IRS ruled that a certification program established by a component
      of a 501(c)(3) organization will primarily serve the interests of a profession (not
      substantially related to the purpose for which exemption was granted), and thus will be on
      unrelated trade or business.

   4. In LTR 200432026, the IRS ruled that loan proceeds received by a private foundation was
      not “debt-financed property” under IRC section 514 as long as the proceeds were
      distributed to charitable organizations. Any income derived by private foundation from
      the investment of the loan proceeds prior to distribution to charitable organizations would
      be unrelated debt-financed income.

   5. In LTR 200501017, the IRS ruled that a charity’s receipt of insurance premiums providing
      insurance for the risks of a for-profit subsidiary of a nonprofit healthcare organization will
      be UBI.

   6. In LTR 200512025, the IRS ruled that a charitable organization’s sales of produce grown
      on its site will not constitute unrelated trade or business income, but sales of produce
      grown offsite will be unrelated. [Conduct of activities on a scale larger than necessary to
      carry out organization’s exempt purpose unrelated.]
                                                                                                    33
VI. INTERNATIONAL PHILANTHROPY
    A. IRS Announcement 2003-29, 2003-20 I.R.B. 928 (May 19, 2003). Sets forth the existing law
       with respect to the deductibility of charitable contributions to U.S. charities making grants to
       foreign entities not exempt under 501(c)(3). Announcement also requested public comments
       on how the IRS might clarify existing requirements with respect to international grant making
       and other international activities.

    B. IRS Office of Chief Counsel Advice Memorandum (20054031). Summarizes law on
       international grant making and related activities by U.S.-based charities.

    C. Resources

       1. Council on Foundations (www.cof.org)

       2. U.S. International Grantmaking (USIG) www.usig.org - Project of Council on
          Foundations

           a. Principles of International Charity

           b. Seeking a Safe Harbor

           c. Handbook on Counter-Terrorism Measures – What U.S. Nonprofits and Grantmakers
              Need to Know.

       3. Panel on the Nonprofit Sector Draft Recommendations #3 International
          Grantmaking.   www.nonprofitpanel.org/supplemental/list (includes Executive
          Summary of ABA Comments)


VII. POLITICAL ACTIVITY
    A. House Committee on House Administration hearing on reform of Section 527 organizations,
       April 20, 2005.

    B. Senate Rules and Administration Committee hearing on March 8, 2005, with respect to
       proposal legislation (S.271) which would require some additional organizations registered
       under IRC section 527 to register as “political committees” with the Federal Election
       Commission and comply with the provisions of the Federal Elections Campaign Act,
       including the contribution limitations and reporting provisions.

    C. Treasury Inspector General for Tax Administration (TIGTA) Report (August 2005)
       (www.treas.gov/tigta/auditreports/2005reports/200510035fr.pdf)

       1. Purpose was to assess effectiveness of Exempt Organizations efforts to ensure political
          organizations (Sec. 527) file timely and complete Political Organization Notices of Sec.
          527 status (Form 8871) and Political Organization Reports of Contributions and
          Expenditures (Form 8872).
                                                                                           34
   2. Report relates to IRS initiative to enforce reporting and disclosure by Section 527
      organization (IR-2004-10, August 19, 2004) (www.irs.gov/charities/political/index.html),
      and involved contacting 30 organizations whose filings appeared to be incomplete, were
      filed late, or were amended and were materially different from original filing.

   3. Preliminary results indicated 22 of the 30 organizations established reasonable cause for
      not filing and disclosing information timely and completely. Of the remaining eight, three
      believed they were qualified. Qualified State and Local Political Organizations (QSLPO),
      and not required to file Form 8871, assessed penalties in two cases, two cases are still
      being worked, and closed one, despite incomplete From 8872, because further review of
      organization’s records would be necessary to sustain penalty.

D. IRS Examination of NAACP

   1. IRS decision to examine NAACP four months before the 2004 general election has
      generated a controversy. The genesis of the examination was a speech given by Julian
      Bond at the NAACP Annual Convention. The speech was on the state of civil rights in
      the U.S. on the Fiftieth anniversary of Brown v. Board of Education and the fortieth
      anniversary of the Civil Rights Act of 1964.
   2. As part of its Political Initiative Project (PIP) the IRS contacted a number of exempt
      entities regarding activities that might be inconsistent with their exempt purpose,
      including NAACP.
   3. The controversy involves not only the timing of the letter, but that the PIP was undertaken
      in direct response to the request of two unnamed members of Congress, and the
      examination was being commenced in advance of the likely due date for the 990s of any
      of the selected organizations.

   4. Since waiting for the 990 to be filed would allow organizations to engage in prohibited
      political activity, IRC section 6852 provides for termination assessments in the case of
      “flagrant” violations of the prohibition against making political expenditures. Section
      7409 provides IRS may “seek to enjoin any section 501(c)(3) organization from making
      further political expenditures and for such other relief as may be appropriate to ensure that
      the assets of such organizations are prescribed for charitable or other proposes in section
      501(c)(3).”
      a. Three conditions must be met to impose section 7409
          (1) IRS must notify organization of the intention to seek injunction of political
              expenditures not ceased immediately
          (2) Commissioner must have personally determined that organization has “flagrantly”
              participated or intervened in political campaign.
          (3) Commissioner has “personally” determined that injunctive relief is appropriate to
              prevent future political expenditures.
      b. Question is whether section 6852 prohibits examination of type initiated under PIP
         when asserted violation is not flagrant. IRS has never invoked its authority under
         either section 6852 or 7409.
                                                                                                   35
     E. In TAM 20046033 the IRS ruled that a section 501(c)(3) organization’s administration of a
        payroll deduction plan through which employees can contribute to a hospital industry political
        action committee described in section 527 constitutes participation or intervention in a
        political campaign prohibited by section 501(c)(3).


VIII. EXEMPT STATUS
     A. Churches

        1. In LTR 200530028, the IRS ruled that a religious organization qualified as a church. The
           ruling refers to American Guidance Foundation, Inc. v. United States, 490 F.Supp. 304
           (D.D.C. 1980), where the court recognized the IRS’s 14-part test in determining whether a
           religious organization was a church.

            a. Fourteen-part test
                (1) a distinct legal existence; (2) a recognized creed and form of worship; (3) a
                definite and distinct ecclesiastical government; (4) a formal code of doctrine and
                discipline; (5) a distinct religious history; (6) a membership not associated with any
                other church or denomination; (7) an organization of ordained ministers (8) ordained
                ministers selected after completing prescribed studies; (9) a literature of its own; (10)
                established places of worship; (11) regular congregations; (12) regular religious
                services; (13) Sunday schools for religious instruction of the young and; (14) schools
                for the preparation of its ministers
        2. In LTR 200502044 the IRS ruled that an organization that conducts religious services on
           Sundays and offers Bible study but lacks ecclesiastical government, has no code or
           doctrine or literature, and whose pastor is not formally ordained and has no formal
           training does not qualify for exemption as a church. The ruling states that the IRS
           suggested applying as a religious organization rather than a church but the organization
           did not want to pursue that avenue.

     B. The IRS ruled that an organization that seeks to encourage the development of affordable
        low-income rental housing by participating through a wholly owned for-profit subsidiary in
        partnership with for-profit investors does not qualify for tax-exempt status as an organization
        described under section 501(c)(3). LTR 200502046

     C. The IRS denied a business league’s claim for tax-exempt status as an organization described
        under section 501(c)(6), finding that the league failed to show it was organized to advance the
        interests of a line of business rather than to furnish services to its members. LTR 200505024

     D. The IRS denied a credit counseling organization’s application for exempt status as an
        organization described in section 501(c)(3) because it operated primarily to provide debt-
        management plans to customers and did not provide education. LTR 200506038
                                                                                                   36
IX. EXCESS BENEFIT TRANSACTIONS
   A. In a series of technical advice memoranda (200435018 – 200425) the IRS ruled that excise
      taxes under section 4958 should be imposed on the founder of a charitable organization, and
      several family members, who engaged in excess benefit transactions with the organization.
      The transactions included expenditures paid for with organization credit cards, but without
      records evidencing a business purpose, and property owned by the organization (access
      limited to founder and his wife) that appeared to be personal residence. IRS concluded that
      both the 25% tax and the 200% tax should be imposed because the transactions were not
      corrected within the taxable period.
   B. Dzina v United States, KJC 2004-297 (N.D. Ohio 2004) The case is a refund suit filed by the
      plaintiff who challenged the IRS’s assessment of excise taxes against him and his company
      for excess benefits he received from selling property to a charitable organization for which he
      served as an executive and trustee. IRS contended that plaintiffs reaped substantial benefits
      from reclaiming property upon default on land sale contract, improved by $300,000 in
      renovations and repairs paid by charity, and by selling property to a third party for over
      $2,000,000 more than plaintiff paid for it.
   C. Internal Revenue Manual
      IRM 7.27.30, which addresses excess benefits transactions was added on March 15, 2005. In
      addition to summarizing the statute and regulations, the new section addresses procedural
      issues. IRM 7.27.30.7 pertains to correction and IRM 7.27.30.7.3.5 (“Reasonable Cause and
      Not Willful Neglect” – Safe Harbor Guidelines) sets forth an important safe harbor with
      respect to whether the 25% first tier tax will be abated.
   D. Proposed Regulations on Recognition of Tax-Exempt Status and Intermediate Sanctions
      1. Proposed Reg. 1-501(c)(3)-(l)(g)(2)(ii) - Determining whether revocation of tax-exempt
         status is appropriate when section 4958 excise taxes also apply. In determining whether to
         continue to recognize the tax-exempt status of an applicable tax-exempt organization
         described in section 501(c)(3) that engages in one or more excess benefit transactions that
         violate the prohibition on inurement under this section, the Commissioner will consider all
         relevant facts and circumstances, including, but not limited to, the following:
          a. The size and scope of the organization’s regular and ongoing activities that further
             exempt purposes before and after the excess benefit transaction or transactions
             occurred;
          b. The size and scope of the excess benefit transaction or transactions (collectively, if
             more than one) in relation to the size and scope of the organization’s regular and
             ongoing activities that further exempt purposes;
          c. Whether the organization has been involved in repeated excess benefit transactions;
          d. Whether the organization has implemented safeguards that are reasonably calculated
             to prevent future violations; and
          e. Whether the excess benefit transaction has been corrected or the organization has
             made good faith efforts to seek correction from the disqualified persons who benefited
             from the excess benefit transaction.
                                                                                                  37
     2. Proposed Reg. 1-501(c)(3)-(1)(g)(2)(iii) - All Factors will be considered in combination
        with each other. Depending on the particular situation, the Commissioner may assign
        greater or lesser weight to some factors than to others. The factors listed in paragraphs (d)
        and (e) above will weigh more strongly in favor of continuing to recognize exemption
        where the organization discovers the excess benefit transaction or transactions and takes
        action before the Commissioner discovers the excess benefit transaction or transactions.
        Further, with respect to the factor listed in paragraph (e), correction after the excess
        benefit transaction or transactions are discovered by the Commissioner, by itself, is never
        a sufficient basis for continuing to recognize exemption.
     3.    Proposed Reg. 1-501(c)(3)-(1)(g)(2)(iv) – Example 5 Involves an organization with
          substantial assets and revenues that conducts activities that further its exempt purposes.
          The organization pays $2,500 of its CFO’s personal expenses under a non-accountable
          plan, and does not report the payments on the CFO’s Form W-2 or on a Form 1099-MISC,
          nor on Form 990. The example states that none of the payments can be disregarded under
          section 4958 as nontaxable fringe benefits (Sec. 132) and none consisted of fixed
          payments under the initial contract exception. It is also stated that the CFO did not report
          such payments on his Form 1040. In the subsequent years payments of personal expenses
          not under an accountable plan are reported as income. The transaction in the first year is
          an excess benefit transaction.
          a. In applying the factors set forth in D.1., it is stated that the organization engages in
             regular and ongoing activities that further its exempt purpose, the payment of the
             personal expenses represented only a de minimis portion of the organization’s assets
             and revenues, and reporting omission that resulted in excess benefit transaction was
             not repeated in subsequent years. Based on the application of the factors to the facts
             the organization continues to be described in sec 501(c)(3).


X. MISCELLANY
  A. Flexible Spending Accounts. The IRS has modified the “use or lose it role.” Employers may
     amend their cafeteria plan document to extend the deadline for reimbursement of health care
     and dependent care expenses up to two-and-a-half months after the cafeteria plan year. IRS
     Notice 2005-42. May 15, 2005
  B. Forms W-4. Employers no longer are required to send copies of questionable W-4
     withholding forms to the IRS. Employers are no longer required to submit W-4s claiming
     more than 10 allowances or claiming exemption from withholding if $200 or more in weekly
     wages was expected. IR-2005-45. April 13, 2005
  C. Final Regulations with respect to automatic extensions of time to file exempt organization
     returns. Reg. 1-6081-9, clarifies the rules that grant an automatic six-month extension of time
     to file Form 990-T. Filers of Form 990 series (except 990-C), 1041-A, 4720, 5227 are
     allowed an automatic three month extension (second three-month extension requires
     statement of reason.
  D. The IRS has stated its intention to undertake an examination initiative that will focus on
     section 501(c)(3) bond issues. Between 30 and 40 exams will be launched in fiscal 2006.
     Although a number of topics related to the bonds will be explored, the IRS is most interested
     in private use.
                                                                                                         38
         E. Charitable Remainder Trusts

             1. Final regulations issued with respect to ordering rules for charitable remainder trusts. The
                final regulations reflect changes made to income tax rates, including the rates applicable
                to capital gains and qualified dividends. Reg. 1.664-1.

             2. Sample Charitable Remainder Trusts
                a. Inter Vivos CRUT for One Life – Rev. Proc. 2005-52
                b. Inter Vivos CRUT for a Term of Years – 2005-53
                c. Inter Vivos CRUT for Consecutive Lives – Rev. Proc. 2005-54
                d. Inter Vivos CRUT for Concurrent and Consecutive Lives – Rev. Proc. 2005-55
                e. Testamentary CRUT for One Life – Rev. Proc. 2005-56
                f. Testamentary CRUT for a Term of Years – Rev. Proc. 2005-57
                g. Testamentary CRUT for Consecutive Lives – Rev. Proc. 2005-58
                h. Testamentary CRUT for Concurrent and Consecutive Measuring Lives – Rev. Proc.
                   2005-59
                i. Testamentary CRUT

         F Private Foundation Grants to Public Charities that Lobby. In response to a letter requesting
           clarification (response 2 year after receipt of request) the IRS stated that private foundations
           may make grants to public charities for a specific project that includes lobbying subject to
           certain restrictions.

             1. Restrictions

                a. No part of grant earmarked for lobbying.

                b. Foundation obtains a proposed budget signed by an officer of the public charity that
                   the amount of the grant – together with other grants by the same foundation for the
                   same project and year – does not exceed the amount budgeted, for the year of the
                   grant, by the public charity for activities of the project that are not lobbying.

                c. The private foundation has no reason to doubt the budget’s accuracy.
AICPA10-15

				
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