PREFACE irs relief by jennyyingdi

VIEWS: 5 PAGES: 136

									                                         PREFACE


Exempt Organizations is dedicated to fulfilling the IRS mission to help all customers understand
and meet their tax responsibilities. Customer Education & Outreach (CE&O) works closely with
Exempt Organizations staff to accomplish this by:


       Developing tailored education programs for customer sub-segments

       Coordinating the development, revision and design of forms, publications and other non-
        speaker outreach activities

       Making standardized educational materials available for outreach efforts, and

       Establishing a means for customers to be heard


This workshop and our materials are part of a tailored program for representatives of small and
mid-sized exempt organizations. We hope that this presentation and these materials help you
better understand and comply with the tax laws governing exempt organizations.

The material in this book is for educational use only and may not be cited as precedent.




                              Roberta “Bobby” Zarin
                              Director, Customer Education and
                              Outreach, Exempt Organizations
                         Exempt Organizations Workshop
                                          AGENDA
Opening and Welcome

Introduction

Session 1

        Tax-Exempt Status
        Jeopardizing 501(c)(3) Status

               State the main distinction between “tax-exempt” and “non-profit”
               List the major types of exempt organizations
               Identify the benefits of tax-exempt status
               Identify the actions that jeopardize tax-exempt status
               Identify major categories of public charities

Break

Session 2

        Unrelated Business Income (UBI)
        Discussion of Gaming Activities

             List the three parts of the UBI test
             Discuss the types of activities that commonly generate UBI for exempt
              organizations
             List the common exceptions and modifications to UIBI
             Identify and define “gaming activities,” especially those that might give rise to
              UBI
             Identify the form used to report UBI and pay the tax

Lunch

Session 3

        Employment Issues

             List the main factors used to categorize a worker as either an employee or an
              independent contractor
             Identify the workers that are statutorily classified as employees and those that are
              statutorily classified as independent contractors
             List the major employment tax forms and their uses for the typical small EO
Session 4

        Recordkeeping

        Form 990

               Identify recordkeeping requirements
               State purpose of Form 990
               List entities that must file Form 990
               Identify what is reported on major sections of Form 990
               List common errors made on Form 990

Break

Session 4 (cont’d)

        Form 990 (cont’d)
        Discussion of the Audit Process

               List common types of audits of exempt organizations
               List types of records required by IRS auditor

Session 5

        Required Disclosures

               List the public inspection rules applicable to 501(c)(3) organizations
               List the major substantiation rules for contributions
               List other disclosure rules applicable to 501(c)(3) organizations

Closing
                           Exempt Organizations Workshop

                                   TABLE OF CONTENTS
CHAPTERS:                                                  Page

1. Introduction                                                 1-1

2. Tax Exempt Status                                            2-1

3. Jeopardizing 501(c)(3) Status                                3-1

4. Unrelated Business Income (UBI)                              4-1

5. Gaming Activities                                            5-1

6. Employment Issues                                            6-1

7. Record keeping                                               7-1

8. Form 990                                                     8-1

9. Audit Process                                                9-1

10. Required Disclosures                                       10-1

11. Closing                                                    11 - 1




APPENDICES

I. Glossary                                                 I-1

II. Other Information                                      II – 1
                                            Chapter 1

                                      INTRODUCTION

Course Objective

At the end of the course you will be able to identify rules that an exempt organization needs to follow
in order to:

                       1. Retain their exempt status

                      2. Meet their filing requirements

                       3. Meet any other applicable tax requirements

Please Note

The material in this text is for educational use only in association with the Exempt Organizations
Workshop. It is not intended to establish Internal Revenue Service positions and may not be relied
upon or cited as precedent.

For More Information

This text focuses on the requirements for organizations exempt under section 501(c)(3) of the Internal
Revenue Code. Some basic information is presented about organizations exempt under other code
sections for your reference. For a more detailed discussion, including exceptions provided in this text
material, please refer to the publications and sections of law cited herein. Each chapter of this text
contains a complete list of references. Also, you may call the IRS or visit Chapter 11.

Legal Authority

The Internal Revenue Code appears as Title 26 of the United States Code. Congress originally enacted
the Internal Revenue Code on August 16, 1954, as the Internal Revenue Code of 1954. It was
comprehensively updated when Congress passed the Internal Revenue Act of 1986. Both of these
original laws have been amended numerous times by Congress. The resulting body of law guides all
tax administration in the United States.

The IRS issues regulations that set forth its interpretation of the law. The regulations are issued over
the signature of the Secretary of the Treasury (or his delegate) under Title 26 of the Code of Federal
regulations. The regulations carry more weight than any rulings or releases on tax matters otherwise
issued by IRS or the Treasury.

                                       Chapter 1 – Introduction
                                                   -


                                              Page 1-1
INTRODUCTION, Continued

Internal Revenue Code (LRC) Citations

All references to “section” in this text refer to sections of the Internal Revenue Code (LRC) unless
otherwise stated. For example, 501(c)(3) is Internal Revenue Code section 501(c)(3). The Internal
Revenue Code is also sometimes referred to as simply “the Code”.


You may order Forms and Publications by calling toll free (800) 829-3676 or by
      downloading them from the IRS website at: www.irs.gov.




                                       Chapter 1 – Introduction
                                                    -


                                              Page 1-2
                                             Chapter 2

                                  TAX-EXEMPT STATUS


Types of Exempt Organizations

The Internal Revenue Code specifies certain types of organizations that are exempt from federal
income tax. The most common types are charitable, religious, and educational organizations, civic
associations, labor organizations, business leagues, social clubs, fraternal organizations, and veteran’s
organizations.

The focus of this text is on organizations exempt under section 501(c)(3). However, general
information will be presented about organizations exempt under other Code sections for your
reference.

Obtaining Exempt Status

Because an organization may be organized as a nonprofit corporation, association, or trust under state
law does not mean the organization is tax-exempt under federal law. To be tax exempt under Federal
law, the organization must be described in one of the sections specified in the Code, and apply by
filing either Form 1023 for 501(c)(3) or Form 1024 for almost all others. Generally, the organization
will have a determination letter issued by the IRS to verify that it has been recognized as tax exempt.

Who Can Be Tax-Exempt?

There are numerous Code sections that identify organizations that may qualify for tax-exempt status.
The Organization Reference Chart included at the end of this chapter (Exhibit A) provides:

    A brief description of each type of organization that may qualify

    The general nature of its activities, and

    The section under which it may qualify




                                     Chapter 2 – Tax-Exempt Status
                                               Page 2-1
TAX-EXEMPT STATUS, Continued

Common Types of Exempt Organizations
Some of the more common exempt organizations are defined in the following Code sections:

     501(c)(3) Religious, Educational, Charitable

     501(c)(4) Civic Leagues, Social Welfare Organizations

     501(c)(5) Labor, Agricultural, or Horticultural

     501(c)(6) Business Leagues, Chambers of Commerce

     501(c)(7) Social and Recreational Clubs

     501(c)(8) Fraternal Beneficiary Societies and Associations

     501(c)(l0) Domestic Fraternal Societies and Associations

     501(c)(19) Veteran’s Organizations

This chapter addresses the specific requirements and characteristics of organizations exempt under
501(c)(3). A basic description of organizations exempt under other Code sections is provided at the
end of this chapter.

Main Benefit of Exempt Status
The main benefit of exempt status is exemption from paying federal income tax on any income related
to the organization’s exempt purpose.

If an organization is not recognized as tax-exempt it generally must file one of the following annual
income tax returns:

       Form 1120, US. Corporation Income Tax Return

       Form 1041, US. Income Tax Return for Estates and Trusts, or

       Form 1065, US. Partnership Return of Income

Additionally, there are other benefits of exempt status, such as possible exemption from certain
employment taxes; possible exemption from state income, sales, and property taxes; and reduced
postal rates offered to certain organizations by the U.S. Postal Service.

                                    Chapter 2 – Tax-Exempt Status
                                              Page 2-2
TAX-EXEMPT STATUS, Continued

A Special Advantage to Exempt Status as a 501(c)(3)

A special advantage of qualifying for exemption under section 501(c)(3) is that contributions to the
organization are deductible as charitable contributions on the donor’s Federal income tax return.
Contributions to most tax exempt organizations other than 501(c)(3) organizations are not tax
deductible.

501(c)(3) Organizations- 3 Key Components

Organizations described in section 501(c)(3) make up the largest category of exempt organizations.
There are three key components for an organization to be exempt from federal income tax under
section 501(c)(3) of the Code. A not-for-profit organization must be organized and operated
exclusively for one or more exempt purposes.

Organized

A 501(c)(3) organization must be organized as a nonprofit corporation, trust, or unincorporated
association under state law. In addition, an organization’s organizing documents (articles of
incorporation, trust documents, articles of association) must:

     Limit its purpose to those described in section 501(c)(3)

    Not expressly permit activities that do not further its exempt purposes (i.e., unrelated activities),
     and

    Permanently dedicate its assets to exempt purposes




                                    Chapter 2 – Tax-Exempt Status
                                              Page 2-3
TAX-EXEMPT STATUS, Continued
Operated

Because a substantial portion of an organization’s activities must further its exempt purpose(s), certain
other activities are prohibited or restricted. A 501(c)(3) organization:

        Must absolutely refrain from participating in the political campaigns of candidates for local,
         state, or federal office

         Must restrict its lobbying activities to an insubstantial part of its total activities

         Must ensure that its earnings to not inure to the benefit of any private shareholder or
          individual

         Must not operate for the benefit of private interests such as those of its founder, the
          founder’s family, its shareholders, or persons controlled by such interests

         Must not operate for the primary purpose of conducting a trade or business that is not related
          to its exempt purpose, such as a school’s operation of a factory

         May not have purposes or activities that are illegal or violate fundamental public policy




                                      Chapter 2 – Tax-Exempt Status
                                                Page 2-4
TAX-EXEMPT STATUS, Continued
Exempt Purpose

An organization must state one or more exempt purpose in its organizing document. Section 501(c)(3)
lists the following exempt purposes:

         Charitable
         Educational
         Religious
         Scientific
         Literary
         Fostering national or international sports competition
         Preventing cruelty to children or animals
         Testing for public safety
Typical 501(c)(3) Organizations

The most common types of 501(c)(3) organizations are charitable, educational, and religious. The
following provides a brief description of Organizations these types of organizations.

Charitable organizations

Charitable organizations conduct activities that promote:

         Relief of the poor, the distressed, or the underprivileged
         Advancement of religion
         Advancement of education or science
         Erection or maintenance of public buildings, monuments, or works
         Lessening the burdens of government
         Lessening of neighborhood tensions
         Elimination of prejudice and discrimination
         Defense of human and civil rights secured by law
         Combating community deterioration and juvenile delinquency

                                      Chapter 2 – Tax-Exempt Status
                                                Page 2-5
TAX-EXEMPT STATUS, Continued
Educational Organizations

Educational organizations include:
    Schools such as a primary or secondary school, a college, or a professional or trade school

      Organizations that conduct public discussion groups, forums, panels, lectures, or other similar
       programs

      Organizations that presents a course of instruction by means of correspondence or through the
       use of television or radio

      Museums, zoos, planetariums, symphony orchestras, or similar organizations

      Nonprofit day-care centers

      Youth sports organizations


Religious Organizations

While all churches are religious organizations, not all religious organizations are churches.

Churches: The term church includes synagogues, temples, mosques, and similar types of
organizations. Although the Code excludes these organizations from the requirement to file an
application for exemption, many churches voluntarily file applications for exemption. Such recognition
by the IRS assures church leaders, members, and contributors that the church is tax exempt under
section 501(c)(3). To be recognized as a church, an organization must meet certain criteria. These
criteria are outlined in Publication 1828, Tax Guide for Churches and Religious Organizations.

Other Religious Organizations: Other religious organizations that do not meet the “church criteria,”
such as mission organizations, speakers’ organizations, nondenominational ministries, ecumenical
organizations, or faith-based social agencies, must apply for tax-exempt status like all other 501(c)(3)
organizations.




                                    Chapter 2 – Tax-Exempt Status
                                              Page 2-6
TAX-EXEMPT STATUS, Continued
Public Charity or Private Foundation Classifications

Every organization that qualifies as tax-exempt under section 501(c)(3) is further classified as either a
public charity or a private foundation. Under section 508 of the Code, every organization is
automatically classified as a private foundation unless it meets one of the exceptions listed in section
509(a).

The primary distinction between classification as a public charity or a private foundation is the
organization’s source of financial support. Generally, a public charity has a broad base of support
while a private foundation has very limited sources of support. This classification is important because
different tax rules apply to the operations of each.

For example, deductibility of contributions to a private foundation is more limited than deductibility of
contributions to a public charity. In addition, private foundations are subject to excise taxes that are not
imposed on public charities.

Public Charities

Organizations statutorily classified as public charities under section 509(a) are:

    Churches

    Schools

    Organizations that provide medical or hospital care (including the provision of medical
     education and, in certain cases, medical research)

    Organizations that receive a substantial part of their support in the form of contributions from
     publicly supported organization, governmental units, and/or from the general public

    Organizations that normally receive not more than one-third of their support from gross
     investment income and more than one-third of their support from contributions, membership
     fees, and gross receipts from activities related to their exempt functions

    Organizations that support other public charities

If the organization requests public charity classification based on receiving support from the public, it
must continue to seek significant and diversified public support in later years.




                                     Chapter 2 – Tax-Exempt Status
                                               Page 2-7
TAX-EXEMPT STATUS, Continued

Advance Ruling of Status

A new 501(c)(3) organization seeking public charity status that cannot show that it has received enough
public support may receive an advance ruling of this status. An advance ruling provides an
organization with a five-year period to show that it is in fact publicly supported. Generally, after five
years the organization must file Form 8734, Support Schedule for Advance Ruling Period, showing its
sources of support.

If the schedule indicates sufficient public support, the organization receives a definitive ruling of its
public charity status. However, if the organization does not meet the public support requirements in the
future, it could be reclassified as a private foundation retroactively to the date it no longer qualifies as a
public charity.

In order to receive this advance ruling, an organization must consent to extend the statute of limitations
for the advance ruling period. This is to allow for the retroactive assessment of any applicable private
foundation excise taxes, if the organization is reclassified as a private foundation.

Unless the organization is committed to raising funds from the public, it may be more appropriate to
consider alternate statutorily based public charity classifications.

Other Common Types of Exempt Organizations

Included in the remainder of this chapter are basic descriptions of the most common organizations
defined as exempt under code sections other than 501(c)(3).

501(c)(4) Civic Leagues, Social Welfare Organizations
          –




Organizations under this section must be organized exclusively for the promotion of social welfare. A
501(c)(4) organization operates primarily to further the common good and the general welfare of the
people of the community, such as by bringing about civic betterment and social improvements.

Examples of 501(c)(4) organizations are volunteer fire companies, civic leagues, and community
associations.

Although the activities of a 501(c)(4) organization are similar to those of a 501(c)(3) organization, a
501(c)(4) organization does not have the same restrictions and prohibitions on activities. Contributions
to 501(c)(4) organizations are not deductible.




                                      Chapter 2 – Tax-Exempt Status
                                                Page 2-8
TAX-EXEMPT STATUS, Continued
501(c)(5) - Labor, Agricultural, or Horticultural Organizations

Organizations under this section must have as an objective the betterment of the conditions of workers,
the improvement of the grade of products, and/or the development of a higher degree of efficiency in
particular occupations.

A labor organization is an association of workers who have combined to protect or promote the
interests of the members by bargaining collectively with their employer to secure better working
conditions, wages, and similar benefits. The term includes labor unions, councils, and committees.

Agricultural and horticultural organizations are connected with raising livestock, forestry, cultivating
laud, raising and harvesting crops or aquatic resources, cultivating useful or ornamental plants, and
similar pursuits.

501(c)(6) – Business Leagues, Chambers of Commerce, etc.

This section describes organizations that are devoted to the improvement of business conditions of one
or more lines of business. They may not be engaged in the performance of particular services for
individual persons or m a business of a kind ordinarily carried on for profit.

Examples of 501(c)(6) organizations are business leagues and chambers of commerce.




                                     Chapter 2 – Tax-Exempt Status
                                               Page 2-9
TAX-EXEMPT STATUS, Continued
501(c)(7) - Social and Recreation Clubs

A social club is organized for pleasure, recreation, and other similar nonprofit purposes. Substantially
all of its activities must be for these purposes. Characteristics of an exempt social club include
membership of individuals, the existence of personal contact, fellowship among members, and sharing
of active interest among members.

Typical organizations under this section include:

      College alumni associations that do not qualify as educational organizations

      College fraternities or sororities operating chapter houses for students

      Country clubs

      Amateur hunting, fishing, tennis, swimming, and other sport clubs

      Dinner clubs that provide a meeting place, library, and dining room for members

      Hobby clubs

      Garden clubs

      Variety clubs

A club that engages primarily in a business activity open to the general public will not qualify for
exemption. In addition, the law prohibits a written policy of discrimination against any person on the
basis of race, color, or religion.

501(c)(8) – Fraternal Beneficiary Societies and Associations

A fraternal beneficiary society, order, or association under 501(c)(8) must:

    Be a fraternal organization

    Be operated under the lodge system or for the exclusive benefit of the members of a fraternal
      organization itself operating under the lodge system, and
    Provide for the payment of life, sick, accident, or other benefits to the members of such society,
      order, or association or their dependents

All members, not only a particular class of members, must be eligible for the benefits in order to
sustain exemption.
                                    Chapter 2 – Tax-Exempt Status
                                              Page 2-10
TAX-EXEMPT STATUS, Continued

501(c)(10) – Domestic Fraternal Societies and Associations

Domestic fraternal societies and associations are similar to fraternal beneficiary societies except that no
payment of life, sick, accident, or other benefits are made.


501(c)(19) – Veterans Organization

A veteran’s organization is a post or organization of past or present members of the Armed Forces, or
an auxiliary unit of such a post or organization. Examples of groups that would qualify for exemption
are posts and/or auxiliaries of Veterans of Foreign Wars and the American Legion.


Contributions to These Other Common Types of Exempt Organizations

Contributions to organizations exempt under sections 501(c)(4), (5), (6), (7), (8), (10) and (19) are
generally not tax-deductible as charitable contributions.




                                     Chapter 2 – Tax-Exempt Status
                                               Page 2-11
TAX-EXEMPT STATUS, Continued
For More Information

Publication 526, Charitable Contributions

Publication 557, Tax-Exempt Status for Your Organization

Publication 578, Tax Information for Private Foundations and Foundation Managers

Publication 1771, Charitable Contributions, Substantiation and Disclosure Requirements


Publication 1828, Tax Guide for Churches and Religious Organizations

Publication 3386, Tax Guide - Veterans’ Organizations

Publication 3833, Disaster Relief - Providing Assistance Through Charitable Organizations

Publication 4220, Applying for 501(c)(3) Tax-Exempt Status

Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue
Code

Form 1024, Application for Recognition of Exemption Under Section 501(a) or for Determination
Under Section 120


    You may order Forms and Publications by calling toll free (800) 829-3676 or
          by downloading them from the IRS website at: www.irs.gov.




                                  Chapter 2 – Tax-Exempt Status
                                            Page 2-12
                                                                                                                Exhibit A (p. 1 of 2)

                            Organization Reference Chart
Section of 1986 Code   Description of organization                               General nature of activities

501(c)(1)              Corporations Organized Under Act of Congress              Instrumentalities of the United States
                       (including Federal Credit Unions)


501(c)(2)              Title Holding Corporation for Exempt Organization         Holding title to property of an exempt
                                                                                 organization

501(c)(3)              Religious, Educational. Charitable, Scientific,           Activities of a nature implied by the
                       Literary, Testing for Public Safety, Fostering National   description of the class of organization
                       or International Amateur Sports Competition, or the
                       Prevention of Cruelty to Children or Animals

501(c)(4)              Civic Leagues, Social Welfare Organizations, and          Promotion of community welfare;
                       Local Associations of Employees                           charitable, educational, or recreational

501(c)(5)              Labor, Agricultural, and Horticultural Organizations      Educational or instructive, the purpose
                                                                                 being to improve conditions of work and to
                                                                                 improve products and efficiency

501(c)(6)              Business Leagues, Chambers of Commerce, Real              Improvement of business conditions of one
                       Estate Boards, Etc.                                       or more lines of business

501(c)(7)              Social and Recreation Clubs                               Pleasure, recreation, social activities

501(c)(8)              Fraternal Beneficiary Societies arid Associations         Lodge providing for payment of life,
                                                                                 sickness, accident, or other benefits to
                                                                                 members

501(c)(9)              Voluntary Employees’ Beneficiary Associations             Providing for payment of life, sickness,
                                                                                 accident, or other benefits to members

501(c)(10)             Domestic Fraternal Societies and Associations             Lodge devoting its net earnings to
                                                                                 charitable, fraternal, and other specified
                                                                                 purposes. No life, sickness, or accident
                                                                                 benefits to members

501(c)(11)             Teachers Retirement Fund Associations                     Teachers’ association for payment of
                                                                                 retirement benefits

501(c)(12)             Benevolent Life Insurance Associations, Mutual Ditch      Activities of a mutually beneficial nature
                       or Irrigation Companies, Mutual or Cooperative            similar to those implied by the description
                       Telephone Companies, Etc.                                 of the organization

501(c)(13)             Cemetery Companies                                        Burials and incidental activities

501(c)(14)             State Chartered Credit Unions, Mutual Reserve Funds       Loans to members
501(c)(15)             Mutual Insurance Companies or Associations                Providing insurance to members
                                                                                 substantially at cost

501(c)(16)             Cooperative Organizations to Finance Crop                 Financing crop operations in conjunction
                       Operations                                                with activities of a marketing or purchasing
                                                                                 association



                                        Chapter 2 – Tax-Exempt Status
                                                  Page 2-13
                                                                                                     Exhibit A (p.2 of 2)
                              Organization Reference Chart
Section of 1986 Code   Description of organization                      General nature of activities

501(c)(17)             Supplemental Unemployment Benefit Trusts         Provides for payment of supplemental
                                                                        unemployment compensation benefits

501(c)(18)             Employee Funded Pension Trust (created before    Payments of benefits under a pension plan
                       June 25, 1959)                                   funded by employees
501(c)(19)             Post of Organization of Past or Present          Activities implied by nature of organization
                       Members of the Armed Forces

501(c)(21)             Black Lung Benefit Trusts                        Funded by coal mine operators to satisfy
                                                                        their liability for disease or death due to
                                                                        black lung diseases

501(c)(22)             Withdrawal Liability Payment Fund                To provide funds to meet the liability of
                                                                        employers withdrawing from a multi-
                                                                        employer pension fund
501(c)(23)             Veterans Organization (created before 1880)      To Provide Insurance and other benefits to
                                                                        veterans
501(c)(25)             Title Holding Companies or Trusts with           Holding title and paying over income from
                       Multiple Parents                                 property to 35 or fewer parents or
                                                                        beneficiaries
501(c)(26)             State-Sponsored Organization Providing Health    Provides heaith care coverage to high-risk
                       Coverage for High-Risk Individuals               individuals
501(c)(27)             State-Sponsored Workers’ Compensation            Reimburses members for losses under
                       Reinsurance Organization                         workers’ compensation acts
501(d)                 Religious and Apostolic Associations             Regular business activities. Communal
                                                                        religious community
501(e)                 Cooperative Hospital Service Organizations       Performs cooperative services for hospitals

501(f)                 Cooperative Service Organizations of Operating   Performs collective investment services for
                       Educational Organizations                        education organizations
501(k)                 Child Care Organization                          Provides care for children
501(n)                 Charitable Risk Pools                            Pools certain insurance risks of 501(c)(3)
                                                                        organizations
521(a)                 Farmers’ Cooperative Associations                Cooperative marketing and purchasing for
                                                                        agricultural producers
527                    Political Organizations                          A party, committee, fund, association, etc.,
                                                                        that directly or indirectly accepts
                                                                        contributions or makes expenditures for
                                                                        political campaigns

529                    Qualified Tuition Programs                       Established and maintained to allow either
                                                                        prepaying, or contributing to an account
                                                                        established for paying, a student’s qualified
                                                                        higher education expenses at an eligible
                                                                        educational institution



                                      Chapter 2 – Tax-Exempt Status
                                                Page 2-14
                                              Chapter 3

                          JEOPARDIZING 501(c)(3) STATUS

Jeopardizing Tax-Exempt Status

A 501(c)(3) organization that does not restrict its participation in Certain activities and does not
absolutely refrain from others, risks failing the operational test, and jeopardizes its tax-exempt status.

Section 501(c)(3) organizations may not be used for the private benefit of any individual, nor may their
earnings inure to the benefit of insiders. Moreover, the amount of legislative or political activity an
exempt organization can. be involved in may be limited, or may not be permitted at all.

Additionally, more than an insubstantial amount of unrelated trade or business activity could also
jeopardize tax-exempt status under 501(c)(3). See Chapter 4 for a complete discussion of this topic.

Private Benefit

A 501(c)(3) organization is prohibited from allowing more than an insubstantial accrual of benefits,
including non-monetary benefits, to individuals or organizations. The intent is to ensure that a tax-
exempt organization serves a public interest, not a private one. Private benefit must be substantial in
order to jeopardize exempt status.




                                Chapter 3 – Jeopardizing 501(c)(3) Status
                                                Page 3-1
                   JEOPARDIZING 501(c)(3) STATUS, Continued
Inurement

Section 501(c)(3) of the Code states that no part of an organization’s net earnings may inure to the
benefit of a private shareholder or individual. This means that a 501(c)(3) organization is prohibited
from allowing its income or assets to accrue to insiders.

An insider is a person who has a personal and private interest in the activities of the organization.
Examples of typical insiders are officers, directors, and key employees.

Examples of prohibited inurement include the payment of dividends, the payment of unreasonable
compensation to insiders, and the transfer of property to insiders for less than fair market value.

The prohibition against inurement to insiders is absolute; therefore, any amount of inurement is
grounds for loss of tax-exempt status. In addition, the insider involved may be subject to excise tax.
Note that prohibited inurement does not include reasonable payments for services rendered, payments
that further tax-exempt purposes, or payments made for the fair market value of real or personal
property.

              Tip: All inurement is private benefit but all private benefit is not inurement.




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-2
JEOPARDIZING 501(c)(3) STATUS, Continued

Inurement Excess Benefit Transactions

In cases where an exempt organization provides an excess economic benefit to an insider (i.e.,
inurement), both the organization and the insider have engaged in an excess benefit transaction. The
IRS may impose an excise tax on any insider who improperly benefits from an excess benefit
transaction, as well as on organization managers who participate in such a transaction knowing that it
is improper. An insider who benefits from an excess benefit transaction is also required to return the
excess benefit to the organization.

Preventing Private Benefit and Inurement: Internal Controls

Adopting and implementing internal controls may help prevent private benefit and inurement, and thus
help protect an organization’s tax-exempt status. An internal control system may include some or all of
the following elements:

    Segregation of financial duties

    Requiring second signatures on large checks

    Tracking inventory

    Internal audit (i.e., formal review of an organization’s activities to ensure that proper policies are
     in place to implement internal controls)

    Recordkeeping (see Chapter 7)

Preventing Private Benefit and Inurement: Conflict of Interest Policy

Adopting a conflict of interest policy may also help prevent inurement. A conflict of interest policy
may include the following elements:

      Disclosure by interested persons of financial interest and all material facts relating thereto

      Procedures for determining whether the financial interest of the interested person may result in
       a conflict of interest
    Procedures for address the conflict of interest after determining that there is a conflict

      Procedures for adequate recordkeeping with respect to actions relating to conflicts

      Procedures ensuring that the policy is distributed to all trustees, principal officers, and members
       of committees with board-delegated powers

                              Chapter 3 – Jeopardizing 501(c)(3) Status
                                              Page 3-3
JEOPARDIZING 501(c)(3) STATUS, Continued
Lobbying and Political Activities

Political activities and legislative activities are two different activities that can jeopardize 501(c)(3)
status and are subject to two different sets of rules. The rules depend on the type of tax-exempt
organization, the type of activity (political or legislative) at issue, the scope or amount of the activity
conducted, and the consequences of exceeding the given set of limitations.


Lobbying Activity

A 501(c)(3) organization may conduct lobbying activities as long as they are insubstantial in relation to
their exempt purpose activities. Lobbying is defined as the attempt to influence legislation.

Legislation includes action by Congress, any state legislature, any local council, or similar governing
body, with respect to acts, bills, resolutions, or similar items (such as legislative confirmation of
appointive office), or by the public in referendum, ballot initiative, constitutional amendment, or
similar procedure. It does not include actions by executive, judicial, or administrative bodies.

An organization will be regarded as attempting to influence legislation if it contacts, or urges the
public to contact, members or employees of a legislative body for the purpose of proposing,
supporting, or opposing legislation, or if the organization advocates the adoption or rejection of
legislation.

Organizations may, however, involve themselves in issues of public policy without the activity being
considered as lobbying. For example, organizations may conduct educational meetings, prepare and
distribute educational materials, or otherwise consider public policy issues in an educational manner
without jeopardizing their tax-exempt status.

If lobbying activities are substantial, a 501(c)(3) organization may fail the operational test and risks
losing its tax-exempt status. Substantiality is measured by one of two tests:

       (1)   The substantial part test, or

       (2)   The expenditure test




                                Chapter 3 – Jeopardizing 501(c)(3) Status
                                                Page 3-4
JEOPARDIZING 501(c)(3) STATUS, Continued
Measuring Lobbying Activity: Substantial Part Test

The substantial part test determines substantiality on the basis of all the pertinent facts and
circumstances in each case. The IRS considers a variety of factors, including the time devoted (by both
compensated and volunteer workers) and the expenditures devoted by the organization to the activity,
when determining whether the lobbying activity is substantial.

Under the substantial part test, an organization that conducts excessive lobbying activity in any taxable
year may lose its tax-exempt status, resulting in all of its income being subject to tax. In addition, an
organization is subject to an excise tax equal to 5% of its lobbying expenditures for the year in which it
ceases to qualify for exemption.

Further, a tax equal to 5% of the lobbying expenditures for the year may be imposed against
organization managers, jointly and severally, who agree to the making of such expenditures knowing
that the expenditures would likely result in the loss of tax-exempt status.


Measuring Lobbying Activity: Expenditure Test

As an alternative to the subjective substantial part test, an organization may elect to use the
expenditure test under section 501(h), which is an objective, mathematical test. Under the expenditure
test, an organization’s lobbying activity will not jeopardize its tax-exempt status, provided its
expenditures related to such activity, do not normally exceed an amount specified in section 4911. This
limit is generally based upon the size of the organization and may not exceed $1,000,000.

Organizations electing to use the expenditure test must file Form 5768, Election/Revocation of Election
by an Eligible IRC Section 501(c)(3) Organization to Make Expenditures to Influence Legislation, at
any time during the tax year for which it is to be effective. The election remains in effect for
succeeding years unless it is revoked by the organization. Revocation of the election is effective
beginning with the year following the year in which the revocation is filed.

Under the expenditure test, an organization that engages in excessive lobbying activity over a four-year
period may lose its tax-exempt status, making all of its income for that period subject to tax. Should
the organization exceed its lobbying expenditure dollar limit in a particular year, it must pay an excise
tax equal to 25% of the excess.




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-5
JEOPARDIZING 501(c)(3) STATUS, Continued
Political Campaign Activity

Under the Internal Revenue Code, all section 501(c)(3) organizations are absolutely prohibited from
directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in
opposition to) any candidate for elective public office. Contributions to political campaign funds or
public statements of position (verbal or written) made on behalf of the organization in favor of or in
opposition to any candidate for public office clearly violate the prohibition against pobtical campaign
activity. Violation of this prohibition may result in denial or revocation of tax-exempt status and the
imposition of certain excise tax.

Certain activities or expenditures may not be prohibited depending on the facts and circumstances. For
example, certain voter education activities (including the presentation of public forums and the
publication of voter education guides) conducted in a non-partisan manner do not constitute prohibited
political campaign activity.

In addition, other activities intended to encourage people to participate in the electoral process, such as
voter registration and get-out-the-vote drives, would not constitute prohibited political campaign
activity if conducted in a nonpartisan manner. On the other hand, voter education or registration
activities with evidence of bias that: (a) would favor one candidate over another; (b) oppose a
candidate in some manner; or (c)have the effect of favoring a candidate or group of candidates, would
constitute prohibited participation or intervention.


Individual Activity by Organization Leaders

The political campaign activity prohibition is not intended to restrict free expression on political
matters by leaders of organizations speaking for themselves, as individuals. Nor are leaders prohibited
from speaking about important issues of public policy. However, for their organizations to remain tax-
exempt under section 501(c)(3), leaders cannot make partisan comments in official organization
publications or at official functions.

To avoid potential attribution of their comments outside of organization functions and publications,
organization leaders who speak or write in their individual capacity are encouraged to clearly indicate
that their comments are personal and not intended to represent the views of the organization.




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-6
JEOPARDIZING 501(c)(3) STATUS, Continued


Inviting a Candidate to Speak

Depending on the facts and circumstances, an organization may invite political candidates to speak at
its events without jeopardizing its tax-exempt status. Political candidates may be invited in their
capacity as candidates, or individually (not as a candidate).

Speaking as a Candidate: When a candidate is invited to speak at an organization event as a political
candidate, the organization must take steps to ensure that:

       It provides an equal opportunity to political candidates seeking the same office

       It does not indicate any support of or opposition to the candidate (This should be stated
        explicitly when the candidate is introduced and in communications concerning the candidate’s
        attendance.), and

       No political fundraising occurs

Equal Opportunity to Participate: In determining whether candidates are given an equal opportunity to
participate, an organization should consider the nature of the event to which each candidate is invited,
in addition to the manner of presentation.

For example, an organization that invites one candidate to speak at its well attended annual banquet,
but invites the opposing candidate to speak at a sparsely attended general meeting, will likely be found
to have violated the political campaign prohibition, even if the manner of presentation for both
speakers is otherwise neutral.



                                                             Continued on next page




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-7
JEOPARDIZING 501(c)(3) STATUS, Continued
Inviting a Candidate to Speak (continued)

Public Forum: Sometimes an organization invites several candidates to speak at a public forum. A
public forum involving several candidates for public office may qualify as an exempt educational
activity. However, if the forum is operated to show a bias for or against any candidate, then the forum
would be a prohibited campaign activity, as it would be considered intervention or participation in a
political campaign.

When an organization invites several candidates to speak at a forum, it should consider the following
factors:

     Whether questions for the candidate are prepared and presented by an independent nonpartisan
      panel

       Whether the topics discussed by the candidates cover a broad range of issues that the
        candidates would address if elected to the office sought and are of interest to the public

       Whether each candidate is given an equal opportunity to present his or her views on the issues
        discussed

    Whether the candidates are asked to agree or disagree with positions, agendas, platforms, or
     statements of the organization, and

    Whether a moderator comments on the questions or otherwise implies approval or disapproval
     of the candidates



                                                             Continued on next page




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-8
JEOPARDIZING 501(c)(3) STATUS, Continued


Inviting a Candidate to Speak (continued)

Speaking as a Non-Candidate: An organization may invite political candidates to speak in a non-
candidate capacity. For instance, a political candidate may be a public figure because he or she: (a)
currently holds, or formerly held, public office; (b) is considered an expert in a non-political field; or
(c)is a celebrity or has led a distinguished military, legal, or public service career. When a candidate is
invited to speak at an event in a non-candidate capacity, it is not necessary for the organization to
provide equal access to all political candidates.

However, the organization must ensure that:

       The individual speaks only in a non-candidate capacity

       Neither the individual nor any representative of the organization makes any mention of his or
        her candidacy or the election, and

       No campaign activity occurs in connection with the candidate’s attendance

In addition, the organization should clearly indicate the capacity in which the candidate is appearing
and should not mention the individual’s political candidacy or the upcoming election in the
communications announcing the candidate’s attendance at the event.




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-9
JEOPARDIZING 501(c)(3) STATUS, Continued

Voter Guides

Organizations undertake voter education activities by distributing voter guides. Voter guides,
generally, are distributed during an election campaign and provide information on how all candidates
stand on various issues. These guides may be distributed with the purpose of educating voters;
however, they may not be used to attempt to favor or oppose candidates for public elected office.

A careful review of the following facts and circumstances may help determine whether or not an
organization’s publication or distribution of voter guides constitutes prohibited political campaign
activity:

       Whether the candidates’ positions are compared to the organization’s position

       Whether the guide includes a broad range of issues that the candidates would address if elected
        to the office sought

       Whether the description of issues is neutral

       Whether all candidates for an office are included, and

       Whether the descriptions of candidates’ positions are either:

           o The candidates’ own words in response to questions, or

           o A neutral, unbiased and complete compilation of all candidates’ positions




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                              Page 3-10
JEOPARDIZING 501 (c)(3) STATUS, Continued

Business Activity

The question of whether an activity constitutes participation or intervention in a political campaign
may also arise in the context of a business activity of the organization, such as the selling or renting of
mailing lists, the leasing of office space, or the acceptance of paid political advertising. (The tax
treatment of income from such unrelated business activities follows.)

In this context, some of the factors to be considered in detennining whether the organization has
engaged in prohibited political campaign activity include the following:

      Whether the good, service, or facility is available to the candidates on an equal basis

      Whether the good, service, or facility is available only to candidates and not to the general
       public

      Whether the fees charged are at the organization’s customary and usual rates, and

      Whether the activity is an ongoing activity of the organization or whether it is conducted only
       for the candidate




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                              Page 3-11
JEOPARDIZING 501 (c)(3) STATUS, Continued

Consequences of Political Campaign Activity

When it participates in political campaign activity, an organization jeopardizes both its tax-exempt
status under section 501(c)(3) and its eligibility to receive tax-deductible contributions. In addition, it
may become subject to an excise tax on its political expenditures. This excise tax may be imposed in
addition to revocation, or it may be imposed instead of revocation. Also, the organization should
correct the violation.

Excise Tax: An initial tax is imposed on an organization at the rate of 10% of the political
expenditures. Also, a tax at the rate of 2.5% of the expenditures is imposed against the organization
managers (jointly and severally) who, without reasonable cause, agreed to the expenditures knowing
they were political expenditures. The tax on management may not exceed $5,000 with respect to any
one expenditure.

In any case in which an initial tax is imposed against an organization, and the expenditure is not
corrected within the period allowed by law, an additional tax equal to 100% of the expenditures is
imposed against the organization. In that case, an additional tax is also imposed against the
organization managers (jointly and severally) who refused to agree to make the correction. The
additional tax on management is equal to 50% of the expenditures and may not exceed $10,000 with
respect to any one expenditure.

Correction: Correction of a political expenditure requires the recovery of the expenditure, to the extent
possible, and establishment of safeguards to prevent future political expenditures.


For More Information

Publication 557, Tax-Exempt Status for Your Organization Information

Publication 1828, Tax Guide for Churches and Religious Organizations

Publication 4221, Compliance Guide for 501 (c)(3) Tax-Exempt Organizations

Form 1 120-POL, U.S. Income Tax Return for Certain Political Organizations

The Conflict of Interest article in Exhibit C, which can also be found at:

                               http://www.irs.gov/pub/irs-tege/topice00.pdf

    You may order Forms and Publications hy calling toll free (800) 829-3676 or
          by downloading them from the IRS website at: www.irs.gov.

                                Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-12
                                                                                      Exhibit B (p. 1 of 2)


                         Jeopardizing § 501(c)(3) Status Case Studies


Case Study 1

Jane Doe founded XYZ Charity, a 501(c)(3) organization, and is President of it. XYZ’s bylaws specify
that the President is a voting member of the seven-person Board of Directors. Jane also owns 49% of
M Corporation, a for-profit, direct mail company run by her husband, Jim, who owns the other 51%.
XYZ Charity signed a $200,000 contract with M Corporation to provide and mail its solicitation
materials. Jane signed this contract on behalf of XYZ Charity, without bringing it to the entire Board
of Directors for discussion and action. Since Jim knows that there will be no competitive bidding for
the contract, he decides to bill at a rate of about 120% of the fair market value of the work. He calls the
contract the “M Company Deluxe Services Package,” but in reality the services provided are the same
as M Company provides to any other customer.

        I. Does this scenario show private benefit or inurement? Why?

        2. If there is private benefit or inurement, what could the organization have done to prevent it?


Case Study 2

Joe Doe is Executive Director of ABC Charity, a section 501(c)(3) tax-exempt organization. Joe’s best
friend, John, owns commercial real estate throughout the city in which ABC Charity operates. Because
of their long-standing friendship, John is able to talk Joe into signing a five-year lease on ABC’s behalf
to rent some hard-to-fill space that John owns in a run-down part of town. Joe has vague plans about
moving one of ABC’s exempt-function programs into this rented space, but that never happens. ABC
does, however, make the monthly rental payments to John for the space. Joe gets nothing out of the
deal, other than being able to maintain his friendship with John. Unbeknownst to Joe, the rate John
charges ABC for the rental property is about twice the going market rate for similar properties.

        1. Does this scenario show private benefit or inurement? Why?

        2. If there is private benefit or inurement, what could the organization have done to prevent it?




                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                              Page 3-13
                                                                                   Exhibit B (p. 2 of 2)


                Jeopardizing § 501(c)(3) Status Case Studies, Continued


Case Study 3

DEF Hospital is a tax-exempt hospital with 750 beds, a busy emergency room, and a full range of
medical and surgical specialties. Bob is the CEO of the hospital. Bob is paid an annual compensation
of $175,000. His compensation was determined by the compensation committee of the hospital’s board
of directors. Bob is not a member of this committee. His salary is comparable to the salaries paid to
CEOs of other similar-sized health-care organizations. In addition to his salary, Bob’s compensation
agreement with the hospital requires that Bob be provided with the use of a BMW for both business
and personal use. His personal use of the car is carefully documented and is included as compensation
on his Form W-2. Over the past few years, the cost of his personal use of the car has averaged about
$7,500 per year.


       1. Does this scenario show private benefit or inurement? Why?



       2. If there is private benefit or inurement, what could the organization have done to prevent it?




                              Chapter 3 – Jeopardizing 501(c)(3) Status
                                             Page 3-14
                                                                                          Exhibit C (p. 1 of 7)

                    TAX-EXEMPT HEALTH CARE ORGANIZATIONS
                     REVISED CONFLICTS OF INTEREST POLICY
                                                 by
                             Lawrence M. Brauer and Charles F. Kaiser III

1.      Introduction

         The 1997 CPE Text discussed a community board and conflicts of interest policy as factors the
Service takes into consideration in determining whether hospitals and other health care organizations
satisfy the community benefit standard in Rev. Rul. 69-545, 1969-2 C.B. 117. One significant fact
demonstrating that a tax-exempt health care organization promotes the health of the community as a
whole, rather than benefitting private interests, is the organization’s adoption of a substantial conflicts
of interest policy. The 1997 CPE Text included a sample conflicts of interest policy that can be
adopted in an organization’s bylaws or through resolution by its board of directors.

         Based on comments we received from the interested community, the sample policy has been
modified in several respects, as explained below. The revised sample policy is also attached to this
article.

2.      Article II. Definitions

      A.      Section 2. Financial Interest

         The sample policy was revised to clarify that a person having a financial interest does not
necessarily have a conflict of interest. The board of directors or the appropriate board committee has
the responsibility to determine, based on all the facts and circumstances, whether the financial interest
of an interested person rises to the level of a conflict of interest. Thus, the following new sentence was
added:

               A financial interest is not necessarily a conflict of interest. Under Article Ill, Section 2, a
               person who has a financial interest may have a conflict of interest only if the appropriate
               board or committee decides that a conflict of interest exists.

3.    Article III. Procedures

           Several clarifications were made to the Procedures part of the sample policy.

      A.      Section 1. Duly to Disclose

         Before the board or committee makes a determination whether the financial interest of an
interested person rises to the level of a conflict of interest, the interested person must be given the
opportunity to disclose all material facts relating to his/her financial interest.

                                  Chapter 3 – Jeopardizing 501(c)(3) Status
                                                 Page 3-15
                                                                                         Exhibit C (p. 2 of 7)

           B.        Section 2, Determining Whether A Conflict of Interest Exists

         If the interested person discloses all material facts relating to his/her financial interest, the
board or committee can continue to discuss the issue with the interested person to clarify or obtain
additional information relevant to the financial interest. However, before the board or committee
discusses and votes on whether the interested person’s financial interest is a conflict of interest, the
interested person must leave the meeting.

        C.       Section 3(a), Procedures for Addressing the Conflict of Interest

         An interested person with a conflict of interest in a transaction or arrangement is not precluded
from making a presentation to the board or committee regarding the transaction or arrangement.
However, before the board or committee discusses and votes on the transaction or arrangement, the
interested person must leave the meeting.

4.    Article V. Compensation

        The Compensation part of the sample policy was also modified to clarify several items.
      A. Section 1

         A new paragraph was added providing that an individual who is a voting member of the board
of directors and receives compensation from the corporation for services may not vote on any matter
pertaining to that member’s compensation.

      B.     Section 2

         Another new paragraph was added stating that a physician who is a voting member of the
board of directors and receives compensation, directly or indirectly, from the Corporation for services
is precluded from discussing and voting on matters pertaining to that member’s and other physicians’
compensation. In addition, the sample policy provides that no physician or physician director, either
individually or collectively, is prohibited from providing information to the board of directors
regarding physician compensation.

      C.        Section 4

        A new sentence was added providing that although a physician with a direct or indirect
financial interest in a corporation may not be a member of a compensation committee, the physician
may provide information to the committee regarding physician compensation in general.

        In all other respects, the sample conflicts of interest policy that appeared in the 1997 CPE text
remains unchanged.

                                 Chapter 3 – Jeopardizing 501(c)(3) Status
                                                Page 3-16
                                                                                       Exhibit C (p. 3 of 7)

                       SAMPLE CONFLICTS OF INTEREST POLICY
                                              (Revised 1999)

                                                 Article I

                                                Purpose
         The purpose of the conflicts of interest policy is to protect the Corporation’s interest when it is
contemplating entering into a transaction or arrangement that might benefit the private interest of an
officer or director of the Corporation. This policy is intended to supplement but not replace any
applicable state laws governing conflicts of interest applicable to nonprofit and charitable corporations.

                                                 Article II

                                                Definitions

1. Interested Person

         Any director, principal officer, or member of a committee with board delegated powers who
has a direct or indirect financial interest, as defined below, is an interested person. If a person is an
interested person with respect to any entity in the health care system of which the Corporation is a part,
he or she is an interested person with respect to all entities in the health care system.

2.    Financial Interest

       A person has a financial interest if the person has, directly or indirectly, through business,
investment or family -

           a.   an ownership or investment interest in any entity with which the Corporation has a
                transaction or arrangement, or

           b.   a compensation arrangement with the Corporation or with any entity or individual with
                which the Corporation has a transaction or arrangement, or

           c.   a potential ownership or investment interest in, or compensation arrangement with, any
                entity or individual with which the Corporation is negotiating a transaction or
                arrangement.

        Compensation includes direct and indirect remuneration as well as gifts or favors that are
substantial in nature.

                               Chapter 3 – Jeopardizing 501(c)(3) Status
                                              Page 3-17
                                                                                       Exhibit C (p. 4 of 7)

        A financial interest is not necessarily a conflict of interest. Under Article Ill, Section 2, a
person who has a financial interest may have a conflict of interest only if the appropriate board or
committee decides that a conflict of interest exists.

                                                 Article III

                                                Procedures

1.    Duty to Disclose

        In connection with any actual or possible conflicts of interest, an interested person must
disclose the existence of his or her financial interest and must be given the opportunity to disclose all
material facts to the directors and members of committees with board delegated powers considering the
proposed transaction or arrangement.

2.    Determining Whether a Conflict of Interest Exists

         After disclosure of the financial interest and all material facts, and after any discussion with
the interested person, he/she shall leave the board or committee meeting while the determination of a
conflict of interest is discussed and voted upon. The remaining board or committee members shall
decide if a conflict of interest exists.

3.   Procedures for Addressing the Conflict of Interest

      a.   An interested person may make a presentation at the board or committee meeting, but after
           such presentation, he/she shall leave the meeting during the discussion of, and the vote on,
           the transaction or arrangement that results in the conflict of interest.

      b.   The chairperson of the board or committee shall, if appropriate, appoint a disinterested
           person or committee to investigate alternatives to the proposed transaction or arrangement.

      c.   After exercising due diligence, the board or committee shall determine whether the
           Corporation can obtain a more advantageous transaction or arrangement with reasonable
           efforts from a person or entity that would not give rise to a conflict of interest.

      d.   If a more advantageous transaction or arrangement is not reasonably attainable under
           circumstances that would not give rise to a conflict of interest, the board or committee shall
           determine by a majority vote of the disinterested directors whether the transaction or
           arrangement is in the Corporation’s best interest and for its own benefit and whether the
           transaction is fair and reasonable to the Corporation and shall make its decision as to
           whether to enter into the transaction or arrangement in conformity with such determination.

                                Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-18
                                                                                     Exhibit C (p. 5 of 7)

4.   Violations of the Conflicts of Interest Policy

     a.   If the board or committee has reasonable cause to believe that a member has failed to
          disclose actual or possible conflicts of interest, it shall inform the member of the basis for
          such belief and afford the member an opportunity to explain the alleged failure to disclose.

      b. If, after hearing the response of the member and making such further investigation as may
         be warranted in the circumstances, the board or committee determines that the member has
         in fact failed to disclose an actual or possible conflict of interest, it shall take appropriate
         disciplinary and corrective action.


                                              Article IV

                                       Records of Proceedings

      The minutes of the board and all committee with board-delegated powers shall contain:

1.   the names of the persons who disclosed or otherwise were found to have a financial
     interest in connection with an actual or possible conflict of interest, the nature of the financial
     interest, any action taken to determine whether a conflict of interest was present, and the
     board’s or committee’s decision as to whether a conflict of interest in fact existed.

2.   the names of the persons who were present for discussions and votes relating to the transaction
     or arrangement, the content of the discussion, including any alternatives to the proposed
     transaction or arrangement, and a record of any votes taken in connection therewith.

                                              Article V

                                            Compensation

1.   A voting member of the board of directors who receives compensation, direcfly or indirectly,
     from the Corporation for services is precluded from voting on matters pertaining to that
     member’s compensation.

2.   A physician who is a voting member of the board of directors and receives compensation,
     directly or indirectly, from the Corporation for services is precluded from discussing and
     voting on matters pertaining to that member’s and other physicians’ compensation. No
     physician or physician director, either individually or collectively, is prohibited from providing
     information to the board of directors regarding physician compensation.

                             Chapter 3 – Jeopardizing 501(c)(3) Status
                                            Page 3-19
                                                                                      Exhibit C (p. 6 of 7)

3.         A voting member of any committee whose jurisdiction includes compensation matters and
           who receives compensation, directly or indirectly, from the Corporation for services is
           precluded from voting on matters pertaining to that member’s compensation.

4.         Physicians who receive compensation, directly or indirectly, from the Corporation, whether as
           employees or independent contractors, are precluded from membership on any committee
           whose jurisdiction includes compensation matters. No physician, either individually or
           collectively, is prohibited from providing information to any committee regarding physician
           compensation.


                                                Article VI

                                            Annual Statements

           Each director, principal officer and member of a committee with board delegated

powers shall annually sign a statement which affirms that such person-
     a. has received a copy of the conflicts of interest policy,

      b.     has read and understands the policy,

      c.     has agreed to comply with the policy, and

      d.     understands that the Corporation is a charitable organization and that in order to maintain
             its federal tax exemption it must engage primarily in activities which accomplish one or
             more of its tax-exempt purposes.


                                                Article VII

                                             Periodic Reviews

          To ensure that the Corporation operates in a manner consistent with its charitable purposes and
that it does not engage in activities that could jeopardize its status as an organization exempt from
federal income tax, periodic reviews shall be conducted. The periodic reviews shall, at a minimum,
include the following subjects:

      a.     Whether compensation arrangements and benefits are reasonable and are the result of
             arm’s-length bargaining.



                                Chapter 3 – Jeopardizing 501(c)(3) Status
                                               Page 3-20
                                                                                   Exhibit C (p. 7 of 7)

      b.   Whether acquisitions of physician practices and other provider services result in inurement
           or impermissible private benefit.

      c.   Whether partnership and joint venture arrangements and arrangements with management
           service organizations and physician hospital organizations conform to written policies, are
           properly recorded, reflect reasonable payments for goods and services, further the
           Corporation’s charitable purposes and do not result in inurement or impermissible private
           benefit.

      d.   Whether agreements to provide health care and agreements with other health care
           providers, employees, and third party payors further the Corporation’s charitable purposes
           and do not result in inurement or impermissible private benefit.


                                             Article VIII

                                        Use of Outside Experts

       In conducting the periodic reviews provided for in Article VII, the Corporation may, but need
not, use outside advisors. If outside experts are used their use shall not relieve the board of its
responsibility for ensuring that periodic reviews are conducted.




                              Chapter 3 – Jeopardizing 501(c)(3) Status
                                             Page 3-21
                                               Chapter 4

                      UNRELATED BUSINESS INCOME (UBI)


Unrelated Business Income Tax

Tax-exempt organizations may engage in income-producing activities unrelated to their tax-exempt
purposes, as long as the unrelated activities are not a substantial part of the organization’s activities.
However, the net income from such activities will be subject to the Unrelated Business Income Tax
(UBIT) if the following three conditions are met:
 The activity constitutes a trade or business

   The trade or business is regularly carried on, and

   The trade or business is not substantially related to the organization’s exempt purpose


Trade or Business

The term “trade or business” generally includes any activity carried on for the production of income
from selling goods or performing services.

An activity does not lose its identity as a trade or business merely because it is carried on within a
larger group of similar activities.

Example: The regular sale of pharmaceutical supplies to the general public by a hospital pharmacy that
also furnishes supplies to the hospital and its patients is a trade or business.


Regularly Carried On

Business activities ordinarily are considered regularly carried on if they show a frequency and
continuity, and are pursued in a manner similar to comparable commercial activities of nonexempt
organizations.

Example: A hospital auxiliary’s operation of a sandwich stand for two weeks at a state fair would not be
the regular conduct of a trade or business. However, operating the sandwich stand daily at the hospital
would be the regular conduct of a trade or business.




                              Chapter 4 – Unrelated Business Income (UBI)
                                               Page 4-1
UNRELATED BUSINESS INCOME (UBI), Continued

Not Substantially Related

A business activity is not substantially related to an organization’s exempt purpose if it does not
contribute importantly to accomplishing that purpose (other than through the production of funds). The
fact that they organization used the income to further its charitable purposes does not make the activity
substantially related to its exempt purposes. Whether an activity contributes importantly depends upon
on the facts involved in each case.

In determining if activities contribute importantly to accomplishing 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 they serve. If an activity is conducted on a larger scale than is reasonably necessary to
perform an exempt purpose, it does not contribute importantly to accomplishing the organization’s
exempt purposes. An activity does not lose its identity as a trade or business merely because it is
carried on within a larger group of similar activities that may be related to the organization’s exempt
purposes.

Example: The hospital sandwich stand that operates daily would generate both related and unrelated
business income. Income from sales to hospital staff and patients would be related (because of the
“convenience” exception, explained below), while income from sales to the general public would be
unrelated. Income from the latter only would be subject to UBIT.


Examples of Unrelated Trade or Business Activities

There are nearly as many examples of unrelated business income as there are types of businesses.
Unrelated trade or business activities vary depending on types of activities. Examples of some of the
more common forms of UBI include:

      Advertising
      Gaming
      Sale of merchandise and publications
      Rental income
      Parking lots

Advertising

Many tax-exempt organizations sell advertising in their publications or other forms of public
communication. Generally, income from the sale of advertising is unrelated trade or business income.
This may include the sale of advertising space in weekly bulletins, magazines, or journals, or on the
organization’s website.

                             Chapter 4 – Unrelated Business Income (UBI)
                                              Page 4-2
UNRELATED BUSINESS INCOME (UBI), Continued
Are There Exceptions to UBI?

Whether an income-producing activity is an unrelated trade or business activity depends on all the
facts and circumstances. Even though these activities generally result in tax on an unrelated trade or
business, certain exceptions discussed next may apply that will eliminate the income, and any
applicable expenses, from the unrelated trade or business income tax computation.

Exceptions to UBI

The main exceptions to the definition of UBI are:

    Activities conducted substantially by volunteers
       Activities conducted for the convenience of members, students, patients, officers, or employees
       Sales of donated merchandise
       Distribution of “low cost” articles
       Convention and trade show activity
       Qualified sponsorship income
       Bingo income
Activities Conducted by Volunteers

The volunteer labor exception excludes from tax any trade or business income if substantially all of the
work is performed without compensation. For example, an exempt orphanage that operates a gift shop
where all of the clerks work without being paid would meet this exception.

Convenience

The convenience exception applies to a section 501(c)(3) organization or a state college or university,
which operates a trade or business primarily for the convenience of its members, students, patients,
employees, or officers. For example, a hospital that operates a cafeteria to provide food for staff,
visitors, and patients would meet this exception.

Sale of Donated Merchandise

This exception excludes income from a trade or business resulting from the sale of articles donated to
an organization. For example, income received by an exempt organization that operates a thrift store
selling clothes and other goods donated by members of the general public would meet this exception.




                             Chapter 4 – Unrelated Business Income (UBI)
                                              Page 4-4
UNRELATED BUSINESS INCOME (UBI), Continued


Distribution of Low Cost Articles

The distribution of low cost article exception applies to exempt organizations that can solicit charitable
contributions from the general public. It excludes activities related to the distribution of low cost items
incidental to soliciting charitable contributions.

An article is considered low cost if the cost of the item distributed to a single recipient in any one year
is not more than $5.00, indexed annually for inflation. For example, any contributions received by an
exempt organization that includes mailing labels with its solicitations for contributions would meet this
exception.

Convention or Trade Show

This exception excludes income from qualified trade shows. This involves an activity in conjunction
with a convention, annual meeting, or show if one of the purposes of the organization in sponsoring the
activity is promoting and stimulating interest in, and demand for, the products and services of that
industry.

In addition, the trade show could include educating persons in attendance regarding new products and
services or new rules and regulations affecting the industry. An example would be the rental of display
space to exhibitors at an annual meeting of a 501(c)(3) organization. Only section 501(c)(3), (4), (5), or
(6) organizations may use this exception.

Sponsorship

The sponsorship exception applies to payments made to an exempt organization by a person in a trade
or business for which the person will receive no substantial benefit other than the use or
acknowledgment of the business’s name, logo, or product lines in connection with the organization’s
activities.

An example would be the payment by an oil company to an exempt organization sponsoring a
collegiate post-season football game. In return for its payment, the oil company gets its name included
in the title of the game.




                             Chapter 4 – Unrelated Business Income (UBI)
                                              Page 4-5
UNRELATED BUSINESS INCOME (UBI), Continued
Bingo

Income derived from bingo games may be eligible for a special tax exception (in addition to the
exception regarding uncompensated volunteer labor), if the bingo game is:

     The traditional type of bingo

       Legal under state and local law, and

       Not ordinarily carried out on a commercial basis

Traditional: To qualify as a bingo game, wagers must be placed, winners must be determined, and
prizes must be distributed in the presences of all persons placing wagers in that game. Satellite and
Internet bingo do not qualify because these games are conducted in many different places
simultaneously and the participants are not all present when the wages are placed, the winners are
determined, and the prizes are distributed. Instant bingo, Mini bingo, and similar scratch off cards are
pull-tab games, not bingo.

Legal under state and local law: The exception only applies if the game is legal under state and local
law. If bingo is expressly prohibited under state law or local law, it is immaterial whether state or local
officials enforce the law.

Not ordinarily carried out on a commercial basis: The bingo exception also does not apply to bingo
games conducted in a jurisdiction in which the games are ordinarily carried out on a commercial basis.
Therefore, if for-profit businesses regularly conduct bingo games in any part of the jurisdiction, the
bingo exception does not apply. Ordinarily, the jurisdiction is the entire state.

If, however, state law permits local jurisdictions to determine whether for-profit businesses may
conduct bingo, or if state law limits or confines the conduct of bingo games by for-profit entities to
specific local jurisdictions, then the local jurisdiction is the appropriate jurisdiction for determining
whether bingo games are ordinarily carried out in a commercial manner.




                              Chapter 4 – Unrelated Business Income (UBI)
                                               Page 4-6
UNRELATED BUSINESS INCOME (UBI), Continued
Other Exceptions

Other exceptions may also apply, but they are less common and will not be covered here.

Expenses allocable to any activity that meets one of these exceptions may not be deducted when
calculating the unrelated business income tax.


Exclusions and Deductions from UBI

In addition to the exceptions discussed earlier, the Code provides certain other exclusions and
deductions from the calculation of the unrelated business income tax.

Exclusions:

      Interest and dividends

     Royalties

      Certain rents from real properties

     Certain gains and losses


Deductions:

     Net operating loss deduction

      Charitable contribution deduction

      $1,000.00 specific deduction




                            Chapter 4 – Unrelated Business Income (UBI)
                                             Page 4-7
UNRELATED BUSINESS INCOME (UBI), Continued
Exclusions

Interest and Dividends: Interest and dividends, and certain other income from an exempt organization’s
routine investments are excluded when calculating the organization’s unrelated business income tax.
An example is interest from the exempt organization’s bank account.

Royalty Income: Royalty income is also excluded in calculating unrelated business income tax.
Royalties are payments for the use of a right, such as a trademark, trade name, or copyright. However,
when substantial services are required as part of the agreement to use a right, the payment is not a
royalty but a payment for services. An example of an excluded royalty is a payment from a
manufacturer to an exempt labor organization for the use of the organization’s logo in the
manufacturer’s advertising.

Rents from Real Property: Rents from real property are excluded in calculating unrelated business
income tax. This exclusion does not apply to rents from personal property, rents from real property
based on net profit, rents from real property when personal services are provided, or rents from real
property that is debt-financed. Rent received for the use of an exempt organization’s hall for a
wedding, where no services such as bartending or catering are provided and the building’s mortgage
has been paid in full, is an example of excluded rental income.

Certain Gains and Losses from Sale of Property: Gains and losses from the sale of property, other than
inventory and property held primarily for sale in the course of a trade or business, are excluded in
calculating unrelated business income tax. For example, gain on the sale of stock held as an investment
by an exempt organization is excluded.




                            Chapter 4 – Unrelated Business Income (UBI)
                                             Page 4-8
UNRELATED BUSINESS INCOME (UBI), Continued
Deductions

The calculation of UBIT is similar to the calculation of other income taxes in that UBI can be offset by
related expenses (see below). Other deductions include, but are not limited to, the following:

Net Operating Loss: A net operating loss deduction is allowed in computing unrelated business taxable
income. This deduction is allowed in one tax year based on a loss generated in either a previous or
subsequent tax year. For example, during the first year of operation, an exempt organization had a net
operating loss of $10,000 from an unrelated trade or business activity. During its second year, net
income from its unrelated trade or business activity was $12,000. The organization may claim a net
operating loss deduction of $10,000 in the second year, based on the prior year loss, and reduce the
unrelated trade or business income for the second year from $12,000 to $2,000.

Charitable Contributions: An exempt organization is allowed a deduction for charitable contributions.
This deduction is limited to 10% of its unrelated business taxable income computed without regard to
the deduction for contributions. To be deductible, the contribution must be paid to another qualified
organization. For example, an exempt university that operates an unrelated trade or business producing
taxable income of $100,000 may deduct up to $10,000 of a charitable contribution to another
university for educational work.

“Specific”: A specific deduction of $1,000.00 is allowed in computing unrelated business taxable
income. The specific deduction is similar to the personal exemption for an individual. For example, an
organization with taxable income from an unrelated trade or business of $15,000 pays tax on $14,000.

Expenses allocable to any activity that meets one of these exclusions may not be used when calculating
unrelated business income tax.


Allocation of Expenses Related to UBI

For an expense to be deductible, it must be directly connected to carrying on an unrelated trade or
business. There must be a proximate and primary connection between unrelated business income
received and expenses used to offset the income. If expenses are related to two or more activities, they
must be allocated on a reasonable basis.




                            Chapter 4 – Unrelated Business Income (UBI)
                                             Page 4-9
UNRELATED BUSINESS INCOME (UBI), Continued

Categories of Expenses

The following three categories are used to allocate expenses used in computing unrelated business
income:

   1. Direct expenses

   2. Indirect expenses

   3. Non-deductible expenses

Direct expenses include purchases specifically for the activity, salaries directly attributable to the
activity, and repairs to a specific area used for the activity.

Indirect expenses include interest, rent, taxes, insurance, utilities, depreciation, and repairs affecting
the entire building in which both exempt and unrelated activities are conducted.

Non-deductible expenses include purchases for an activity that does not produce unrelated business
income, repairs to areas used specifically for exempt purposes, and depreciation on capital items used
specifically for exempt purposes.




                              Chapter 4 – Unrelated Business Income (UBI)
                                               Page 4-10
UNRELATED BUSINESS INCOME (UBI), Continued
Expense Allocation Methods: Examples

Example 1: A school recognized as a tax-exempt organization contracts with an individual to conduct a
summer tennis camp, an activity unrelated to the school’s exempt purpose. The school provides the
tennis courts, housing, and dining facilities. The contracted individual hires the instructors, recruits
campers, and provides supervision. The income the school receives from this activity is from a dual
use of the facilities and personnel. The school, in computing its unrelated business taxable income,
may deduct an allocable part of the expenses attributable to the facilities and personnel. The school
determined that the summer revenues were 40% student and 60% non-student (i.e., camper). School
expenses (e.g. real estate taxes, building insurance, and personnel) totaled $20,000. Since only half the
school facilities were used for an unrelated trade or business activity (tennis courts, housing, dining
facilities, and personnel), 50% of these expenses can be allocated to this activity ($20,000 x .5
$10,000). However, since the student use is not subject to tax, expenses attributable to them are not
deductible. Therefore, only 60% of the $10,000 expense allocated to the activity is deductible on Form
990-T ($10,000 x .60 = $6,000).

Example 2: XYZ Charity has an employee who spends 70% of his time on gaming activities and 30%
on activities related to the charity’s exempt purpose. The organization may allocate 70% of the
employee’s wages to unrelated business taxable income on Form 990-T.

NOTE: The organization should maintain adequate records and contemporaneous documentation to
support how the employee’s time was spent.


UBI’s Effect on an Organization’s Exempt Status

Generally, a section 501(c)(3) organization may have some unrelated trade or business income without
any adverse impact on its exempt status. If, however, a 501(c)(3) organization’s unrelated trade or
business activity becomes substantial, the organization jeopardizes its exempt status. Wits exempt
status is revoked, taxable returns, such as Form 1120, US. Corporation Income Tax Return, are required.


Form 990-T: Who Must File

If an exempt organization has gross income of $1,000 or more for any taxable year from the conduct of
any unrelated trade or business, it is required to file Form 990-T, Exempt Organization Business
Income Tax Return. The requirement to file Form 990-T is in addition to the requirement to file Form
990, 990-EZ, or 990-PF.




                             Chapter 4 – Unrelated Business Income (UBI)
                                              Page 4-11
UNRELATED BUSINESS INCOME (UBI), Continued

When to File

Form 990-T is due the 15th day of the 5th month following the end of the organization’s accounting
period (tax year). For example, May 15 for a December 31st year-end.


Extension of Time to File

Corporations may request an automatic 6-month extension of time to file Form 990-T by using Form
8868, Application for Extension of Time To File Exempt Organization Return.


Interest and Penalties

Your organization may be subject to interest and penalty charges if it files a late return or fails to pay
tax when due. Generally, the organization is not required to include the interest and penalty charges on
Form 990-T because the IRS will calculate the amount and bill the organization for it.


Form 990-W

Generally, an organization filing Form 990-T must make installment payments of estimated tax if its
estimated tax (tax minus allowable credits) is expected to be $500 or more. Both corporations and
trusts use Form 990-W, Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt
Organizations.


For More Information

Publication 598, Tax on Unrelated Business Income of Exempt Organizations

Form 990-T, Exempt Organization Business Income Tax Return, and Instructions

Form 990-W, Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt Organizations

Form 1120, U.S. Corporation Income Tax Return

Form 8868, Application for Extension of Time To File Exempt Organization Return

    You may order Forms and Publications by calling toll free (800) 829-3676 or
          by downloading them from the IRS website at: www.irs.gov.

                             Chapter 4 – Unrelated Business Income (UBI)
                                              Page 4-12
                                             Chapter 5

                                   GAMING ACTIVITIES

Gaming as a Fundraising Activity

One of the most common and successful types of fundraising engaged in by many exempt
organizations is gaming. Tax-exempt organizations sponsor or conduct gaming activities to raise funds
for their exempt programs. Organizations that conduct or sponsor gaming activities, whether for one
night or throughout the year, whether in their primary place of operations or at a remote location, are
subject to federal tax law requirements and must be aware of the requirements for income,
employment, and excise taxes.

The term gaming includes activities such as Bingo, Beano, raffles, lotteries, pull-tabs, scratch-offs,
pari-mutuel betting, Calcutta wagering, pickle jars, punchboards, tip boards, tip jars, and certain video
games.

Unrelated Business Income Tax: Generally, unless another exception applies, unrelated business
income tax (UBIT) is paid on receipts derived from gaming. Income from bingo is excluded from the
unrelated business income tax by the Code, as is income from lawful gaming conducted in North
Dakota. See Chapter 4.

Lawful gaming ordinarily requires a license from the state in which the gaming is conducted.

Gaming Activities and 501(c)(3) Organizations

Gaming is generally a business activity that does not further section 501(c)(3) purposes. Thus, a
section 501(c)(3) organization may conduct gaming if the gaming is not a substantial part of the
organization’s activities and if it provides funds for the organization’s exempt purposes.


Wagering Taxes

In addition to the application of UBIT, all organizations that conduct gaming activities should be aware
that the sponsorship of such activities might lead to the imposition of a wagering excise tax and
occupational tax per sections 4401 and 4411 of the Code. The wagering excise tax applies to the
amount of the wager; the occupational (or stamp) tax applies to persons receiving wagers.




                                     Chapter 5 – Gaming Activities
                                               Page 5-1
GAMING ACTIVITIES, Continued

Definition of Wager

The wager is the amount risked by the person placing the bet, not the amount the person stands to win.
The term “wager” does not include drawings conducted by exempt organizations so long as no part of
the net proceeds of such drawing inures to the benefit of any private shareholder or individual. If,
however, any part of the net proceeds from taxable wagers is used to pay the administrative or
operational expenses of the exempt organization, the exception does not apply and excise taxes must
be paid.

The taxes on wagering apply to wagers placed in a lottery conducted for profit (i.e., for the purpose of
raising funds). Pull-tabs, raffles, and tip jars meet the definition of taxable wagers placed in a lottery.
Bingo Games (not Instant Bingo) are specifically excluded from the application of the wagering tax.


Wagering Excise Tax

The wagering excise tax applies to the gross amount of wagers received. This means that the tax is
based on the total amount received before any payout of prizes or other expenses.
The tax rate is determined by whether the wager is authorized under the laws of the state in which it is
accepted. If the wager is authorized, the rate of tax is 0.25% of the amount of the wager. If the wager is
not authorized, the tax is 2% of the amount of the wager.


Form 730, Monthly Tax on Wagers

The organization reports and pays the wagering excise tax by filing Form 730, Monthly Tax on
Wagering. It is due each month by the last day of the month after the month in which the wager was
placed. If you are in the business of accepting taxable wagers, file a return for each month whether or
not you have taxable wagers to report for that month. If you have none to report, write “0” (zero) in the
last box of the dollar amount. If you stop accepting wagers, check the final return box above Line 1.
An organization may be subject to a penalty for failure to file the form and for failure to pay the tax.




                                      Chapter 5 – Gaming Activities
                                                Page 5-2
GAMING ACTIVITIES, Continued

Occupational Tax

The code also imposes an occupational or stamp tax in connection with certain wagers. This tax is an
annual fee imposed on both the organization and each of its employees who receive wagers.
The amount of the occupational tax depends on whether the wager is authorized under the laws of the
state in which the wager is accepted. If the wager is authorized, the amount of the tax is $50 per year
per person. If the wager is not authorized, the amount of the tax is $500 per year per person.


Form 11C, Occupational Tax and Registration Return for Wagering

An organization reports and pays the occupational tax on wagering with Form 11 C, Occupational Tax
and Registration Return for Wagering. Form 11C must be filed before an organization begins
accepting wagers. After that, the organization must file a renewal return by July 1 for each year in
which the organization accepts wagers. A Form 11C should also be filed when certain changes in
ownership occur, while a supplemental registration return should be filed when certain other changes
occur. An organization may be subject to a penalty for failure to file the form and for failure to pay the
tax.


Examples of Excise and Occupational Tax Applicability

Example 1: An exempt organization conducts a raffle open to the general public. The organization
deposits all of the proceeds into its scholarship fund for local college students. (Awarding an annual
scholarship is one of the organization’s exempt purposes.) Since the organization does not use any of
the raffle’s proceeds for administrative expenses or to benefit a private individual, the raffle does not
meet the definition of a taxable wager. Therefore, no wagering taxes apply.

Example 2: An exempt organization sells pull-tabs at its building. The organization uses some
proceeds to pay its real estate taxes. The organization has four employees selling pull-tabs. This
organization would be liable for the wagering excises tax because it used a portion of the proceeds
from its pull-tab sales to pay for its operational expenses. Since the excise tax applies, the organization
and its four pull-tab sellers would be required to file the annual occupational tax.




                                     Chapter 5 – Gaming Activities
                                                 Page 5-3
GAMING ACTIVITIES, Continued

Form W-2G, Statement for Recipients of Certain Gambling Winnings

Certain wagering transactions require the filing of Form W-2G, Statement for Reczpients of Certain
Gambling Winnings, and Form 1096, Annual Summary and Transmittal of US. Information Returns.
The organization conducting the gaming event completes Form W-2G, showing the amount won and
taxes withheld, if any, when an individual(s) wins a prize with a minimum specific dollar amount. The
winner must provide the game operator with proper identification including his/her social security
number. Form W-9, Request for Taxpayer Ident~fi cation Number and Certification, may be used to
record this information. Sources of gambling subject to reporting requirements and withholding
include horseracing, dog racing, jai alai, sweepstakes, wagering pools, lotteries, raffles, bingo, keno,
and slot machines.

Generally, gambling winnings must be reported if the amount paid and reduced, at the option of the
payer, by the wager is:

        (1)    $600 or more, and

        (2)    At least 300 times the amount of the wager

However, these requirements do not apply to winnings from keno, bingo, and slot machines. If
winnings from a keno game (reduced by the wager) are $1,500 or more, they are reportable gambling
winnings. If the winnings (not reduced by the wager) from a bingo game or slot machine are $1,200 or
more, they are reportable gambling winnings.

If the prize is not cash, the fair market value of the item won is considered the amount of the winnings.
A noncash payment, such as a car, must be taken into account at its fair market value for reporting
purposes.


When to File Form W-2G

The gaming operator should complete Form W-2G upon payment of the prize to the winner. Copies B,
C, and 2 of this form should be given to the prizewinner at the time of completion. Send Copy A of
Form W-2G to the IRS by the last day of February of the year after the year in which the gaming
winnings were paid.




                                     Chapter 5 – Gaming Activities
                                               Page 5-4
GAMING ACTIVITIES, Continued

Income Tax Withholding from Gaming Winnings

Regular withholding refers to the withholding of income tax from prizes paid.
Withholding is required at the rate of 25% and is reported on Form W-2G and
Form 945. See below.

Regular withholding applies to winnings of more than $5,000 from instant bingo, pull-tabs, and raffles.
Regular withholding is not required for winnings from bingo games. Regular withholding applies to
the total prize won (winnings wagers) and not just to individual prizes over $5,000.
                              —




Backup Withholding from Gaming Winnings

A person receiving gambling winnings must furnish the payer a statement providing a taxpayer
identification number. If the recipient fails to furnish a correct taxpayer identification number, the
payer (the organization) must withhold a portion of the total proceeds, less the amount wagered. This is
called backup withholding.

Backup withholding applies to winnings from bingo games equal to or exceeding $1,200. It applies to
winnings equal to or more than $600 from instant bingo, pull-tabs, and raffles. Backup withholding is
required at the rate of 28% and is reported on Form W-2G and Form 945.


Withholding from Non-Cash Prizes

If the prize is not cash, the fair market value of the item won is considered the amount of the winnings.
The withholding and backup withholding rates, if required, are applied to the fair market value of the
item won. The amount to be withheld should be collected from the prizewinner.


Reporting the Withholding on Form 945

The organization is responsible for paying regular or backup withholding, whether or not it collects the
withholding from the prize recipient. The best time to collect withholding or backup withholding is
before the prize is paid. An organization reports regular and backup withholding from gaming
winnings on Form 945, Annual Return of Withheld Federal Income Tax. Form 945 is an annual return
and is due by January 31 of the year after the year in which the taxes were withheld.



                                     Chapter 5 – Gaming Activities
                                             Page 5-5
GAMING ACTIVITIES, Continued
Examples of Reporting and Withholding

Example 1: ABC Charity conducts a raffle in which it sells tickets for $25 each. The grand prize is
$6,000 in cash. Form W-2G is required because withholding is required for raffle proceeds that exceed
$5,000. Withholding on raffle prizes is not affected by the ratio of the prize to the wager. Since the
prize less the price of the ticket is $5,975 ($6,000 - $25 = $5,975), the withholding would be $1,494
($5,975 x 25%).

Example 2: Nonprofit Charity conducts a fundraising event in which it sells raffle tickets for $2 each.
The prize is a large screen TV with a fair market value of $2,000. Since the prize less the value of the
ticket is $600 or more and greater than 300 times the amount of the wager, the organization must
complete form W-2G, but does not have to withhold since the prize is less than $5,000.

Example 3: CDN, an exempt organization, has a winner of $5,100 from one of the pull-tabs, which
cost $10. Because the winnings, less the wager, exceed $5,000, Form W-2G is completed and federal
income tax is withheld. Income tax withheld is reported on Form 945. The winner would receive
$3,827 ($5,100 gross winnings less $1,273 withholding tax) (computed ($5,100 - $10) x 25%).

Example 4: CDN, an exempt organization, conducts a weekly bingo game. A payout of $1,300 is made
for a single game. The winner furnishes identifying information, along with her SSN, to the
organization. The organization must complete Form W-2G because the winnings exceed $1,200. The
regular gambling withholding of 25% does not apply to bingo.

Example 5: XYZ Charity conducts a raffle in which it sells tickets for $10 each. The grand prize is a
snowmobile with a fair market value of $7,000. As explained in Example I (above) the winnings are
subject to regular gambling withholding and Form W-2G is required.

The tax an organization must withhold is computed and paid under either of the following two
methods:

     1. The winner pays the withholding tax to the organization. The withholding is 25% of the
        noncash payment (fair market value) minus the amount of the wager. The withholding tax is
        submitted to the IRS on Form 945.

     2. The organization pays the withholding tax on behalf of the winner. The withholding is
        33.33% of the noncash payment (fair market value) minus the amount of the wager. The
        withholding tax is submitted to the IRS on the Form 945.




                                     Chapter 5 – Gaming Activities
                                               Page 5-6
GAMING ACTIVITIES, Continued

Failure to File Correct Information Returns by the Due Date

If you do not file a correct information return (Form 945) by the due date and you cannot show
reasonable cause, you may be subject to a penalty. The penalty applies if you fail to file timely, you
fail to include all information required to be shown on a return, or you include incorrect information on
the return. The penalty is generally $50 per document unless correction is made within certain time
frames.


Failure to Furnish Correct Payee Statements

If you fail to provide correct payee statements (Form W2-G) and you cannot show reasonable cause,
you may be subject to a penalty. The penalty applies if you fail to provide the statement by January 31,
you fail to include all information required to be shown on the statement, or you include incorrect
information on the statement. The penalty is $50 per statement, regardless of when correct statement is
furnished, with a maximum of $100,000 per year.


For More Information

Publication 510, Excise Taxes

Publication 3079, Gaming Publication for Tax-Exempt Organizations

Form 730, Monthly Tax on Wagering, and Instructions

Form 11 C, Occupational Tax and Registration Return for Wagering, and Instructions

Form W-2G, Statement for Recipients of Certain Gambling Winnings

Form 945, Annual Return of Withheld Federal Income Tax


You may order Forms and Publications by calling toll free (800) 829-3676 or
by downloading them from the IRS website at: www.irs.gov.




                                    Chapter 5 – Gaming Activities
                                              Page 5-7
                                              Chapter 6

                                  EMPLOYMENT ISSUES


Employment Taxes

In general, exempt organizations withhold and pay employment taxes under the same rules as other
entities. Like other employers, 501(c)(3)
organizations that pay wages to employees must withhold, deposit, and pay employment tax, including
federal income tax withholding and Social Security and Medicare (FICA) taxes. However, there is an
exception applicable to exempt organizations: if total compensation paid to an employee be an exempt
organization is less than $100 in a calendar year, then that compensation is not subject to FICA tax.

Section 501(c)(3) organizations do not pay federal unemployment (FUTA) taxes on the wages of their
employees, but other exempt organizations must pay FUTA taxes. Any person that fails to withhold
and pay employment tax may be subject to penalties.

Exempt organizations do not generally have to withhold or pay employment tax on payments to
independent contractors, but they may have information reporting requirements. If an organization
incorrectly classifies an employee as an independent contractor, it may be held liable for employment
tax for that worker. Therefore, understanding worker classification is essential to properly fulfilling an
entity’s legal responsibilities for withholding and information reporting on workers.


Employee

For federal tax purposes, a worker is an “employee” if the employer has the right to direct and control
the worker as to the manner and means of the worker’s job performance. In other words, an employer
has the right to tell an employee not only what shall be done but also how it shall be done. The right to
control is the important thing, even if it is not exercised.

Generally, when workers are employees, the entity that employs them must withhold and pay federal
employment taxes from their compensation and report withheld amounts to the IRS. Federal
employment taxes are taxes under the Federal Insurance Contributions Act (FICA or Social Security),
taxes under the Federal Unemployment Tax Act (FUTA), and income tax withholding. State taxes and
workmen’s compensation may also apply. When a worker is an independent contractor, the entity may
have information-reporting responsibilities, but does not have to withhold and pay employment taxes.



                                    Chapter 6 – Employment Issues
                                               Page 6-1
EMPLOYMENT ISSUES, Continued

Independent Contractor

An independent contractor is self-employed, carrying on an independent trade or business. An entity
has some right to direct or instruct an independent contractor, but less than in the case of an employee.
An independent contractor has a genuine possibility of profit or loss. An employee who receives a
salary does not normally incur business losses.


Volunteers

Many exempt organizations periodically provide volunteers with awards, bonuses, or gifts. In general,
if these are non-cash items of nominal value, such as turkeys or hams around the holidays, they would
not be included in taxable wages. However, cash items, including gift certificates, as well as any other
taxable fringe benefit would be included in taxable wages.


Worker Classification: Three Categories of Evidence

Worker classification is determined by the totality of the relationship between the entity and the
worker. The IRS has developed three categories of evidence used in determining if a worker is an
employee or an independent contractor. In any relationship, some facts will favor employee status and
some will favor independent contractor status. To make a correct determination, an entity must
consider both the evidence for autonomy and the evidence for right to control.

The three categories of evidence are:

      Behavioral control
      Financial control
      Relationship of the parties

The factors considered in each category are addressed below.

Behavioral Control

The factors showing the right to direct or control how the worker performs the task are:

     Instructions - When, where, how to accomplish the task; what tools or equipment to use, what
      order or sequence to follow; whether there are employee manuals, etc.

     Training - Specific procedures to be followed and methods to be used in completing the task.
                                  Chapter 6 – Employment Issues
                                              Page 6-2
EMPLOYMENT ISSUES, Continued
Financial Control

The factors showing the right to direct or control the financial aspects of the worker’s activities
include:

      Significant Investment Does the worker own the standard tools and equipment of the trade or
                                    -


       profession? Is there is significant investment in equipment? Does the worker maintain a
       separate office?

      Unreimbursed Expenses A large amount of expenses tends to indicate independence. Does the
                                            -


       worker hire and pay helpers?

      Services Available to the Relevant Market Does the worker advertise and maintain a visible
                                                                   -


       business location?

      Method of Payment Is the worker paid a flat fee or by the job? (Employees tend to be paid on
                                -


       an hourly, daily, weekly or monthly basis.)

      Opportunity for Profit or Loss The risk of incurring a loss is one of the strongest indicators of
                                                      -


       independence.


   Relationship of the Parties

   The factors which show how the parties perceive their relationship are:

      Intent of the Parties/Written Contracts A written contract specifying employee or independent
                                                             -


       contractor status is important evidence. The entire substance of the relationship must be
       considered, however.

      Employee Benefits Providing a worker with typical employee benefits, e.g., health insurance
                            -


       or a pension plan, is evidence of employee status.

      Discharge/Termination Can the firm terminate or discharge the worker or can the worker leave
                                        -


       before the task is completed without becoming liable for nonperformance under the contract or
       agreement? These facts suggest employee status.

      Regular Business Activity Are the services a key aspect of the regular business of the entity? If
                                                -


       so, an employer-employee relationship may be indicated.




                                                    Chapter 6 – Employment Issues
                                                                 Page 6-3
EMPLOYMENT ISSUES, Continued

IRS Help on Classification Issues

The IRS has free publications to assist in resolving questions of worker classification and other
questions in the area of employment. These are:

         Publication 15, Circular E, Employer’s Tax Guide

         Publication 15-A, Employer’s Supplemental Tax Guide, and

         Publication 1779, Independent Contractor or Employee

For a ruling from the IRS, complete federal Form S S-8, Determination of Employee Work Stat us for
Purposes of Federal Employment Tax and Income Tax Withholding. The form’s instructions provide
the correct mailing address.

Also consider consulting your accountant, attorney, or the IRS for more help on these tests.

State or Other Federal Classification Requirements

Different federal and state agencies make determinations of employee classification based on the facts
of each case and the applicable law. Thus IRS determinations may differ from those of state
government agencies. Consequently, if you plan to classify some of your workers as independent
contractors, you may want to obtain a separate ruling from each agency. Each agency has its own
appeal process, which you must follow carefully to protest an initial adverse decision.


Employees and Non-Employees - Defined by Statute

Certain individuals are classified as employees or non-employees by statute.

Corporate Officers: An officer of a corporation is an employee unless he or she performs no services,
or only minor services, and neither receives nor is entitled to receive any remuneration, directly or
indirectly. Corporate officers include presidents, vice-presidents, treasurers, etc. This is so even if:

    (1)      The officer is the sole shareholder and, as such, controls his or her own duties and
             remuneration or

    (2)      The officer is supplied by a leasing company

Corporate Director: A director of a corporation in his/her capacity as director is not an employee of
the corporation and is treated as an independent contractor.
                                     Chapter 6 – Employment Issues
                                                Page 6-4
EMPLOYMENT ISSUES, Continued

Payment of Compensation

After an organization has decided on the proper classification of its workers, it must consider
numerous other requirements for paying compensation. The following paragraphs are an outline of
important issues and requirements for dealing with the IRS and the Social Security Administration
(SSA).


Registering For a Federal ID Number

Every entity and certain sole proprietors must have an Employer Identification Number (EIN). The EN
is a nine-digit number issued by the IRS, with digits arranged as follows: xx-xxxxxxx. The EN
identifies tax accounts of employers and certain entities without employees. Use your EN on all items
you send to the IRS or SSA.

If an organization does not have an EIN, it must request one by completing Form SS-4, Application for
Employer Identification Number. Form SS-4 has information on how to apply for an EN by mail or by
telephone. An organization now may also apply for an EN online at:
http://www,irs.gov/businesses/small/article/0,,id=102767,00.html. Upon submitting the online
application, an EIN will be immediately issued to the organization. A copy of the EIN will also be
mailed to the organization at the address listed in the application.


Federal Forms Completed by Employees

The following forms are completed by employees and retained by employers:

       Form 1-9, Employment Eligibility Verification

       Form W-4, Employee’s Withholding Allowance Certificate

       Form W-5, Earned Income Credit Advance Payment Certificate




                                  Chapter 6 – Employment Issues
                                             Page 6-5
EMPLOYMENT ISSUES, Continued

Form 1-9, Employment Eligibility Verification

The federal Immigration and Nationality Act (8 U.S. Code section 1356 et seq.) requires employers to
verify that all persons they hire are legally authorized to work in the United States. The law prohibits
employers from knowingly hiring or employing persons not authorized to work in the United States.
This law applies to all employers, regardless of how many employees they have and to all individuals
hired after November 6, 1986. Form 1-9 is used to verify employment. This form is available from the
United States Citizenship and Immigration Services (USCIS).

If you are an employer, the law requires you to ensure that every employee completes Section 1 of
Form 1-9 at the beginning of employment. New employees must also properly complete Section 2 of
the form within three days of hire. This law requires you to review documents establishing the
employee’s identity and work eligibility. The documents that satisfy the verification requirements are
listed on Form 1-9.

To minimize discrimination charges, you should make hiring decisions irrespective of applicants’
national origin or citizenship status when they are authorized to work in the United States. Questions
like “What is your national origin?” and “Are you a United States citizen?” may be considered
discriminatory.

You can, however, ask whether an applicant is legally authorized to work in this country.

The USCIS provides detailed information on requirements of this law in their Handbook for
Employers, Publication M-274. This material may be obtained via the Citizenship and Immigration
Services’ website at:

http://uscis.gov/graphics/lawsregs/handbook/hnmanual.htm.




                                    Chapter 6 – Employment Issues
                                                Page 6-6
EMPLOYMENT ISSUES, Continued
Form W-4. Employee’s Withholding Allowance Certificate

All new employees should complete Form WA when they start work, and the Form should be effective
with the first pay date. Form WA guides an employer in determining the proper withholding rate for
each employee. If a new employee does not provide a completed Form WA, single status with zero
withholding allowances should be assumed.

A Form W-4 remains in effect until the employee submits a new one. However, employees who claim
exemption from withholding must complete a new Form WA each year by February 15. For the
effective date of a replacement Form W-4, see IRS Publication 15, Circular E, Employer’s Tax Guide.

Copies of Forms WA must be sent to the IRS if the employee:

       Claims more than 10 withholding allowances or

       Claims an exemption from withholding and his or her wages would normally exceed $200 per
        week

Copies of Forms WA received during the quarter from employees still employed at the end of that
quarter can be sent to the IRS with the quarterly Form 941 filing (see below). Employers must
complete boxes 8 and 10 on any Form W-4 sent to the IRS. For further information about Form WA
see Publication 15.


Form W-5, Earned Income Credit Advance Payment Certificate

Employees who are eligible for the Earned Income Credit (EIC) and who have a qualifying child living
with them may receive advance EIC payments with their pay during the year. Employees who want to
get advance EIC payments must provide a completed Form W-5, Earned Income Credit Advance
Payment Certificate. Form W-5 shows eligibility requirements for advance EIC payments.

An organization that uses independent contractors will need to file:

       Form W-9, Request for Taxpayer Identification Number and Certification

       Form 1099-MISC, Miscellaneous Income




                                   Chapter 6 – Employment Issues
                                              Page 6-7
EMPLOYMENT ISSUES, Continued

Form W-9, Request for Taxpayer Identification Number and Certification

Use Form W-9, Request for Taxpayer Identification Number and Cert~fi cation, to request the
taxpayer identification number (T1N) from a U.S. person (including a resident alien), partnership, or
corporation, and to request certain certifications and claims for exemption. You should retain this form
permanently. Do not send it to the IRS.


Reporting Non-Employee Payments on Form 1099-MISC

Use Form 1099-MISC, Miscellaneous Income, to report fees, salaries, commissions, wages, prizes,
awards, or other forms of compensation for services rendered for your trade or business as non-
employee compensation to an individual who is not an employee.

Payments:

     For services rendered in a trade or business, including govermuent agencies and nonprofit
       organizations

     To a payee who is not a corporation (exceptions below), and

     Totaling $600 or more to the payee during the year (total payments include payments for parts
      or materials used by the payee in rendering services)

must generally be reported as non-employee compensation on Form 1099-MISC.

If the payment is to a corporation, see the instructions for Form 1099. Reporting is now required for
payments for health care services and to attorneys, regardless of incorporation.

Forms 1099-MISC must be provided to payees by January31 and filed with the IRS by February 28 for
all payments made in the prior calendar year. Paper Forms 1099-Misc are transmitted to the IRS using
Form 1096, Annual Summary and Transmittal of US. Information Returns.




                                   Chapter 6 – Employment Issues
                                                Page 6-8
EMPLOYMENT ISSUES, Continued
Penalties for Failure to Furnish Form 1099-MISC

Failure to file a correct Form 1099-MISC with the IRS by the due date without reasonable cause can
result in penalties. The penalty applies if organizations:

       Fail to file timely

       Fail to include all information required to be shown on the Form 1099-MISC, or

       Provide incorrect information on the form

The penalty is generally $50 per document unless correction is made within certain time frames.

Failure to provide a correct Form 1099-MISC to the payee without reasonable cause, results in
additional penalties. The penalty applies if organizations:

       Fail to provide the statement to the payee by January 31

       Fail to include all information required to be shown on the statement, or

       Include incorrect information on the statement

The penalty is $50 per statement, regardless of how soon after the due date a correct statement is
furnished, with a maximum of $100,000 per year.




                                    Chapter 6 – Employment Issues
                                               Page 6-9
EMPLOYMENT ISSUES, Continued

Withholding Federal Taxes

The amount of federal income tax to withhold is based on the employee’s WA. See Publication 15 to
determine how much federal income tax to withhold. Social Security and Medicare taxes are levied on
both the employer and the employee. The employer must withhold the employee’s part of the taxes and
must pay a matching amount. The Social Security tax rate is 6.2% for each; a total of 12.4%. For
wages paid in 2004, tax is withheld and paid until the employee’s wages exceed $87,900. The
Medicare tax rate is 1.45 % for each; a total of 2.9%. There is no wage base for Medicare.

Backup Withholding

An organization has a reporting requirement for employees and non-employees who do not provide a
TIN. In this case, the organization must backup withhold. For federal purposes, the backup
withholding rate is 28%. Your state may also require backup withholding. An organization may also
have to backup withhold for other reasons if the IRS asks.

Depositing Federal Taxes

In general, employers deposit federal employment taxes using the Electronic Federal Tax Payment
System (EFTPS) or by mailing or delivering a check, money order, or cash to an authorized financial
institution. Some employers are required to use EFTPS, however.

Filing Federal Employment Tax Returns

The following are some employment returns or forms that are required of most organizations:

      Form 940, Federal Unemployment (FUTA) Tax Return

    Form 941, Employer’s Quarterly Federal Tax Return

    Form 945, Annual Return of Withheld Federal Income Tax

    Form W-2, Wage and Tax Statement

    Form W-3, Transmittal of Wage and Tax Statements

    Form 5500, Annual Return/Report of Employee Benefit Plan




                                  Chapter 6 – Employment Issues
                                            Page 6-10
EMPLOYMENT ISSUES, Continued
Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax

The Federal Unemployment Tax Act (FUTA), along with state unemployment systems, provides for
payments of unemployment compensation to workers who have lost their jobs. While FUTA does not
apply to the wages of employees of section 501(c)(3) organizations (i.e., charitable organizations)
wages paid by other tax-exempt organizations are subject to FUTA.

NOTE: Only the employer pays FUTA tax; it is not deducted from employees’ wages.

Most employers pay both federal and state unemployment tax. Use Form 940 or Form 940-EZ, if
eligible, to report federal unemployment tax. The return is due on January 31 for wages paid in the
prior calendar year.

The FUTA tax only applies to the first $7,000 paid to each employee during a calendar year. Wages
are generally subject to FUTA tax if the employee earns $50 or more in a calendar quarter.


Form 941, Employer’s Quarterly Federal Tax Return

Generally, entities subject to income tax withholding or social security and Medicare taxes must file
Form 941, Employer’s Quarterly Federal Tax Return. The following are exceptions:

     Seasonal businesses, like skiing resorts, do not have to file for the quarters they are regularly
      closed. To alert the IRS, check the “Seasonal Employer” box above line 1 on Form 941.
      Businesses that hire seasonal employees, but remain open during the off-season, must still file
      quarterly.

    Agricultural employers use Form 943, Employer’s Annual Tax Return for Agricultural
     Employees.

    Income tax withholding on non-payroll items and backup withholding must be reported on Form
     945, Annual Return of Withheld Income Tax.

The due dates for Form 941 are on or before April 30, July 31, October 31, and January 31 after the
end of the quarter in which the tax liability arose.




                                   Chapter 6 – Employment Issues
                                             Page 6-11
EMPLOYMENT ISSUES, Continued

Form 945, Annual Return of Withheld Federal Income Tax

Federal backup withholding amounts are reported annually on IRS Form 945, Annual Return of
Withheld Federal Income Tax. Check with your state’s tax department for details on state withholding
and reporting requirements.

Form 945 is due by January 31 following the calendar year in which the reportable payments were
made.


Form 940, Form 941, and Form 945 Penalties

There are penalties for:

     Late deposits

     Insufficient deposits

     Failure to deposit using EFTPS (when required)

     Late filing, unless you can show reasonable cause. If you file late, attach an explanation to the
      return.

There are also penalties for willful failure to pay tax, file returns, and for filing false or fraudulent
returns.


Form W-2, Wage and Tax Statement

Use Form W-2 to report employees’ annual earnings. From these reports the SSA computes
employees’ benefits at the time of retirement or disability or their family’s survivor benefits at death.
Earnings are also used to determine eligibility for Medicare. The IRS uses the reports to enforce
income tax laws and to ensure that the FICA taxes you pay are properly credited to both programs.

Form W-2 is used to report any wages and tips paid, income tax withholding, social security and/or
Medicare tax withholding, and any advance EIC payments for a calendar year. It also reports whether
or not an employee is covered by a pension plan or receives other fringe benefits.


                                                                 Continued on next page


                                      Chapter 6 – Employment Issues
                                                Page 6-12
EMPLOYMENT ISSUES, Continued

Form W-2, Wage and Tax Statement (continued)

Unlike Form 1099-MISC, there is no dollar threshold for filing a Form W-2. Every employer engaged
in a trade or business, who pays wages for services performed by an employee, must furnish a Form
W-2 to that employee. An employer must prepare a Form W-2 for each employee from whose wages it
has withheld federal income tax, social security, or Medicare taxes. If federal income tax would have
been withheld but for a Form W-4 filed by the employee indicating zero withholding, the employer
must still provide a W-2.

The employer must send the appropriate copies to the employee by January 31 and to the SSA by
February 28 for the prior calendar year or within 30 days of going out of business. Form W-3,
Transmittal of Income and Tax Statements, must accompany the copies to the SSA.

Penalties for Failure to Furnish Form W-2

Failure to file a correct Form W-2 with the IRS by the due date without reasonable cause can result in
penalties. The penalty applies if organizations:

      Fail to file timely

      Fail to include all information required to be shown on a return

      Include incorrect information on the return

The penalty is generally $50 per document unless correction is made within certain time frames.

Failure to provide a correct Form W-2 to the payee by the due date without reasonable cause can result
in penalties. The penalty applies if organizations:

     Fail to provide the statement by January 31

      Fail to include all information required to be shown on the statement, or

     Include incorrect information on the statement

The penalty is $50 per statement, regardless of when correct statement is furnished, with a maximum
of $100,000 per year.




                                   Chapter 6 – Employment Issues
                                             Page 6-13
EMPLOYMENT ISSUES, Continued


Form 5500, Annual Return/Report of Employee Benefit Plan

Any administrator or sponsor of an employee benefit plan subject to the Employee Retirement Income
Security Act (ERISA) must annually file information about each the plan. Generally, every employer
maintaining a specified fringe benefit plan must also file annually. The IRS, Department of Labor
(DOL), and Pension Benefit Guaranty Corporation (PBGC) have consolidated their returns and report
forms to minimize the filing burden for plan administrators and employers.

File all required forms and schedules by the last day of the 7th month after the end of the plan year. For
a calendar year plan the due date would be July 31.


Form 5500 Penalties

A penalty of $25 a day (up to $15,000) may be assessed for not filing returns for certain plans of
deferred compensation, certain trusts and annuities, and bond purchase plans by the due date(s).

In addition, ERISA and the Code provide for assessing or imposing penalties for not giving complete
information and not filing statements and return/reports. Certain penalties are administrative (i.e. they
may be assessed by one of the governmental agencies delegated to administer the collection of Form
5500 series data). Others require a legal conviction.


Records to Retain About Employees

It is important to keep accurate and complete records for income tax, Social Security and Medicare
taxes, and Federal Unemployment (FUTA) Tax paid for each employee.
Examples of the types of records that should be kept are identified below. These records should be kept
for four years.




                                    Chapter 6 – Employment Issues
                                              Page 6-14
EMPLOYMENT ISSUES, Continued
Income Tax Records

1.   Each employee’s name, address, and Social Security number.

2.   The total amount and date of each wage payment and the period of time the payment covers.

3.   For each wage payment, the amounts subject to withholding.

4.   The amount of withholding tax collected on each payment and the date collected.

5.   If the taxable amount is less than the total payment, the reason.

6.   Copies of any statements furnished by employees relating to nonresident alien status, residence in
     Puerto Rico or the Virgin Islands, or residence or physical presence in a foreign country.

7.   The fair market value and date of each payment of noncash compensation.

8.   For accident or health plans, information about the amount of each payment.

9.   The withholding allowance certificates (Forms WA) filed by each employee.

10. Any agreement between you and the employee on Form WA for voluntary withholding of
    additional amounts of tax.

11. If necessary to figure tax liability, the dates in each calendar quarter on which any employee
    worked for you, but not in the course of your trade or business, and the amount paid for that work.

12. Copies of employee statements employees give you reporting tips received in their work, unless
    the information shown on the statements is in another item on this list.

13. Requests by employees to have their withheld tax figured based on their individual cumulative
    wages and any notice that such a request was revoked.

14. Forms W-5, Earned Income Credit Advance Payment Certificate, and the amounts and dates of the
    advance payments.




                                    Chapter 6 – Employment Issues
                                              Page 6-15
EMPLOYMENT ISSUES, Continued

Social Security and Medicare Taxes Records

1. The amount of each wage payment subject to Social Security tax.

2. The amount of each wage payment subject to Medicare tax.

3. The amount of Social Security and Medicare taxes collected for each payment and the date
   collected.

4. If the total wage payment and the taxable amount differ, the reason.


Federal Unemployment (FLITA) Tax Records

1. The total amount paid to your employees during the calendar year.

2. The amount of compensation subject to the unemployment tax and, if it differs from total
   compensation, why.

3. The amount you paid into the state unemployment fund.

4. Any other information required to be shown on Form 940 (or Form
   940-EZ).


Other Federal Agencies

Other federal agencies regulate employment issues. For more information contact them at:

Social Security Administration (SSA)
Telephone: 1-800-772-1213
Website:     www.ssa.gov

U. S. Department of Labor (DOL)
Telephone: 1 -866-4-USA-DOL
Website:    www.do.gov

U.S. Citizenship and Immigration Services
Telephone: 1-800-375-5283
Website:     wxvw.uscis.gov


                                   Chapter 6 – Employment Issues
                                             Page 6-16
EMPLOYMENT ISSUES, Continued
For More Information

Publication 15, Circular E – Employer’s Tax Guide
Publication 15A, Employer’s Supplemental Tax Guide
Publication 505, Tax Withholding and Estimated Tax
Publication 509, Tax Calendars
Publication 531, Reporting Tip Income
Publication 919, How Do I Adjust My Tax Withholding?
Publication 966, Now a Full Range of Electronic Choices to Pay All Your Federal Taxes
Publication 1244, Employee’s Daily Record and Report of Tips to Employer
Publication 1779, Independent Contractor or Employee
Publication 3144, Tips on Tips: A Guide to Tip Income Reporting for Employer
Publication 3148, Tips on Tips: A Guide to Tip Income Reporting for Employees
Form SS-4, Application for Employer Identification Number
Form SS-8, Information for Use in Determining Whether a Worker Is an Employee for Federal
           Employment Taxes and Income Tax Withholding
Form W-2, Wage and Tax Statement
Form W-3, Transmittal of Wage and Tax Statements
Form W-4, Employee’s Withholding Allowance Certificate
Form W-5, Earned Income Credit Advance Payment Certificate
Form W-9, Request for Taxpayer Identification Number and Cert~/ication
Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Form 940-EZ, Employer’s Annual Federal Unemployment (FUTA) Tax Return
Form 941, Employer’s Quarterly Federal Tax Return
Form 945, Annual Return of Withheld Federal Income Tax
Form 1096, Annual Summary and Transmittal of US Information Returns
Form 1099-MISC, Statement for Recipients of Miscellaneous Income
You may order Forms and Publications by calling toll free (800) 829-3676 or
      by downloading them from the IRS website at: www.irs.gov.
                                  Chapter 6 – Employment Issues
                                            Page 6-17
                                                                                    Exhibit D (p. 1 of 3)

                                    Employment Issues Quiz    -




These organizations are fictitious and are used only for learning purposes. Information in these
samples may not be cited as law.

1. ABC Foundation placed the following advertisement in the newspaper.

      A friendly individual who enjoys working with people is needed to answer a multi-line
      telephone, greet visitors when they come in the door, make coffee, and perform various other
      tasks when time perm its. This qualified individual must be able to work from 8:00 a.m. 5.00
                                                                                                —


      p.m. The position pays $10.00 an hour.

  Would this person be an employee or independent contractor?


2. DEF Country Club, Inc. is looking for an experienced accountant who specializes in working with
   tax-exempt organizations. The accountant must be able to prepare a compilation of the financial
   statements on a monthly basis, present these statements to the board of directors at the monthly
   meetings, perform the annual gambling audit, and prepare the 990 and 990-T returns at the end of
   the year by the due date.

Would this person be an employee or independent contractor?


3. The president of ABC Foundation manages the day-to-day activities of the organization, supervises
   managers who supervise the employees, signs the organization’s checks, presides over monthly
   board meetings, and performs other tasks as necessary to ensure the successful operation of the
   organization.

Would this person be an employee or independent contractor?


4. GHI Private School for the Gifted hired a janitor to clean up the school after hours. The janitor
   must provide all necessary equipment and supplies. He may come in and clean anytime that school
   is not in session but must come in at least three times per week. The janitor is provided a key to the
   school. The school is billed monthly for the services of the janitor: The janitor has several other
   clients.

Would this person be an employee or independent contractor?



                                    Chapter 6 – Employment Issues
                                              Page 6-19
                                                                                  Exhibit D (p. 2 of 3)
Employment Issues Quiz, Continued
                      —




5.    JKL Youth Bowling League was sued as a result of a youth dropping a bowling ball on a
      spectator’s foot. The spectator, Mr. Jackson, filed suit in district court and is suing for
      $250,000. JKL Youth Bowling League contracts with a local attorney who specializes in this
      type of lawsuit. The attorney charges $250 per hour.

     Would this person be an employee or independent contractor?


6.    The MNO Little League organization hired coaches selected by the League’s officers. The
      board sets the times and places for all the games. The coaches are fathers or mothers of the
      children who play on the team. The organization has established policies and procedures that
      coaches are required to follow. Generally, the officers do not interfere with the coaching
      unless there is a problem. The coaches receive $500 per season.

     Would these coaches be employees or independent contractors?


7.   PQR Theatre places the following advertisement in the newspaper.

          Needed: ushers, ticket takers, and ticket sellers. Hourly rate is negotiable based on
          experience and reliability.

     Would these workers be employees or independent contractors?


8.   A salaried golf professional and his assistants manage the pro shop of a country club. In
     addition, the club requires them to give lessons to the club’s members at its established rates.

     Would these persons be employees or independent contractors?


9.   A golf professional sells lessons and equipment on the premises of a golf club. She sets prices,
     makes appointments, and carries on her activities with permission of the club, but without
     orders or instructions from club members or officials.

     Would this person be an employee or independent contractor?




                                 Chapter 6 – Employment Issues
                                           Page 6-20
                                                                                     Exhibit D (p. 3 of 3)

Employment Issues Quiz, Continued
                        —




10.    The STU Foundation hires van drivers to transport physically disabled individuals to their
       doctors’ appointments. The STh Foundation owns the vans, pays the insurance and all other
       related expenses for the vans, and only uses the vans for this purpose. The van drivers are not
       allowed to take side trips. Their purpose is solely to transport physically disabled individuals to
       their doctor’s appointments.

       Would these persons be employees or independent contractors?



11.    The STU Foundation hires van drivers to transport physically disabled individuals to their
       doctors’ appointments. The drivers own their own vans and pay for the gas, insurance and
       maintenance. The drivers charge $1.00 per mile and are willing to stop anywhere.

       Would this person be an employee or independent contractor?



12.   XYZ Anonymous engages in charitable gambling. It hired a gambling manager who supervises
       employees conducting the pull tab games, prepares the monthly reports, audits the games,
       makes the deposits, and reports at the monthly meetings.

       Would this person be an employee or independent contractor?




                                   Chapter 6 – Employment Issues
                                             Page 6-21
                                            Chapter 7

                                    RECORDKEEP1NG

Importance of Recordkeeping

In general, an organization must keep books and records to show that it complies with tax rules. The
organization must be able to document the sources of receipts and expenditures reported on Form 990,
Return of Organization Exempt From Income Tax.

If an organization does not keep required records, it may be unable to show that it qualifies for
exemption. Thus, the organization may lose its tax-exempt status. In addition, an organization may be
unable to complete its returns accurately and may be subject to penalties. A good recordkeeping
system will also enable an organization to monitor the progress of programs and aid in the preparation
of financial statements and returns.

Monitor Programs: Records can show whether programs are improving, which programs are
successful, and what changes an organization may need to make. Good records management may be a
contributing factor to the success of a program.

Prepare Financial Statements: It is important to maintain revenue and expense statements and balance
sheets to prepare accurate financial statements. These statements can help an organization when
working with banks, creditors, and contributors and funding organizations.

Prepare Annual Returns and Tax Returns: Records must support income, expenses, and credits
reported on Form 990 series and other tax returns. Generally, these are the same records used to
monitor programs and prepare financial statements. Also, books and records of exempt organizations
must be available for inspection by the IRS. If the IRS examines an organization’s returns, the
organization may be asked to explain items reported. A complete set of records will speed up the
examination.

Identify Sources of Receipts: Organizations may receive money or property from many sources.
Records can identify the sources of receipts. Organizations need this information to separate program
from non-program receipts, taxable from non-taxable income, and to complete Schedule A of Form
990. Organizations that check box 10, 11, or 12, Part IV, of Schedule A, must keep records that show
how much support they receive from specific contributors.




                                                                             Continued on next page




                                      Chapter 7 – Recordkeeping
                                              Page 7-1
RECORDKEEPING, Continued

Importance of Recordkeeping (continued)

Comply with Racial Nondiscrimination Requirements (Private Schools): Private schools must keep
records that show that they have complied with requirements relating to racial nondiscrimination. For
more information, see Part V, Schedule A of Form 990, Supplementary Information - Organization
Exempt Under Section 501(c)(3).

Record Deductible Expenses for UBIT Purposes: An organization may overlook deductible expenses
when it prepares its unrelated business income tax (UBIT) return (Form 990-T, Exempt Organization
Income Tax Return) unless it records the expenses when they occur.


Legal Authority for Recordkeeping

Section 1.6001 -1 of the Income Tax Regulations requires an exempt organization to keep books and
records sufficient to show specific items of gross income, receipts, and disbursements and to
substantiate the information required by section 6033 of the IZRC requiring the filing of Form 990.


What Records Should be Kept?

Except in a few cases, the law does not require a special kind of record. An organization can choose
any recordkeeping system, suited to its activities, that clearly shows the organization’s income and
expenses. The type of activities an organization conducts affects the type of records necessary to keep
for federal tax purposes. An organization should set up a recordkeeping system using an accounting
method that clearly shows its income for the tax year. If an organization has more than one program,
the organization should keep a complete and separate set of records for each program.

A recordkeeping system should generally include a summary of transactions. This summary is
ordinarily written in an organization’s books (for example, accounting journals and ledgers). The
books must show gross receipts and functional expenses, as well as deductions and credits. For most
small organizations, the checkbook is the main source for entries in the books. In addition, an
organization must keep documentation that supports entries in the books.




                                      Chapter 7 – Recordkeeping
                                              Page 7-2
RECORDKEEPING, Continued

Supporting Documents

Organization transactions such as contributions, purchases, sales, and payroll will generate supporting
documents. These documents - grant applications and awards, sales slips, paid bills, invoices, receipts,
deposit slips, and canceled checks contain information to be recorded in accounting records. It is
                                   —


important to keep these documents because they support the entries in books and the entries on tax and
information returns. Organizations should keep them in an orderly fashion and in a safe place. For
instance, organize them by year and type of receipt or expense.


Types of Records to Maintain

Gross Receipts: Gross receipts are the amounts received from all sources. An organization must keep
supporting documents that show the amounts and sources of its gross receipts. Documents that show
gross receipts include: cash register tapes, bank deposit slips, receipt books, invoices, credit card
charge slips, and Form 1099 - MISC, Miscellaneous lncome.

Purchases. Including Accounting For Inventory: Purchases are items bought, including any items
resold to customers. If an organization produces items, it must account for any items resold to
customers. Thus, for example, it must account for the cost of all raw materials or parts purchased for
manufacturing into finished products. Supporting documents should show the amount paid, and that
the amount was for purchases. Documents for purchases include:
canceled checks, cash register tape receipts, credit card sales slips, and invoices. These records will
help an organization determine the value of its inventory at the end of the year. See Publication 538,
Accounting Periods and Methods, for general information on methods for valuing inventory.

Expenses: Expenses are the costs an organization incurs (other than purchases) to carry on its
program. Supporting documents should show the amount paid and the purpose of the expense.
Documents for expenses include: canceled checks, cash register tapes, account statements, credit card
sales slips, invoices, and petty-cash slips for small cash payments.

Employment Taxes: Organizations that have employees must keep specific employment tax records.
See Publication 15, Circular E, Employer’s Tax Guide, for details.



                                                                                   Continued on next page




                                       Chapter 7 – Recordkeeping
                                               Page 7-3
RECORDKEEPING, Continued
Types of Records to Maintain (continued)

Assets: Assets are the property, such as investments, buildings, and furniture that an organization owns
and uses in its activities. An organization must keep records to verify certain information about its
assets. Records should show:

      When and how the asset was acquired
      Whether any debt was used to acquire the asset
      Purchase price
      Cost of any improvements
      Deductions taken for depreciation, if any
      Deductions taken for casualty losses, if any, such as losses resulting from fires or storms
      How the asset was used
      When and how the asset was disposed of
      Selling price
      Expenses of sale

Documents that may show the above information include: purchase and sales invoices, real estate
closing statements, canceled checks, and financing documents. If an organization does not have
canceled checks, it may be able to show payment with certain financial account statements prepared by
financial institutions. These include account statements prepared for the financial institution by a third
party. Account statements must be highly legible.

The following defines acceptable account statements:

   IF payment is by:                  THEN statement must show:
check                         check number, amount, payee’s name, and date the check amount was
                              posted to the account by the financial institution
electronic funds transfer     amount transferred, payee’s name, and date the transfer was posted to
                              the account by the financial institution
credit card                   amount charged, payee’s name, and transaction date




                                       Chapter 7 – Recordkeeping
                                               Page 7-4
RECORDKEEPING, Continued

How Long Should You Keep Records?

Exempt organizations must keep records as long as they may be needed to administer provisions of the
Internal Revenue Code. Generally, this means you must keep records that support an item of income or
deduction on a return until the statute of limitations for that return runs out. The statute of limitations is
the period of time in which an organization can amend its return to claim a credit or refund, or the IRS
can assess additional tax. The most common limitations period is three years after the date the return is
due or filed, whichever is later.


Records and Timeframe Periods

Timeframes for keeping records vary depending on the types of records and returns.

Permanent Records: Some records should be kept permanently. These include the application for
recognition of exempt status, the determination letter recognizing exempt status, and organizing
documents, such as articles of incorporation and by-laws, with amendments.

Employment Tax Records: If an organization has employees, it must keep employment tax records for
at least four years after the date the tax becomes due or is paid, whichever is later.

Records for Non-Tax Purooses: When records are no longer needed for tax purposes, an organization
should keep them until they are no longer needed for non-tax purposes. For example, a grantor,
insurance company, creditor, or state agency may require that records be kept longer than the IRS
requires.




                                        Chapter 7 – Recordkeeping
                                                Page 7-5
RECORDKEEPING, Continued

Accounting Timeframe Periods and Methods

Organizations must keep books, report, and file returns based on an annual accounting period called a
tax year.

Accounting Periods: A tax year is usually 12 consecutive months. There are two kinds of tax years:
    Calendar tax year: This is a period of 12 consecutive months beginning January 1 and ending
      December 31.

      Fiscal tax year: This is a period of 12 consecutive months ending on the last day of any month
       except December.

Accounting Methods: An accounting method is a set of rules used to determine when and how income
and expenses are reported. An organization chooses an accounting method when it files its first annual
return. There are two basic accounting methods:

      Cash method - Under the cash method, an organization reports income in the tax year
       received. It usually deducts expenses in the year paid.

     Accrual method - Under an accrual method, an organization generally records income in the
      tax year earned, even though it may receive payment in a later year. It records expenses in the
      tax year incurred, whether or not it pays the expenses that year.

For more information about accounting periods and methods, see Publication 538 and the instructions
to Forms 990, 990-EZ, and 990-PF.


For More Information

Publication 583, Starting a Business and Keeping Records

Publication 4221, Compliance Guide for 501(c)(3) Tax-Exempt Organizations



You may order Forms and Publications by calling toll free (800) 829 - 3676 or
          by downloading them from the IRS website at: www.irs.gov.




                                     Chapter 7 – Recordkeeping
                                               Page 7-6
                                            Chapter 8

                                            FORM 990


Overview
The Form 990 series of returns are unique for three key reasons. First, tax-exempt organizations, by
definition, do not generally pay income taxes. The primary purpose of their filing requirements is not
to report taxes but to provide information on their programs and activities. This information verifies
that organizations are operating in accordance with their stated tax-exempt purpose and are not
violating the rules and regulations governing their tax-exempt status.

Secondly, the returns are unique because tax-exempt organizations are required, by Internal Revenue
Code section 6104, to make their information returns widely available for public inspection. This
means that organizations must allow members of the public to inspect Forms 990-EZ, 990 and 990-PF
filed with the IRS. Exempt organizations are also required to provide copies of the returns when
requested or make them available on the Internet.

Finally, exempt organization returns are unique because they are multi-jurisdictional forms, with
nearly forty states using the IRS forms to satisfy their filing requirements.

This chapter discusses the Form 990, Return of Organization Exempt From Income Tax, and 990-EZ,
Short Form Return of Organization Exempt From Income Tax, filing requirements for 501(c)(3) public
charities. A discussion of Schedule A and Schedule B is also included since a 501(c)(3) organization
must attach these to its Form 990 or 990-EZ. Form 990-T, Exempt Organizations Business Income Tax
Return, was discussed in Chapter 4. Discussion of Form 990-PF, Return of Private Foundation, is
beyond the scope of this workshop.




                                        Chapter 8 – Form 990
                                             Page 8 - 1
FORM 990, Continued
Who Must File

An organization exempt from Federal income tax under section 50 1(a) must file an annual information
return if it has gross receipts greater than $25,000.

The following organizations are not required to file:

             Organizations with gross receipts less than $25,000

             Churches and certain related organizations

             State institutions whose income is excluded from gross income under code section 115 and
              certain other government-affiliated organizations

             Pension, profit sharing, and stock bonus trusts under section 401 (These entities report
              using Form 5500, Annual Return/Report of Employee Benefit Plan)


What to File
An organization may file Form 990-EZ if it meets both of the following requirements.

        1. Its gross receipts during the year were less than $100,000 and

        2.    Its total assets at the end of the year were less than $250,000.

An organization with gross receipts greater than or equal to $100,000 or total assets greater than or
equal to $250,000 must file Form 990.

An organization’s gross receipts are the total amount it received from all sources during its annual
accounting period, without subtracting any costs or expenses.

An organization’s gross receipts are normally to be $25,000 or less if the organization is:

           Up to a year old and has received, or donors have pledged to give, $37,500 or less during its
            first year

           Between 1 and 3 years old and averaged $30,000 or less in gross receipts during each of its
            first 2 tax years, or

           Three years old or more and averaged $25,000 or less in gross receipts. for the immediately
            preceding 3 tax years (including the year for which the return would be filed)


                                            Chapter 8 – Form 990
                                                 Page 8 – 2
FORM 990, Continued

When to File

File Form 990, or Form 990-EZ, by the 15th day of the 5th month after the organization’s accounting
period ends. For example, May 15 would be the due date for an organization with a December 31st
year-end.


Extension of Time to File

Use Form 8868, Application for Extension of Time to File an Exempt Organizations Return, to request
an extension of time to file Form 990 or Form 990-EZ. Generally, the Internal Revenue Service will
not grant an extension of time for more than 90 days. If more time is needed, file a second Form 8868
for an additional 90-day extension. This will be granted only in cases of undue hardship. In no event
will an extension of more than six months be granted to any domestic organization.


Penalties for Late Filing or Failure to File 990 or 990 – EZ Returns

Against the Organization: A penalty of $20 a day, not to exceed the lesser of $10,000 or 5% of the
organization’s gross receipts for the year, may be charged when a return is filed late, unless the
organization shows that the late filing was due to reasonable cause.

Organizations with annual gross receipts exceeding $1 million are subject to a penalty of $100 for each
day the failure continues (with a maximum penalty with respect to any one return of $50,000). The
penalty begins on the due date for filing the Form 990 or Form 990-EZ.

The penalty may also be imposed if the organization files an incomplete return or furnishes incorrect
information.

Against Responsible Person(s): If the organization does not file a complete return or does not furnish
correct information, the IRS will send the organization a letter that includes a fixed time to fulfill these
requirements. After this period expires, the responsible person failing to comply will be charged a
penalty of $10 a day, not to exceed $5,000, unless he or she shows that not complying was due to
reasonable cause. If more than one person is responsible, they are jointly and individually liable for the
penalty.

There are also penalties, fines, and/or imprisonment for willfully not filing returns and for filing
fraudulent returns and statements.




                                          Chapter 8 – Form 990
                                                Page 8-3
FORM 990, Continued

Understanding Form 990

The following sections explain the information requested on various parts of Form 990 and highlights
the most common errors made by exempt organizations in preparing this Form. Because all 990-EZ
items are also requested on Form 990, a separate discussion of Form 990-EZ is not included here.

FACT. 36.1% of Forms 990 and 5 1.7% of Forms 990-EZ are filed in error. Be sure to:

   1. Attach Schedule A when required

   2. Complete all applicable parts and lines

   3. Answer “Yes,” “No,” or “N/A” to each question

   4. Make an entry on all total lines (including zero when appropriate), and

   5. Enter “None” or “N/A” if an entire Part does not apply

Box K

An organization with gross receipts less than $25,000 is not required to file an annual information
return. If an organization meeting this exception receives a Form 990 Package in the mail, it should:

   1. Complete the name and address section

   2. Mark Box K indicating its gross receipts are below $25,000

   3. Sign

   4. Date, and

   5. Mail the return to the IRS




                                        Chapter 8 – Form 990
                                              Page 8-4
FORM 990, Continued

Form 990 Part I - Revenue

Part I - Revenue (lines 1 through 12)

This section requires a detailed reporting of an organization’s revenues.

A common area of confusion is the reporting of contributions. Amounts received as voluntary
contributions are normally reported on Lines 1a through 1c. Revenue generated by special fundraising
activities is reported on Lines 9a through 9c.

When an organization hires a professional fundraiser, it should report, in line la, the entire amount of a
gift solicited in its name by the fundraiser.

Fundraising expenses are not subtracted. Thus, even though the organization receives only the net
amount, it must report the entire amount collected.

Special fundraising activities such as dinners, door-to-door sales of merchandise, carnivals, or bingo
games can produce BOTH contributions and special fundraising revenue.

Example: An organization exempt under section 501(c)(3) conducts a fundraising campaign in which
a donor can choose to receive a book valued at $25 for a contribution of $100. The amount of the book,
$25, should be reported on Line 9a as revenue from a special fundraising event. The remaining $75 of
the total amount received is deemed a charitable contribution. This amount ($75) should be reported on
Line la and again on Line 9a, between the parentheses.



                                                                                Continued on next page




                                         Chapter 8 – Form 990
                                               Page 8-5
FORM 990, Continued
Form 990 Part l Revenue (continued)

Another area of confusion is distinguishing between dues (reported on line 3) and contributions
(reported on line la). Dues and assessments received that compare reasonably with membership
benefits available are reported on line 3. Such benefits can include subscriptions to publications or
discounts on goods or services, but do not include intangible benefits, such as the right to vote or hold
office. However, if a member pays dues mainly to support an organization’s activities rather than to
obtain benefits of more than nominal monetary value, those dues are properly reported as a
contribution on line la. The same is true of that portion of dues exceeding the value of goods or
services provided in return.

Dues and memberships should also be distinguished from program service revenues (line 2). If an
organization uses “membership fees” as a means of selling admissions, merchandise, services, or the
use of facilities to the general public who have no common goal or interest (other than the desire to
purchase these items), then the income from these fees is not membership fees and should be reported
on line 2. The common sense meaning of the word “member” implies an ongoing relationship between
the individual and the organization, not a discrete transaction.

Another common area of confusion is the reporting of donated services, i.e., volunteer labor, including
donated facilities. Generally Accepted Accounting Principles (GAAP) requires organizations to report
these items on their financial statements. However, they are excluded for 990 reporting purposes.


Part I - Expenses (lines 13 through 17)

This section serves two purposes:

   1. It captures totals from the Part II analysis of expenses and enters it in Part I, and

   2. It provides the filing organization a line to enter payments that are made to affiliates

Line 16 is used to report certain types of payments to closely related organizations. For example, a
local organization might be required to pay a certain percentage of its revenues to its parent
organization. Such payments would be reported on line 16. Pass throughs of dues paid by members are
not reported here, since such payments would not have been reported as income.




                                         Chapter 8 – Form 990
                                               Page 8-6
FORM 990, Continued

Form 990 Part I - Net Assets Part I Net Assets (lines 18 through 21)
                                         —




This section focuses on changes in net assets or fund balances. An organization might have more
expenses than revenues for the year. Line 18 asks for the excess or the deficit (i.e., net income or net
loss). Line 19 asks the filing organization to enter the figure from its balance sheet for the net assets or
fund balances at the beginning of the year. Line 20 asks for other changes (apart from the impact of
revenue and expenses) in net assets or fund balances that may have occurred. An example might be an
adjustment to the asset balance from an earlier year’s activities. The final line reconciles these changes
and shows the net assets or fund balances at the end of the year.


Form 990 Part II Part II - Statement of Functional Expenses (lines 22 through 44)

This section requires a detailed analysis of an organization’s expenditures. The total for each category
(column A) must be allocated among Program Services (column B), Management and general
expenses (column C) and Fundraising expenses (column D).

Example: A soup kitchen employee received a $20,000 annual salary. The employee spends 50% of
his time serving soup, 25% performing management functions, and 25% raising money for the kitchen.
His salary would be reported on Line 26 as follows: $20,000 in column A, $10,000 in column B and
$5,000 each in columns C and D.

Note that expenditures entered on Lines 22 through 24 are 100% allocated to Program services so no
part of them must be allocated to management or fundraising.

TIP: The totals for columns B, C and D are carried over onto Page 1, Lines 13 through 16 respectively.
Therefore, complete this section prior to completing Part I Expenses.
                                                             —




                                          Chapter 8 – Form 990
                                                Page 8-7
FORM 990, Continued

Form 990 Part Ill     Part III- Statement of Pro2ram Service Accomplishments

In this section, an organization must state its primary exempt purpose and then describe its exempt
purpose achievements for its four largest programs, as measured by total expenses incurred by
program. Each statement should include the program’s objective, accomplishments (e.g. number of
people assisted) and related expenses.

TIP: Whereas Part II, column B provides a total of Program Service expenditures by category, this
section requires a total of all categories of expenses by Program. Total Program Service Expenses in
Part III (line f) should equal Program Service Expenses in Part II (Line 44, column B).

Example: An organization operates two key programs: a soup kitchen and a job training center. Its
only expenses are employee wages of $30,000 and occupancy (rent) of $20,000. Both expenses are
allocated 100% to Program Services and equally (50/50) between the two programs. The organization
would report $30,000 on Line 26, Part II (columns A and B) and $20,000 on Line 36 (columns A and
B). In addition, it should list Soup Kitchen on Line a, Part III with $25,000 of Program Service
Expenses and Job Training Center on Line B also with $25,000 of Program Service Expenses.

If part of the total expenses of any program service consists of grants and allocations reported on Line
22 (Part II), these expenses should be included in the total Program Services Expenses for each
program. However, these grants and allocations should also be reported separately by program as
requested on Part B of the form.




                                        Chapter 8 – Form 990
                                              Page 8-8
FORM 990, Continued
Form 990 Part IV

Part IV - Balance Sheet

The balance sheet of an exempt organization is similar to the balance sheet of a for-profit entity with
one major exception. For-profit entities maintain “capital” or “equity” accounts that trace partners’ or
shareholders’ interests in the entity. This is generally irrelevant for 501(c)(3) organizations as
inurement of net earnings to insiders is prohibited and private benefit must be insubstantial.

Another area in which an exempt organization must reveal potential private benefit is with loans to
(line 50) or loans from (line 63) officers, directors, trustees and key employees. Among exempt
organizations, Statement of Financial Accounting Standards 117 (SFAS 117) imposes different
reporting requirements for those organizations that utilize “fund accounting,” which is beyond the
scope of this workshop.


Form 990 Parts IV-A and IV-B

Part IV-A - Reconciliation of Revenue

Part IV-B — Reconciliation of Expenses

An organization may prepare its financial statements in accordance with Generally Accepted
Accounting Principles (GAAP), i.e., it may have a Certified Public Accountant (CPA) issue an opinion
on its financial statements. However, this is not required for Form 990 reporting purposes. This section
reconciles the differences between GAAP and Form 990 reporting requirements.

TIP: If your organization does not have an audited financial statement, enter N/A on line “a” of both
Part TV-A and TV-B.




                                         Chapter 8 – Form 990
                                               Page 8-9
FORM 990, Continued

Form 990 Part V

Part V - List of Officers. Directors Trustees, and Key Employees Part V

Information about officers, directors, trustees and key employees, including their names and addresses
and the amount paid to each of them, is required for all 501(c)(3) organizations by IRC 6033(b)(6) and
(7).

TIP: This generally requires a reporting of all compensation paid, whether or not includible in gross
income of the payee.

TIP: Failure to complete this section as specified can subject both the organization and the
individual(s) responsible for such failure to penalties for filing an incomplete return.


Form 990 Part VI

Part VI - Other Information

The primary purpose of this section is to ascertain, through a series of questions, whether an
organization is participating in activities that can jeopardize its tax-exempt status.


Form 990 Parts VII and VIII

Part VII - Analysis of Income Producing Activities


Part VIII - Relationship of Activities to the Accomplishment of an Exempt Purpose

These two sections are similar to Part III. Whereas Part III requires an explanation of how expenses
relate to an organization’s exempt purpose, Parts VII and VIII require an explanation of how revenues
relate to an organization’s exempt purpose.

Part VII requires revenues to be categorized as Unrelated Business Income subject to tax (columns A
and B), Unrelated Business Income excluded from tax (columns C and D), and Related or Exempt
Function Income (column E). The totals of columns B, D and E must equal total revenues as reported
on Part I, Line 12. In other words, all revenue reported in Part I must be further categorized in Part VII.

An item entered in Column E requires further explanation in Part VIII.


                                         Chapter 8 – Form 990
                                              Page 8-10
FORM 990, Continued

Form 990 Parts IX and X

Part LX — Information Regarding Taxable Subsidiaries and Disregarded Entities

Part X — Information Regarding Transfers Associated with Personal Benefit Contracts

These two sections are not applicable for most Small and Mid-Sized exempt organizations. Please see
the Form 990 instructions for more information.


Signature

An officer of the organization must sign the return. For a corporation or association, this officer may
be the president, vice president, treasurer, assistant treasurer, chief accounting officer, or tax officer.
For a trust, the authorized trustee(s) must sign. A receiver, trustee, or assignee must sign any return he
or she files for a corporation or association.

FACT: - 17.6% of Forms 990 and 4.7% of Forms 990-EZ are filed without any signature or with an
inappropriate signature. This causes a delay in processing, and the organization may be assessed a
penalty for filing an incomplete return.


Schedule A

Section 501(c)(3) organizations, other than private foundations, required to file Form 990 or 990-EZ
must also complete and attach Schedule A (Form 990 or 990-EZ). This schedule requires information
supporting an organization’s public charity status, as well as information on activities that can
jeopardize tax-exempt status.

TIP: Schedule A is only required if a 501(c)(3) organization files a Form 990 or 990-EZ.

TIP: indicate “N/A” for sections or questions not applicable to an organization.




                                          Chapter 8 – Form 990
                                               Page 8-11
FORM 990, Continued


Schedule A: Part I Part II Part III

Part I - Compensation of the Five Highest Paid Employees Other Than Officers. Directors, and
Trustees

Part II - Compensation of the Five Highest Paid Independent Contractors for Professional
Services

Part III - Statements About Activities

All three of these sections attempt to identify’ potential inurement and/or private benefit transactions.
In addition, Question 1, Part III, regarding lobbying activity, identifies whether an organization should
complete Parts VI-A/B.


Schedule A: Parts IV and Part IV-A

Part IV - Reason for Non-Private Foundation Status

Part IV-A - Support Schedule

Part TV requests information similar to information requested on Form 1023, Application for
Recognition of Exemption under Section 501(c)(3) of the Internal Revenue Code. An organization must
indicate that it is not a private foundation because it meets one of the listed exceptions.

Part TV-A requires an organization to support its assertion that it is not a private foundation by
providing information on its sources of support.

See Chapter 2 for more information on private foundation and public charity status.


Schedule A: Part V

Part V - Private School Ouestionnaire

This is only required for organizations claiming public charity status as a school. Private schools are
prohibited from discriminating against students on the basis of race. This questionnaire requires private
schools to provide information supporting their compliance with the rules and regulations governing
non-discrimination.



                                         Chapter 8 – Form 990
                                                Page 8-12
FORM 990, Continued

Schedule A: Part VI - A and Part VI – B

Part VI - A - Lobbving Expenditures by Electing Public Charities

Part VI – B – Lobbying Activity by Nonelecting Public Charities

Section 501(c)(3) organizations participating in lobbying activities must complete either Part VI-A or
Part VI-B. See Chapter 3 for more information.


Schedule A: Part VII

Part VII - Information Regarding Transfers To and Transactions and Relationships with
Noncharitable Exempt Organizations

As discussed in Chapter 2, there are over 30 different code sections under which an organization can
be tax-exempt, including section 501(c)(3). This section requires information on a 501(c)(3)
organization’s dealings with non-501(c)(3) tax-exempt organizations.


Schedule B - Schedule of Contributors

The primary purposes of Schedule B are to:

        Report the names and addresses of the contributors of $5,000 or more (Part I)

        Describe donated noncash property (Part II), and

        Provide information about donations to IRC 501(c)(7), (c)(8) and (c)(l0) organizations (Part
         III)

If an organization does not have to file the Schedule B, they must indicate by checking the box in Item
M of the heading of their Form 990 or Form 990EZ. Failure to either check the box or file Schedule B
will result in a determination that the return is not complete.

Generally, organizations that file the Form 990, Form 990-EZ, or Form 990-PF and receive $5,000 or
more during the year (in money or other property) from any one contributor must file Schedule B,
unless they are subject to certain special rules.




                                        Chapter 8 – Form 990
                                             Page 8-13
FORM 990, Continued

Special Rules

The special rules are:

      IRC 501(c)(3) organizations that meet the 33 1/3% support test only have to complete Schedule
       B if they received the greater of $5,000 or 2% of the organization’s total support for the year
       from any one contributor.

      IRC 501(c)(7), (8), or (10) organizations, where a contributor has given more than $1,000 for
       charitable purposes during the year must complete Schedule B. In this case there is a section of
       the return to complete that does not require the names and addresses of the contributors.

      If an JRC 501(c)(7), (8) or (10) organization did not receive a contribution of more than $1,000
       during the year from any one contributor, it simply checks the special rule box and reports the
       total amount of contributions received.


Contributor

“Contributor” includes individuals, fiduciaries, partnerships, corporations, associations, trusts, and
exempt organizations.

As a general rude, unless the organization is covered by one of the special rules, it must list on Part I
every contributor who, during the year, gave the organization directly or indirectly, money, securities,
or any other type of property totaling $5,000 or more for the year.

It must also complete Part II for a noncash contribution. In determining the $5,000 amount, it totals all
of the contributor’s gifts (cash and noncash) of $1,000 or more for the year.


Public Inspection of Schedule B

Schedule B (Form 990 or 990-EZ) is:

       Open to public inspection for a section 527 political organization

       Open to public inspection for a private foundation beginning with the 2002 filing year

       Generally not open to public inspection for other organizations that must file it

                                         Chapter 8 – Form 990
                                               Page 8-14
FORM 990, Continued

Form 990 E-File

Beginning with the 2004 filing season, tax-exempt organizations will be able to electronically file
Forms 990-EZ and 990. For more information on how to participate, visit http://www.irs.gov/efile and
click on “Charities & Non-profits”.


For More Information

Form 990, Return of Organization Exempt from Income Tax

Form 990-EZ, Short Form Return of Organization Exempt from Income Tax

Instructions for Form 990 or 990-EZ

Schedule A, Supplementary Information — Organizations Exempt Under Section 501(c)(3)

Schedule B, Schedule of Contributors

Instructions for Schedules A and B

Form 8868, Application for Extension of Time to File an Exempt Organizations Return

Rev. Proc. 71-17, 1971-1 C.B. 683 (Jan. 1, 1971)

On the following website is an example of a completed Form 990:

       http://www.irs.gov/pub/irs-utl/sample990.pdf

The following two articles provide more information on Form 990, Schedule A, and Schedule B:

http://www.irs.gov/pub/irs-tege/topicg02.pdf

http://www.irs.gov/pub/irs-tege/eotopich03.pdf


    You may order Forms and Publications by calling toil free (800) 829-3676 or
          by downloading them from the IRS website at: www.irs.gov.



                                       Chapter 8 – Form 990
                                               Page 8-15
                                                                                         Exhibit E (p. 1 of 4)

                               Completing Form 990 Exercises     -




Group Exercise 1: Who Must File, What to File

The Acme Charitable Organization incorporated on January 1, 2003. It applied to the IRS for tax-
exempt status in July, 2003 and received its determination letter from the IRS recognizing it as an
organization described in IRC section 501(c)(3) in October, 2003. IRS also decides to treat Acme
Charitable Organization as a publicly supported organization until December 31,2007, at which time it
will determine whether or not it should continue to be treated as such. Acme Charitable Organization’s
accounting period is the calendar year.

From January to December 31, 2003, Acme Charitable Organization took in a total of $35,000 from
bingo games that it conducted during that period. It paid out $25,000 in winnings to the bingo game
winners. In addition, supporters of Acme Charitable Organization contributed $5,000 to the
organization between June 1 and December 31, 2003. On December 31, 2003, Acme Charitable
Organization’s balance sheet showed $10,000 in assets.

1.   Does Acme Charitable Organization have a filing requirement for 2003? Why or why not?
     If Acme Charitable Organization has a filing requirement for 2003, what form should it
     complete to satisfy this requirement?


In 2004, Acme Charitable Organization decides to discontinue conducting bingo games, so it doesn’t
have any revenue during the year from bingo. It continues to solicit support from the general public,
and it institutes a sliding scale of charges for some of its charitable services, based on a client’s ability
to pay. The total income it receives during 2004 from contributions and program service revenue is
$24,000. At the end of the year, Acme Charitable Organization has $15,000 in assets.

2. Does Acme Charitable Organization have a filling requirement for 2004? Why or why not? If
   Acme Charitable Organization has a filing requirement for 2004, what form should it
   complete to satisfy this requirement?



In 2005, Acme Charitable Organization’s President quits, and as a result, it curtails its charitable
services. Many supporters abandon the organization, and previous clients go elsewhere for services.
Acme takes in only $10,000 for the entire year from a few die-hard supporters and a handful of clients.
At the end of the year, Acme’s has $5,000 in the bank; these are its only assets.

3. Does Acme Charitable Organization have a filing requirement for 2005? Why or why not? If
   Acme Charitable Organization has a filing requirement for 2005, what form should it
   complete to satisfy this requirement?

                                          Chapter 8 – Form 990
                                               Page 8-17
                                                                                    Exhibit E (p. 2 of 4)
Completing Form 990 Exercises (continued)
                        —




Group Exercise 2: Reporting Revenue from Contributions/Special Events; Reporting Fundraising Expenses

In 2003, Acme Charitable Organization conducted a fundraising campaign, telephoning and writing to
its previous supporters and asking for contributions. So that the organization’s small staff could focus
on providing its charitable programs, it hired a professional fundraising firm, Richie’s Revenue
Raisers, to conduct the campaign.

The campaign was successful, with the professional fundraiser, Richie, collecting a total of $100,000
in Acme Charitable Organization’s name. According to the terms of his contract, Richie got to keep 5%
of the total collected as his fee, so when the campaign ended on December 1,2003, Richie wrote a
check for $95,000 to Acme Charitable Organization and presented it to the treasurer.

Contributors to this campaign received nothing for their support except a smile and a thank you. This
campaign was the only fundraising that Acme did in 2003. Acme’s accounting year is the calendar
year.

1.   What amount should Acme Charitable Organization report as revenue from its fundraising
     campaign in Part I of its 2003 Form 990? On what line(s)?

2.   On the Form 990 that Acme files for 2003, should it report the $5,000 that Richie kept as his
     fee for conducting the campaign? If so, where? (Specify the Part(s), Line(s), and Column(s),
     if applicable.)

Since the 2003 project was so successful, Acme decides to rehire Richie’s Revenue Raisers in 2004.
This time the fundraising campaign has an extra twist: In order to entice new supporters, Acme decides
to give a book with a retail value of $25 to contributors who donate $100.

Again, the campaign is successful, with 2,000 contributors each giving exactly $100 and each
receiving the book. $200,000 total raised; $50,000 worth of books distributed. Richie keeps his usual
fee (5% of the total amount raised, or $10,000), and in addition, he pays a book wholesaler $40,000 for
the books sent to the contributors. So, on December 1, 2004, when the campaign ends, he gives
Acme’s treasurer a check for $150,000.

3. What amount should Acme Charitable Organization report as revenue from its fundraising
   campaign in Part I of its 2004 Form 990? On what line(s)?

4. On the Form 990 that Acme files for 2004 should it report the $10,000 that Richie kept as his
   fee for conducting the campaign? If so, where? (Specify the Part(s), Line(s), and Column(s),
   if applicable.)

5. On its 2004 Form 990, should Acme report the $40,000 Richie paid to the book wholesaler? If
   so, where?

                                        Chapter 8 – Form 990
                                             Page 8-18
                                                                                       Exhibit E (p. 3 of 4)

Completing Form 990 Exercises (continued)
                         —




Group Exercise 3: Reporting Expenses by Function; Reporting Program Service Accomplishments

Acme Charitable Organization operates two exempt-purpose programs: a soup kitchen and a job
training center. It rents a building where it operates these two programs, and where it also maintains an
administrative office. Its only expenses are employee wages of $100,000 per year and occupancy costs
(rent, utilities, etc.) of $10,000 per year.

Approximately 10% of the employees’ time is spent equally on management and fundraising duties.
The rest of their time is spent on the soup kitchen and job training programs. Approximately 10% of
the building space is used for the organization’s administrative office. No part of this office is used for
fundraising. The rest of the building houses the soup kitchen and job training center. Each of Acme’s
two exempt-purpose programs utilizes exactly the same amount of resources.

1. In Part II of Form 990, what amounts should be entered in Columns A, B, C and D for Line
   26, Other Salaries and Wages? What amounts should be entered in Columns A, B, C and D
   for Line 36, Occupancy?



                              A               B                     C                     D
                             Total         Program             Management             Fundraising
                                           Services            and General
Line 26, Other
Salaries and Wages
Line 36, Occupancy
Line 44, Total


2. In Part III of Form 990, what information and amounts should be entered on Lines a, b and
   f?




                                         Chapter 8 – Form 990
                                              Page 8-19
                                                                                   Exhibit E (p. 4 of 4)

Completing Form 990 – Exercises (continued)

Group Exercise 4: Reporting Information about loans to officers; Reporting Information about
donated services

In January 2003, Acme Charitable Organization loaned its President and CEO $25,000 to use as a
down payment on a vacation home. The loan is carefully documented, with a written note showing the
purpose of the loan, the original amount and date of the loan, the repayment terms, the amounts and
due dates of payments, the maturity date of the note, and the interest rate.

1. Should this transaction between the organization and an officer be reported on its 2003
   Form 990? If yes, in which Part and on what line(s)?


2. If, on the required attached schedule, the organization showed the interest rate of the loan as
   1.1%, would this raise concern for IRS? If so, why?




In July 2003, employees of Cheryl’s Lawn Services spent a day removing fallen trees and other debris
from the property of Acme Charitable Organization after a tornado passed through. Six employees did
the work for free and used two of Cheryl’s dump trucks to clear the property. Cheryl did not charge for
the use of the dump trucks.

3. Should these donated services and free use of equipment be reported on Form 990? If so,
   where?


4. Does the IRS require that these donated services and free use of equipment be reported on
   Form 990?




                                        Chapter 8 – Form 990
                                             Page 8-20
                                             Chapter 9

                                       AUDIT PROCESS

IRS Exempt Organizations Examinations Office

The goal of Exempt Organizations Examinations is to promote voluntary compliance by analyzing
operational and financial activities of exempt organizations. This office develops processes to identify
areas of noncompliance, develops corrective strategies, and helps other IRS offices implement these
strategies.

EO Examinations’ centralized case-selection and review process ensures consistency of enforcement
activities and helps the office focus its resources on the areas of highest noncompliance. This is the
audit or examination process.


Selection of Cases for Examination

EO Examinations strives to conduct focused, efficient examinations and ensure consistency and
fairness in applying the tax laws. The EO Examinations office publishes an annual plan, available to
the public via the IRS website, describing the types of organizations and issues it will examine. For
example, the plan might describe an area of suspected non-compliance and indicate the type and
number of audits planned for that area. The office uses both automated and manual selection processes
to identify the specific organizations that will be audited.


Types of Audits

IRS examiners conduct audits of exempt organizations in various ways:

   Correspondence examinations The examiner conducts the audit via correspondence with the
                                   —


    organization’s officers or representatives. These audits are often limited in scope, focusing on only
    one or two items on a return.

   Office examinations The examiner conducts the audit in an IRS office. The organization’s
                            —


    officers or representative bring the records to be audited to the office.

   Field examinations The examiner conducts the audit at the organization’s place of business.
                        —


    Generally, these exams are the most comprehensive. The IRS typically uses field exams for the
    largest exempt organizations.


                                       Chapter 9 – Audit Process
                                               Page 9-1
AUDIT PROCESS, Continued

Initial Contact By the IRS

For field and office audits, the agent assigned to examine an organization will contact it by telephone
or letter to schedule an initial appointment. The organization will receive Publication 1, Your Rights as
a Taxpayer, with the appointment letter.


Requested Records

In the appointment letter, the examiner will specify the records he or she wants to have available at the
beginning of the audit. These generally include:

       Governing instruments (articles of incorporation, charter or constitution, including all
        amendments; bylaws, including all amendments)

       Pamphlets, brochures, and other printed literature describing the organization’s activities

       Copies of Forms 990 for the years before and after the year under audit

For the year under audit (at a minimum):

       Minutes of meetings of the Board of Directors and standing committees or councils

       All books and records of assets, liabilities, receipts and disbursements

       Auditor’s report, if any

       Copies of other federal tax returns filed and any related work papers (Forms 990-T, 1 120-
        POL, etc.)

       Copies of employment tax returns and any related work papers (Forms
        W-2, W-3, 941, 1096, 1099)


Opening Conference and Initial Interview

During an opening conference with the organization’s officers or representatives, the examiner will
explain the audit plan he or she has developed, and the reason the organization has been selected for
audit.

The examiner will usually conduct a comprehensive interview and tour the organization’s facilities to
gain a basic understanding of its purposes and activities.
                                       Chapter 9 – Audit Process
                                                Page 9-2
AUDIT PROCESS, Continued


Length of Examination

The length of the examination will depend upon several factors including the size of the organization,
its activities, and the issues that may arise during the examination.


Closing Conference

Every field examination concludes with a closing conference. The agent will discuss his or her
findings, and if necessary, furnish a report explaining the results of the examination and the effect on
the organization.

If the examiner and the organization disagree, the organization may request a meeting with the
examiner’s manager to discuss the disagreement. If the manager cannot resolve the differences, the
organization may pursue its case through the IRS appeals process. For more information see
Publication 5, Your Appeal Rights and How to Prepare a Protest If You Don’t Agree.


For More Information

Publication 1, Your Rights as a Taxpayer

Publication 5, Your Appeal Rights and How to Prepare a Protest If You Don’t Agree

Publication 892, EO Appeal Procedures for Unagreed Issues



    You may order Forms and Publications by calling toll free (800) 829-3676 or
          by downloading them from the IRS website at: www.irs.gov.




                                       Chapter 9 – Audit Process
                                               Page 9-3
                                             Chapter 10

                               REQUIRED DISCLOSURES
Required Disclosures

Certain exempt organizations must disclose to the IRS or the public certain information about their
activities. Generally, an organization discloses this information by entering it on the appropriate lines
of its annual return. In addition, separate rules govern disclosures relating to quid pro quo
contributions and the sale of government information or services that are available for free. Finally,
donors must have written acknowledgment for certain donations. Exempt organization may provide
these, although they are not required.


Public Inspection of Annual Returns and Exemption Applications

A 501(c)(3) organization must make certain documents available for public inspection and copying
upon request and without charge (except a reasonable charge for copying). The organization must
disclose its exemption application (Form 1023) along with all supporting documents and a copy of the
exemption ruling letter issued by the IRS.

The IRS makes these documents available for public inspection and copying. Private foundation
returns filed on or after March 13, 2000, are also subject to these disclosure rules. These items must be
made available to anyone upon request during regular business hours at the organization’s principal
business office and also at the organization’s regional or district offices having three or more
employees.


Annual Information Returns

An organization must disclose its annual information return (Form 990 series), with schedules,
attachments, and supporting documents filed with the IRS. However, the organization does not have to
disclosure Schedule B of Form 990 or Form 990-T and does not need to identify its contributors.
Returns need to be available for disclosure for only three years after the due date or filing date of the
return, whichever is later.




                                  Chapter 10 – Required Disclosures
                                              Page 10-1
REQUIRED DISCLOSURES, Continued

Exemption Application

An organization must disclose its exemption application (Form 1023) along with each of the following
documents:

       All documents submitted with Form 1023

       All documents the IRS requires the organization to submit in support of its application

       The exemption ruling letter issued by the IRS

Certain information may be withheld from public inspection. Organizations may place reasonable
restrictions on the time, place, and manner of in-person inspection and copying. Organization may
charge a reasonable fee for providing copies.


Public Inspection of Application for Exemption for a Subordinate Organization

If an organization that did not file its own application for exemption (because it is a subordinate
organization covered by a group ruling) receives a request for inspection of its application for
exemption and supporting materials, the subordinate organization must acquire from the parent
organization a copy of those documents that were submitted to the Internal Revenue Service by the
parent organization to include the subordinate in the group ruling, and make the material available to
the requester in a reasonable amount of time.

Also, the requester can request from the parent organization, at the parent organization’s principal
office, inspection of the material submitted by the parent organization in connection with including a
subordinate organization in the group ruling.


Public Inspection of Annual Returns for a Subordinate Organization

If an organization that does not file its own Form 990 (because it is a subordinate organization that is
included in a group return) receives a request for inspection, the subordinate organization must acquire
a copy of the group return from the parent organization and make the material available to the
requester in a reasonable amount of time. Also, the requester can request from the parent organization
inspection of the group return at the principal office of the parent organization.




                                  Chapter 10 – Required Disclosures
                                              Page 10-2
REQUIRED DISCLOSURES, Continued

Information That May be Withheld from Public Inspection

Material that may be withheld from public inspection includes:

       Trade secrets, patents, processes, styles of work, or apparatus for which withholding was
        requested and granted (requires prior approval by the Internal Revenue Service to withhold)

       National defense material (requires prior approval by the Internal Revenue Service to
        withhold)

       Unfavorable rulings or determinations

       Rulings or determination letters revoking or modifying a favorable determination letter, and

       Certain other memoranda or letters filed with or issued by the IRS

See Publication 557, Tax-Exempt Status for Your Organization, for specific details.


Method, Place and Time of Inspection

If the organization does not maintain a permanent office and receives a request to inspect its
application for exemption or annual returns, it must give the requester an opportunity to inspect the
material at a reasonable location of the organization’s choice. The required information should
normally be available for inspection on the day of the request and during the normal business hours of
the office.

In the exceptional circumstances where an organization has no office, or where the office has very
limited hours during certain times of the year, the required information should be made available
within a reasonable amount of time (normally not more than two weeks) and at a reasonable time of
day.


Furnishing Copies
An exempt organization also must provide a copy of all, or any specific part or schedule, of its three
most recent annual information returns and/or exemption application to any one who requests a copy
either in person or in writing at its principal, regional or district office during regular business hours.
The organization may charge a reasonable fee for providing copies.




                                   Chapter 10 – Required Disclosures
                                               Page 10-3
REQUIRED DISCLOSURES, Continued

Making Applications and Returns Widely Available

An exempt organization does not have to comply with requests for copies of its annual returns or
exemption applications if it makes them widely available. However, making these documents widely
available does not relieve the organization from making its documents available for public inspection.

The organization can make its application and returns widely available by posting the application and
returns on a World Wide Web page. If the organization has made its application for tax-exemption
and/or annual returns widely available, it must notify any individual requesting a copy where the
documents are available, including the address on the World Wide Web, if applicable. For requests
made in person, the notice must be provided immediately. For requests made in writing, the notice
must be provided within seven days.


Penalties for Failure to Comply with Public Inspection Requirements

Any person who fails to comply with the public inspection requirement for annual returns and
applications for exemption may be assessed a penalty of $20 per day for each day during which the
failure to comply continues. The maximum penalty on all persons for failure to comply with respect to
any one annual return is $10,000.

No penalty will be imposed if the failure is due to reasonable cause. Any person who willfully fails to
comply with the public inspection requirement for any return or application shall pay a penalty of
$5,000 with respect to each such return or application.




                                  Chapter 10 – Required Disclosures
                                              Page 10-4
REQUIRED DISCLOSURES, Continued

Quid Pro Quo Contributions
A contribution made by a donor in exchange for goods or services is known as a quid pro quo
contribution.

A donor may only take a deduction for a quid pro quo contribution to the extent that the contribution
exceeds the fair market value of the goods or services the donor receives in return for the contribution;
therefore, donors need to know the value of the goods or services. An organization must provide a
written disclosure statement to a donor who makes a payment exceeding $75 partly as a contribution
and partly for goods and services provided by the organization.

A required written disclosure statement must:

       Inform a donor that the amount of the contribution that is deductible for federal income tax
        purposes is limited to the excess of money (and the fair market value of property other than
        money) contributed by the donor over the value of goods or services provided by the
        organization

       Provide a donor with a good-faith estimate of the fair market value of the goods or services

An organization must furnish a disclosure statement in connection with either the solicitation or the
receipt of the quid pro quo contribution. The statement must be in writing and must be made in a
manner that is likely to come to the attention of the donor. For example, a disclosure in small print
within a larger document might not meet this requirement.


Example of a Quid Pro Quo Contribution

A donor gives a charitable organization $100 in exchange for a concert ticket with a fair market value
of $40. In this example, the donor’s tax deduction may not exceed $60. Because the donor’s payment
(quid pro quo contribution) exceeds $75, the charitable organization must furnish a disclosure
statement to the donor, even though the deductible amount does not exceed $75.




                                  Chapter 10 – Required Disclosures
                                              Page 10-5
REQUIRED DISCLOSURES, Continued

Exceptions to Written Disclosure

A written disclosure statement is not required:

      Where the goods or services given to a donor meet the “token exception,” the “membership
       benefits exception,” or the “intangible religious benefits exception” described earlier

      Where there is no donative element involved in a particular transaction, such as in a typical
       museum gift shop sale


Written Disclosure: Penalty

A penalty is imposed on charities that do not meet the written disclosure requirement. The penalty is
$10 per contribution, not to exceed $5,000 per fundraising event or mailing. An organization may
avoid the penalty if it can show that failure to meet the requirements was due to reasonable cause.


Disclosure or Sale of Information or Services Available Free From the Government

If an exempt organization offers to sell goods or services that are available free from the federal
government, the organization must disclose that fact in a conspicuous and easily recognized format.
An organization that intentionally disregards this requirement is subject to a penalty.

A penalty applies if an organization fails to comply with this requirement, if the failure is due to
intentional disregard of the requirement. The penalty is the greater of $1,000 for each day the failure
occurred, or 50% of the total cost of all solicitations that were made by the organization the same day
that it fails to meet the requirement.


Notice 88-120

See Notice 88-120 for further guidance on the disclosure of nondeductibility of contributions, public
inspection of annual returns and applications for tax-exempt status, and disclosure of the availability of
material free or at nominal charge from the federal government.




                                  Chapter 10 – Required Disclosures
                                              Page 10-6
REQUIRED DISCLOSURES, Continued

Substantiation of Contributions

In contrast to the disclosure requirements for quid pro quo contributions, an organization has no
disclosure requirements for cash or non-cash contributions for which the organization provides no
goods or services in return.

However, a donor must obtain a written acknowledgement from a charity for any single contribution of
$250 or more before the donor can claim a charitable contribution on his or her federal income tax
return.


Written Acknowledgement: Requirements

A donor cannot claim a tax deduction for any single contribution of $250 or more unless the donor
obtains a contemporaneous, written acknowledgment of the contribution from the recipient
organization. Although it is a donor’s responsibility to obtain a written acknowledgment, an
organization can assist a donor by providing a timely, written statement containing the following
information:

    1. Name of organization

    2. Amount of cash contribution

    3. Description (but not the value) of non-cash contribution

    4. Statement that no goods or services were provided by the organization in return for the
       contribution, if that was the case

    5. Description and good faith estimate of the value of goods or services, if any, that an
        organization provided in return for the contribution

    6. Statement that goods or services, if any, that an organization provided in return for the
       contribution consisted entirely of intangible religious benefits, if that was the case

It is not necessary to include either the donor’s social security number or tax identification number on
the acknowledgment.


                                                               Continued on next page




                                  Chapter 10 – Required Disclosures
                                              Page 10-7
REQUIRED DISCLOSURES, Continued

Written Acknowledgement: Requirements (continued)

A separate acknowledgment may be provided for each single contribution of $250 or more, or one
acknowledgment, such as an annual summary, may be used to substantiate several single contributions
of $250 or more.

There are no IRS forms for the acknowledgment. Letters, postcards, or computer-generated forms with
the above information are acceptable. An organization can provide either a paper copy of the
acknowledgment to the donor, or an organization can provide the acknowledgment electronically, such
as via an e-mail addressed to the donor.

A donor should not attach the acknowledgment to his or her individual income tax return, but must
retain it to substantiate the contribution. Separate contributions of less than $250 will not be
aggregated. An example of this could be weekly offerings to a donor’s church of less than $250, even
though the donor’s annual total contributions are $250 or more.

Written Acknowledgement: Contemporaneous Defined

Recipient organizations typically send written acknowledgments to donors no later than January 31 of
the year following the donation. For the written acknowledgment to be considered contemporaneous
with the contribution, a donor must receive the acknowledgment by the earlier of: the date on which
the donor actually files his or her individual federal income tax return for the year of the contribution;
or the due date (including extensions) of the return.


                                   Chapter 10 – Required Disclosures
                                               Page 10-8
REQUIRED DISCLOSURES, Continued

Written Acknowledgement: Describing Goods and Services

The acknowledgment must describe goods or services an organization provides in exchange for a
contribution of $250 or more. It must also provide a good faith estimate of the value of such
goods or services because a donor must generally reduce the amount of the contribution
deduction by the fair market value of the goods and services provided by the organization. Goods
or services include cash, property, services, benefits or privileges.

However, there are important exceptions as described below:

        Token Exception - Insubstantial goods or services a charitable organization provides in
         exchange for contributions do not have to be described in the acknowledgment. Goods
         and services are considered to be insubstantial if the payment occurs in the context of a
         fund-raising campaign in which a charitable organization informs the donor of the
         amount of the contribution that is a deductible contribution, and:

              1. The fair market value of the benefits received does not exceed the lesser of 2% of
                 the payment or $76, or

              2. The payment is at least $38, the only items provided bear the organization’s name
                 or logo (e.g., calendars, mugs, or posters), and the cost of these items is within the
                 limits for “low-cost articles,” which is $7.60

        Free, unordered low-cost articles are also considered to be insubstantial.

        Example: If a charitable organization gives a coffee mug bearing its logo and costing the
        organization $7.60 or less to a donor who contributes $38 or more, the organization may
        state that no goods or services were provided in return for the $38 contribution. The $38 is
        fully deductible.




                                                               Continued on next page




                                 Chapter 10 – Required Disclosures
                                             Page 10-9
REQUIRED DISCLOSURES, Continued

Written Acknowledgement: Describing Goods and Services

   Membership Benefits Exception - An annual membership benefit is also considered to be
    insubstantial if it is provided in exchange for an annual payment of $75 or less and consists of
    annual recurring rights or privileges, such as:

       1. Free or discounted admissions to the charitable organization’s (continued) facilities or
          events

       2. Discounts on purchases from the organization’s gift shop

       3. Free or discounted parking

       4. Free or discounted admission to member-only events sponsored by an organization,
          where a per-person cost (not including overhead) is within the “low-cost articles”
          limits

Example: If a charitable organization offers a $75 annual membership that allows free admission
to all of its weekly events, plus a $20 poster, a written acknowledgment need only mention the
$20 value of the poster, since the free admission would be considered insubstantial and,
therefore, would be disregarded.

 Intangible Religious Benefits Exception If a religious organization provides only “intangible
                                             -


  religious benefits” to a contributor, the acknowledgment does not need to describe or value
  those benefits. It can simply state that the organization provided intangible religious benefits
  to the contributor.

    What are “intangible religious benefits?” Generally, they are benefits provided by a tax-
    exempt organization operated exclusively for religious purposes, and are not usually sold in
    commercial transactions outside a donative (gift) context. Examples include admission to a
    religious ceremony and a de minimis tangible benefit, such as wine used in a religious
    ceremony. Benefits that are not intangible religious benefits include education leading to a
    recognized degree, travel services, and consumer goods.




                               Chapter 10 – Required Disclosures
                                          Page 10-10
REQUIRED DISCLOSURES, Continued


Written Acknowledgement: Payroll Deductions

When a donor makes a single contribution of $250 or more by payroll deduction, the donor may
use both of the following documents as the written acknowledgment obtained from the
organization:

             A pay stub, Form W-2, Wage and Tax Statement, or other document furnished by the
              employer that sets forth the amount withheld by the employer and paid to a charitable
              organization, and

             A pledge card that includes a statement to the effect that the organization does not
              provide goods or services in consideration for contributions to the organization by
              payroll deduction.

Each payroll deduction amount of $250 or more is treated as a separate contribution for purposes
of the $250 threshold requirement for written acknowledgments.

Written Acknowledgement: Unreimbursed Expenses

If a donor makes a single contribution of $250 or more in the form of unreimbursed expenses,
e.g., out-of-pocket transportation expenses incurred in order to perform donated services for an
organization, then the donor must obtain a written acknowledgment from the organization
containing:

           A description of the services provided by the donor

           A statement of whether or not the organization provided goods or services in return for
            the contribution
           A description and good faith estimate of the value of goods or services, if any, that an
            organization provided in return for the contribution

           A statement that goods or services, if any, that an organization provided in return for the
            contribution consisted entirely of intangible religious benefits, if that was the case

In addition, a donor must maintain adequate records of the unreimbursed expenses.



                                                                  Continued on next page



                                   Chapter 10 – Required Disclosures
                                              Page 10-11
REQUIRED DISCLOSURES, Continued

Written Acknowledgement: Unreimbursed Expenses (continued)

Example: A chosen representative to an annual convention of a charitable organization purchases
an airline ticket to travel to the convention. The organization does not reimburse the delegate for
the $500 ticket. The representative should keep a record of the expenditure, such as a copy of the
ticket. The representative should obtain from the organization a description of the services that
the representative provided and a statement that the representative received no goods or services
from the organization.


Examples of Written Acknowledgments

Some examples of written acknowledgements are as follows:

        “Thank you for your cash contribution of $300 that (organization’s name) received on
         December 12, 2001. No goods or services were provided in exchange for your
         contribution.”

        “Thank you for your cash contribution of $350 that (organization’s name) received on
         May 6, 2001. In exchange for your contribution, we gave you a cookbook with an
         estimated fair market value of $60.”

        “Thank you for your contribution of a used oak baby crib and matching dresser that
         (organization’s name) charity received on March 15, 2001. No goods or services were
         provided in exchange for your contribution.”

The following is an example of a written acknowledgment where a charity accepts contributions
in the name of one of its activities:

        “Thank you for your contribution of $450 to (organization’s name) made in the name
         of its Special Relief Fund program. No goods or services were provided in exchange
         for your contribution.”


No Penalty

An organization that does not acknowledge a contribution incurs no penalty; but, without a
written acknowledgment, the donor cannot claim the tax deduction.




                               Chapter 10 – Required Disclosures
                                            Page 10-12
REQUIRED DISCLOSURES, Continued


For More Information

Publication 526, Charitable Contributions

Publication 557, Tax-Exempt Status for Your Organization

Publication 1771, Charitable Contributions Substantiation and Disclosure Requirements
                                             -




Publication 4221, Compliance Guide for 501(c)(3) Tax-Exempt Organizations

Instructions to Form 990, Return of Organization Exempt from Income Tax

Notice 88-120: available at http://www.irs.gov/charities/article/0,,id=96112,00.html

Revenue Procedure 95—3 5 (proxy tax)

You may order Forms and Publications by calling toll free (800) 829-3676 or
      by downloading them from the IRS website at: www/irs.gov.




                              Chapter 10 – Required Disclosures
                                            Page 10-13
                                        Chapter 11

                                         CLOSING

Importance of the “Non-Profit Sector”

According to The New Nonprofit Almanac & Desk Reference1 published by the Independent
Sector the “non-profit sector” in the United States includes more that 1.6 million organizations,
many of which have been recognized as tax-exempt by the IRS. This report states that these
organizations have combined annual revenues of more than $665 billion. About six percent of all
organizations in the U.S. are nonprofits, and 9.3 percent of all paid employees in the United
States work for a nonprofit.

Probably more important than these “countable” impacts are the ways exempt organizations
touch our lives. Through educational institutions, health care systems, religious organizations,
and the many and varied agencies working for positive change in our country, virtually all
Americans interact regularly with exempt organizations.


Exempt Organizations and the Internal Revenue Service

The goal of the Exempt Organizations office of the IRS is to promote compliance with the tax
laws governing exempt organizations. It does this:

       Through outreach and educational efforts

       By issuing rulings interpreting how tax laws will affect a group of organizations or a
        specific organization, and

       Through examinations and other compliance activities




1
   The New Nonprofit Almanac & Desk Reference, A joint project of the Independent Sector and
the Urban Institute, 2002, http://www.independentsector.org/programs/research/NA01main.html


                                      Chapter 11 – Closing
                                           Page 11-1
CLOSING, Continued

Ways Exempt Organizations Can Get Help from the IRS

The IRS has several ways that officers or representatives of exempt organizations can get help on
tax issues:

      Customer Account Services: Call (877) 829-5500 (toll free). The hours of this office,
       staffed by Exempt Organizations specialists, are 8:00 a.m. 6:30 p.m., Eastern Time. You
                                                                  —


       can ask general questions about exempt organizations or specific questions about your
       organization’s account. When you call, have your organization’s federal identification
       number handy and know your organization’s exact legal name.

      EO Website: Point your browser to www.irs.gov/eo for a wealth of information and
       “how-to” assistance including:

          Descriptions, rules, and requirements for different types ofexempt organizations

          “Tax kit” for exempt organizations

          Memoranda highlighting tax law developments

          Tips on how to avoid filing errors

      Forms and Publications: Call (800) 829-3676 to order free IRS publications and forms or
       download them from the IRS web site at www.irs.gov.

      Call an Exempt Organizations Agent: Agents are available and willing to answer your
       questions. The instructors at today’s workshop will provide their telephone numbers and
       e-mail addresses. If the agent cannot answer your question because it requires in-depth
       research or a specialist, the agent will tell you what steps you should take next.




                                     Chapter 11 – Closing
                                          Page 11-2
CLOSING, Continued

For More Information

General IRS Questions: (800) 829-1040 (toll-free)

TEGE Customer Service: (877) 829-5500 (toll-free) (EO questions)

Forms and Publications: (800) 829-3676 (toll-free)

Digital Daily (IRS website): www.irs.gov

EG Page of the Digital Daily: www.irs.gov/eo


The IRS Needs YOUR Help

The IRS needs your help by providing feedback on our endeavors and products specifically this
                                                                             --


workshop. Evaluation forms will be provided and you will be asked to complete and leave it with
one of your instructors. In your comments, please include your feedback on our printed products
also.




                                    Chapter 11 – Closing
                                         Page 11-3
Appendix I

GLOSSARY
Advance Ruling

An organization normally may be granted an advance ruling period of five taxable years,
allowing it to operate as a publicly supported organization (and a public charity) rather than as a
private foundation. Should your organization wish to continue to be treated as a public charity,
you should submit Form 8734, Support Schedule for Advance Ruling Period, within ninety days
after the end of the advance ruling period. Failure to submit Form 8734 results in your
organization automatically being reclassified as a private foundation required to file Form
990PF. See Chapter 2.


Backup Withholding

Backup withholding refers to the withholding of tax that applies to reportable prizes or payments
to employees and non-employees when the recipient fails to provide a taxpayer identification
number obtained by filing Form W-9. The backup withholding rate is 28%. See Chapters 5 & 6.


Bingo

A game of chance played with cards that are generally printed with five rows of five squares
each. Participants place markers over randomly called numbers on the cards in an attempt to
form a pre-selected pattern such as a horizontal, vertical, or diagonal line, or all four corners. The
first participant to form the pre-selected pattern wins the game. See Chapter 5.


Corporate Director

As classified by statute, a director of a corporation in his/her capacity as director is not an
employee of the corporation. See Chapter 6.


Corporate Officer

As classified by statute, an officer of a corporation is an employee unless he or she performs no
services, or only minor services, and neither receives more is entitled to receive any
remuneration, directly or indirectly. See Chapter 6.




                                       Appendix I – Glossary
                                            Page I-1
GLOSSARY, Continued

Employee

Under common-law rules, anyone who performs services for you is your employee if you can
control what will be done and how it will be done. This is so even when you give the employee
freedom of action. What matters is that you have the right to control the details of how the
services are performed.

To determine whether an individual is an employee or independent contractor under the common
law, the relationship of the worker and the business must be examined. All evidence of control
and independence must be considered. Facts that provide evidence of the degree of control and
independence fall into three categories: behavioral control, financial control, and the type of
relationship of the parties. See Chapter 6.


Employee Identification Number (ElN)

An Employer Identification Number (ElN) is a nine-digit number that IRS assigns in the
following format: xx-xxxxxxx. The IRS uses the number to identify taxpayers that are required
to file various business tax returns. EINs are used by employers, sole proprietors, corporations,
partnerships, nonprofit associations, trusts, estates of decedents, government agencies, certain
individuals, and other business entities. See Chapter 6.


Excess Benefit

An excess benefit transaction is a transaction in which an economic benefit is provided by an 501
(c)(3) or (4) organization, directly or indirectly, to or for the use of a disqualified person, and the
value of the economic benefit provided by the organization exceeds the value of the
consideration received by the organization.

A disqualified person is any person in a position to exercise substantial influence over the affairs
of the 501(c)(3) or (4) organization, such as a voting member of the governing body, a person
holder the powers of the president, or a person holding the powers of the treasurer. See Chapter
3.


Excise Tax

A tax imposed on the manufacture, sale, or use of goods, or on an occupation or activity. See
Chapters 3 & 5.




                                       Appendix I – Glossary
                                            Page 1-2
GLOSSARY, Continued

Gross Receipts

Gross receipts are the gross amount the organization received from all sources without reduction
for any costs or expenses. An organization should keep supporting documents that show the
amounts and sources of your gross receipts. See Chapters 7 & 8.

Group Ruling

The IRS issues a group ruling in the form of a group exemption letter or determination letter to a
central organization recognizing, on a group basis, the exemption under section 501(c) of
subordinate organizations on whose behalf the central organization applied.

A central organization is an organization that has one or more subordinates under its general
supervision or control.

A subordinate organization is a chapter, local, post, or unit of a central organization. A central
organization may be a subordinate itself, such as a state organization that has subordinate units
and is itself affiliated with a national (central) organization. See Chapter 10.

Independent Contractor

A worker is an independent contractor if the employer has the right to control or direct only the
result of the work done, and not the means and methods of accomplishing the result. See Chapter
6.

Insiders

An insider is a person having a personal and private interest in the activities of the organization.
See Chapter 3.

Inurement

The doctrine that prohibits a tax-exempt organization from engaging in any activities which will
permit any of the organization’s income or assets to unduly benefit a person who has some close
relationship to the organization (i.e., an insider). See Chapter 3.

Legislation

Legislation includes action by Congress, any state legislature, any local council, or similar
governing body, with respect to all acts, bills, resolutions, or similar items, or by the public in
referendum, ballot initiative, constitutional amendment, or similar procedure. See Chapter 3.




                                       Appendix I – Glossary
                                            Page 1-3
GLOSSARY, Continued
Legislative Activity

Legislative activity is attempting to influence legislation (i.e., lobbying). A 501(c)(3)
organization can engage in some lobbying, as long as it is not a substantial part of the
organization’s activities. See Chapter 3.

Lottery

In general, a lottery includes any scheme or method for distributing prizes among persons who
have paid (or promised consideration) for a chance to win prizes, usually determined by the
numbers or symbols on tickets drawn from a lottery wheel or other receptacle, or by the outcome
of an event. Instant bingo, mini bingo, pull-tabs, and raffles are common forms of lotteries. See
Chapter 5.

Pickle Jars

A form of pull-tabs that get their name from the empty pickle jars in which the cards are placed.
See Chapter 5.

Political Campaign Activity

Political campaign activity is directly or indirectly participating in, or intervening in, any
political campaign on behalf of (or in opposition to) any candidate for elective public office. A
section 501 (c)(3) organization is absolutely prohibited from engaging in political campaign
activity. See Chapter 3.

Private Benefit

The doctrine that prohibits a tax-exempt organization from engaging in activities which will
substantially benefit the private interest of any individual or organization. See Chapter 3.

Private Foundation

A charitable organization that does not qualify as a public charity. Generally, a private
foundation is a charitable organization that is funded from one source, its ongoing funded is in
the form of investment income, and it makes grants for charitable purposes to other persons.
There is a general rebuttable presumption that a charitable entity is a private foundation. See
Chapter 2.

Public Charity

A charitable organization that does not constitute a private foundation. Generally, an public
charity has a broad base of financial support and falls into one of four categories: a public
institution, a publicly supported charity, a supporting organization, or an organization that tests
for public safety. See Chapter 2.
                                       Appendix I – Glossary
                                               Page 1-4
GLOSSARY, Continued

Pull-Tabs

Games in which an individual places a wager by purchasing preprinted cards that are covered
with pull-tabs. Winners are revealed when the individual pulls back the sealed tabs on the front
of the card and compares the patterns under the tabs with the winning patterns preprinted on the
back of the card. Instant bingo, mini bingo, and similar scratch-off cards are all types of pulltabs.
See Chapter 5.


Quid Pro Quo Contribution

A contribution made by a donor in exchange for goods or services. See Chapter 10.


Religious Organization

An organization that is organized and operated exclusively for a religious purpose. The term
includes churches, as will as other organizations that do not carry out the functions of a church,
such as mission organizations, speakers’ organizations, nondenominational ministries,
ecumenical organizations, or faith-based social agencies. See Chapter 2.


Statute of Limitations

The period of time in which an organization can amend its tax returns to claim a credit or refund,
or the IRS can assess additional tax. See Chapter 2 and Chapter 7.


Wager

The amount risked by the person placing the bet, not the prize amount. See Chapter 5.


Withholding

Withholding refers to the regular withholding of income tax from prizes or the withholding of
income tax from employee’s pay by the employer. The regular withholding rate for gaming
prizes is 25%. Employers use Form W-4 to determine how much federal income tax to withhold
from an employee’s pay, and the amount depends on the employee’s marital status, the number
of withholding allowances the employee claims, any additional amount the employee wants to
withhold, and any exemptions from withholding the employee claims. See Chapters 5 & 6.



                                       Appendix I – Glossary
                                            Page I-5
                                       Appendix II

                                  Other Information

A. Employment Issues Quiz Answers                 -




B. Completing Form 990 Exercises Answers                      -




A.    Employment Issues Quiz - Answers (Chapter 6, Exhibit D)

Question 1

ABC Foundation placed the following advertisement in the newspaper.

     A friendly individual who enjoys working with people is needed to answer a multi-line
     telephone, greet visitors when they come in the door, make coffee, and perform various
     other tasks when time perm its. This qualified individual must be able to work from 8:00
     a.m. 5:00p.m. The position pays $10.00 an hour.
          —




Would this person be an employee or independent contractor?

        Answer 1
        This person is an employee. ABC Foundation, the employer, has the right to direct and
        control the worker.

Question 2

DEF Country Club, Inc. is looking for an experienced accountant who specializes in working
with tax-exempt organizations. The accountant must be able to prepare a compilation of the
financial statements on a monthly basis, present these statements to the board of directors at the
monthly meetings, perform the annual gambling audit, and prepare the 990 and 990-T returns at
the end of the year by the due date.

Would this person be an employee or independent contractor?

        Answer 2
        Given the facts in this scenario, the accountant is an independent contractor.




                                Appendix II – Other Information
                                          Page 11-7
A.      Employment Issues Quiz Answers, Continued
                                   -




Question 3

The president of ABC Foundation manages the day-to-day activities of the organization,
supervises managers who supervise the employees, signs the organization’s checks, presides
over monthly board meetings, and performs other tasks as necessary to ensure the successful
operation of the organization.

Would this person be an employee or independent contractor?

        Answer 3
        The president is a corporate officer by statute. See Internal Revenue Code section
        3121(d)(1). Furthermore, the president is performing duties of a corporate officer.

Question 4

GHI Private School for the Gifted hired a janitor to clean up the school after hours. The janitor
must provide all necessary equipment and supplies. He may come in and clean anytime that
school is not in session but must come in at least three times per week. The janitor is provided a
key to the school. The school is billed monthly for the services of the janitor. The janitor has
several other clients.

Would this person be an employee or independent contractor?

        Answer 4
        Given the facts in this scenario, the janitor is an independent contractor.

Question 5

JKL Youth Bowling League was sued as a result of a youth dropping a bowling ball on a
spectator’s foot. The spectator, Mr. Jackson, filed suit in district court and is suing for $250,000.
JKL Youth Bowling League contracts with a local attorney who specializes in this type of
lawsuit. The attorney charges $250 per hour.

Would this person be an employee or independent contractor?

        Answer 5
        Given the facts in this scenario, the attorney is an independent contractor.




                                 Appendix II – Other Information
                                           Page 11-8
A.       Employment Issues Quiz Answers, Continued
                                    -




Question 6

The MNO Little League organization hired coaches selected by the League’s officers. The board
sets the times and places for all the games. The coaches are fathers or mothers of the children
who play on the team. The organization has established policies and procedures that coaches are
required to follow. Generally, the officers do not interfere with the coaching unless there is a
problem. The coaches receive $500 per season.

Would these coaches be employees or independent contractors?

     Answer 6: Given the facts in this scenario, the coaches are employees.

Question 7

PQR Theatre places the following advertisement in the newspaper.

      Needed: ushers, ticket takers, and ticket sellers. Hourly rate is negotiable based on
      experience and reliability.

Would these workers be employees or independent contractors?

     Answer 7: The ushers, ticket takers, and ticket sellers are all employees of PQR Theatre.

Question 8

A salaried golf professional and his assistants manage the pro shop of a country club. In addition,
the club requires them to give lessons to the club’s members at its established rates.

Would these persons be employees or independent contractors?

     Answer 8: The individuals are employees of the club. Rev. Rul. 68-626, 1968-2 C.B. 466.

Question 9

A golf professional sells lessons and equipment on the premises of a golf club. She sets prices,
makes appointments, and carries on her activities with permission of the club, but without orders
or instructions from club members or officials.

Would this person be an employee or independent contractor?

     Answer 9
     The individual is not an employee. She is engaged in a trade or business and the income there
     from must be considered in computing net earning from self-employment.


                                 Appendix II – Other Information
                                           Page 11-9
A.      Employment Issues Quiz Answers, Continued
                                    -




Question 10

The STU Foundation hires van drivers to transport physically disabled individuals to their
doctors’ appointments. The STU Foundation owns the vans, pays the insurance and all other
related expenses for the vans, and only uses the vans for this purpose. The van drivers are not
allowed to take side trips. Their purpose is solely to transport physically disabled individuals to
their doctor’s appointments.

Would these persons be employees or independent contractors?

     Answer 10
     The van drivers are employees of STU Foundation.

Question 11

The STU Foundation hires van drivers to transport physically disabled individuals to their
doctors’ appointments. The drivers own their own vans and pay for the gas, insurance and
maintenance. The drivers charge $1.00 per mile and are willing to stop anywhere.

Would this person be an employee or independent contractor?

     Answer 11
     The van drivers are independent contractors.

Question 12

XYZ Anonymous engages in charitable gambling. It hired a gambling manager who supervises
employees conducting the pull tab games, prepares the monthly reports, audits the games, makes
the deposits, and reports at the monthly meetings.

Would this person be an employee or independent contractor?

     Answer 12
     The gambling manager is an employee.




                                 Appendix II – Other Information
                                           Page 11-10
B. Completing Form 990 Exercises Answers (Chapter 8, Exhibit E)
                                        -




Group Exercise 1: Who Must File, When to File

Question 1

Does Acme Charitable Organization have a filing requirement for 2003? Why or why not? If
Acme Charitable Organization has a filing requirement for 2003, what form should it complete
to satisfy this requirement?

    Answer 1
    Yes, there is a filing requirement. Although Acme did not apply for exemption until July
    and was not officially recognized by the IRS until October, its exemption is effective
    January 1 because it filed for exemption within 27 months of incorporation. Thus, gross
    receipts from January 1 through December 31 must be considered when determining if
    Acme has a filing requirement for 2003.

    For purposes of this test, Acme’s gross receipts are $40,000 ($35,000 from Bingo and
    $5,000 contributions). Because this exceeds the $37,000 initial year threshold, Acme must
    file Form 990-EZ.


Question 2

Does Acme Charitable Organization have a filing requirement for 2004? Why or why not? If
Acme Charitable Organization has a filing requirement for 2004, what form should it complete
to satisfy this requirement?

    Answer 2
    Yes. Acme’s gross receipts for 2004 are $24,000. When averaged with gross receipts of
    $40,000 from 2003, ($40,000 +$24,000 divided by 2), Acme exceeds the threshold of
    $30,000 for the second year. Thus, Acme must again file Form 990-EZ.


Question 3

Does Acme Charitable Organization have a filing requirement for 2005? Why or why not? If
Acme Charitable Organization has a filing requirement for 2005, what form should it complete
to satisfy this requirement?

    Answer 3
    No. Acme’s gross receipts for 2005 are $10,000. When averaged with the gross receipts
    from 2003 and 2004, Acme does not meet the $25,000 threshold for the third year. ($40,000
    + $24,000 + $10,000 divided by 3 = < $25,000.


                               Appendix II – Other Information
                                         Page II-11
B.     Completing Form 990 Exercises Answers, Continued
                                            —




Group Exercise 2: Reporting Revenue from Contributions/Special Events, Reporting
Fundraising Expenses

Question 1

What amount should Acme Charitable Organization report as revenue from its fundraising
campaign in Part I of its 2003 Form 990? On what line(s)?

     Answer 1: $100,000— Part I, Line la


Question 2

On the Form 990 that Acme files for 2003, should it report the $5,000 that Richie kept as his
fee for conducting the campaign? If so, where? (Specify the Part(s), Line(s), and Column(s), if
applicable.)

     Answer 2: Yes. Part II, Line 30, Columns A and D


Question 3

What amount should Acme Charitable Organization report as revenue from its fundraising
campaign in Part I of its 2003 Form 990? On what line(s)?

     Answer 3: $150,000 – line la
                 $50,000 – line 9a


Question 4
On the Form 990 that Acme files for 2003, should it report the $10,000 that Richie kept as
his fee for conducting the campaign? If so, where? (Specify the Part(s), Line(s), and
Column(s), if applicable.)

     Answer 4: Yes. Part II, line 30, Columns A and D


Question 5
Should it report the $45,000 Richie paid to the book wholesaler? If so, where?

     Answer 5: Yes. Part I line 9b
                            -




                                Appendix II – Other Information
                                          Page II-12
B.     Completing Form 990 Exercises Answers, Continued
                                                     —




Group Exercise 3: Reporting Expenses by Function, Reporting Program Service
Accomplishments

Question 1

In Part II of Form 990, what amounts should be entered in Columns A, B, C and D for Line 26,
Other Salaries and Wages? What amounts should be entered in Columns A, B, C and D for Line
36, Occupancy?

     Answer 1
                             A                    B                 C                D
                            Total          Program Services    Management        Fundraising
                                                               and general
     Line 26            $100,000               $90,000           $5,000              $5,000
     Line 36             $10,000                $9,000           $1,000                  $-0-
     Line 44            $110,000
                        -                      $99,000           $6,000              $5,000


Question 2

In Part III of Form 990, what information and amounts should be entered on Lines a, b and f?

     Answer 2
     Because both programs share resources equally, expenses can be allocated equally or
     $49,500 each Column B above divided by 2? Thus:
                   —




     Line a – Soup Kitchen = $49,500
     Line b – Job Training = $49,500

     Line f – Total =               $99,000 – which equals line 44, Column B above


Group Exercise 4: Reporting Information about loans to officers; Reporting Information about
donated services

Question 1

Should this transaction between the organization and an officer be reported on its 2003 Form
990? If yes, in which Part and on what line(s)?

     Answer 1
     Yes. Part IV (Balance Sheet) – Line 50


                                      Appendix II – Other Information
                                                Page II-13
B. Completing Form 990 Exercises – Answers, Continued


Question 2

If, on the required attached schedule, the organization showed the interest rate of the loan as
0.0%, would this raise concern for IRS? If so, why?

    Answer 2
    Yes. Could be potential inurement since the transaction involves an insider. Acme is losing
    the use of and ability to earn money on the $25,000 for the period of the loan.


Question 3

Should these donated services and free use of equipment be reported on Form 990? If so, where?

    Answer 3
    Yes. Part VI, line 82 a & b

Question 4

Does IRS require that these donated services and free use of equipment be reported on Form
990?

    Answer 4
    No, this is not required. However, if Acme has audited financial statements prepared m
    accordance with SFAS 117 and uses them to prepare its Form 990, then Acme will reconcile
    its return to its financial statements in Part IV-A. It will account for any donated services
    and use of facilities in Part IV-A, and should show them again on line 82b.




                                  Appendix II – Other Information
                                            Page 11-14

								
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