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If you manage a tax-exempt organization or are in the process of forming one, this presentation provides information on the top reasons the IRS revokes tax-exempt status. Organizations that received …

If you manage a tax-exempt organization or are in the process of forming one, this presentation provides information on the top reasons the IRS revokes tax-exempt status. Organizations that received an IRS notice of revocation can find out more about the process of reinstating tax-exempt status.

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  • 1. STAYING ON TARGET Avoiding Loss of Tax-Exempt Status Debra Scott, JD, MPH SP Consulting, a division of The Scott Practice, LLC www.scottpractice.com
  • 2. ONTARGET Form 990 and Tax Compliance – Review reporting requirements under Form 990 which solicits information on these five activities Webinar Agenda Non-profit Tax Exempt Status – Overview of nonprofit organizations and IRC 501(c) Five Activities That Can Jeopardize Tax Exempt Status – Discuss each of the five activities that may cause revocation Failure to File Form 990 – Discuss the consequences of non- filing or incorrect reporting and rules governing automatic revocation Form 990 Analysis –What certain disclosures on Form 990 reveal to third parties and the IRS Questions Brief Outline of Today’s Webinar www.scottpractice.com
  • 3. ONTARGET TAX EXEMPT STATUS Brief Overview of Nonprofit www.scottpractice.com
  • 4. ONTARGET What is a Tax Exempt Organization? Definition: A tax exempt organization is recognized by the Internal Revenue as an entity organized for an exempt purpose as set forth under the Internal Revenue Code section 501(c). Focus of Webinar: 501(c)(3) charitable organizations that are required to file annually Form 990, Form 990 EZ or Form 990 N. www.scottpractice.com
  • 5. ONTARGET Size and Financial Scope of the Nonprofit Sector, 1999-2009 Source: Katie L. Roeger, Amy Blackwood, and Sarah L. Pettijohn, 2011, "The Nonprofit Sector in Brief: Public Charities, Giving and Volunteering, 2011." Urban Institute, National Center for Charitable Statistics, Core Files (1999–2009); the Internal Revenue Service Business Master Files, Exempt Organizations (1999–2009); Notes: Reporting public charities include only organizations that both reported (filed IRS Forms 990) and were required to do so. Organizations that had their tax status revoked for failing to file a financial return for three consecutive years have been removed from the 2009 nonprofit total. www.scottpractice.com
  • 6. ONTARGET Size and Financial Scope of the Nonprofit Sector, 1999-2009 Source: Katie L. Roeger, Amy Blackwood, and Sarah L. Pettijohn, 2011, "The Nonprofit Sector in Brief: Public Charities, Giving and Volunteering, 2011." Urban Institute, National Center for Charitable Statistics, Core Files (1999–2009); the Internal Revenue Service Business Master Files, Exempt Organizations (1999–2009); Notes: Reporting public charities include only organizations that both reported (filed IRS Forms 990) and were required to do so. Organizations that had their tax status revoked for failing to file a financial return for three consecutive years have been removed from the 2009 nonprofit total. 1999 2004 2009 % change 1999- 2009 % change 1999- 2009 (inflation adjusted) All nonprofits 1.2 million 1.39 million 1.43 million 19.1 ─ Reporting nonprofits 425,503 533,119 628,700 47.8 ─ Revenues ($) 1.08 trillion 1.50 trillion 1.87 trillion 72.4 33.9 Expenses ($) 972 billion 1.37 trillion 1.89 trillion 94.1 50.7 Assets ($) 2.41 trillion 3.29 trillion 4.30 trillion 78.6 38.7 Public charities, 501(c)(3) 632,604 823,267 1,007,384 59.2 ─ Reporting public charities 247,308 300,933 362,926 46.8 ─ Revenues ($) 800 billion 1.07 trillion 1.40 trillion 75 35.9 Expenses ($) 731 billion 998 billion 1.40 trillion 91.6 48.8 Assets ($) 1.47 trillion 1.89 trillion 2.53 trillion 71.8 33.4 www.scottpractice.com
  • 7. ONTARGET Revoked Tax Exempt Status Source: Amy Blackwood and Katie L. Roeger, 2011, "Revoked: A Snapshot of Organizations that Lost their Tax-Exempt Status." Urban Institute, National Center for Charitable Statistics, Master File (2011) Type of Organization Number of Revoked Organizations Percent of Revoked Organizations All nonprofits Percentage revoked by type Arts, culture, and humanities 26,991 10 137,779 20 Education 26,870 10 225,119 12 Environment and animals 9,079 3 62,340 15 Health 20,135 7 111,254 18 Human services 87,167 31 444,296 20 International and foreign affairs 3,617 1 21,999 16 Public and social benefit 78,665 28 483,166 16 Religion-related 16,930 6 241,360 7 Unknown 10,145 4 28,777 35 Total 279,599 100 1,756,090 16 Organizations that Lost their Tax-Exempt Status www.scottpractice.com
  • 8. ONTARGET JEOPARDIZE TAX EXEMPTION Brief Overview of Five Activities that May www.scottpractice.com
  • 9. ONTARGET Organized for Exempt Purpose Under Internal Revenue Code Section 501(c)(3), entities that are “organized and operated exclusively” for religious, educational or charitable purposes may obtain receive tax exempt status under the condition that it does not engage in certain types of activities. www.scottpractice.com
  • 10. ONTARGET Inurement & Private Benefit Lobbying Activity Political Campaign Activity Unrelated Business Income Failure to File Most of the activities that jeopardize tax exemption are activities that serve private or political interests. Five Common Activities That Jeopardize Tax Exemption www.scottpractice.com
  • 11. ONTARGET Inurement of Net Earnings versus Private Benefit Inurement Inurement generally is applied only to insiders who have the ability to control and make significant decisions regarding the organization. No part of a tax-exempt organization’s net earnings may inure to the benefit of an insider. An insider is a person who has a private interest in the activities of the organization. The determination is solely a factual case-by- case determination. Issue may arise in the case of executive compensation. Private Benefit Emanates from the basic tenet of 501(c)(3) that requires the organization to operate “exclusively” for exempt purposes. May apply to insiders or outsiders. “Operational Test” and the “Primary Purpose Test” to determine if the organization excessively engages in a private interest. The determination is solely a factual case-by-case determination. Where this issue may develop is in the case of private/nonprofit partnerships. www.scottpractice.com
  • 12. ONTARGET Private Benefit OPERATIONAL TEST The entity must show that it engages primarily in activities which accomplish one or more of the exempt purposes expressed in IRC Section 501(c)(3). Under the operational test the focus is on the entities activities. PRIMARY PURPOSE TEST Here the courts have looked at the purpose of the activity and whether such purpose fulfils a charitable purpose versus a private or commercial purpose. There are different ways to analyze the substantiality of a private benefit such as quantitatively where the amount of the benefit is analyzed. www.scottpractice.com
  • 13. ONTARGET Example of Primary Purpose Test Rev. Rul 76-206, 1976-1 C.B. 154, www.scottpractice.com
  • 14. ONTARGET Inurement of Net Earnings/Executive Compensation Authorizing key employees, such as an Executive Director to receive unreasonable compensation puts the nonprofit’s tax-exemption at risk. What is reasonable compensation depends of the totality of the circumstances. Comparability data is one means of substantiating the reasonableness of executive compensation. www.scottpractice.com
  • 15. ONTARGET Example of Compensation Comparison Comparing compensation of officers, directors and key employees www.scottpractice.com Small (< $200K) Medium (>$200k < $1M) Large (>$1M <$5M) X-Large (> $5M) $44,435 $55,831 $92,853 $104,250 $56,870 $67,826 $106,750 $126,548 $69,250 $72,580 $156,561 $183,502 $72,200 $84,789 $186,510 $201,870 Annual Nonprofit Revenue 2014 Executive Director Salary Comparison 0-3 YRS 3-5 YRS 5-10 YRS 10+ YRS Experience
  • 16. ONTARGET Political Campaign Activity Political campaign activity is not the same as lobbying activity. Tax exempt 501(c)(3)organizations that participate or intervene in any political campaign on behalf of any candidate for public office is subject to revocation of its tax exempt status. www.scottpractice.com
  • 17. ONTARGET Unrelated Business Income An organization may lose its tax exempt status if earns excessive income from a regularly carried on trade or business that is not substantially related to its tax exempt purpose. Here again we go back to that operational test where we look at the activities of the organization and determine if such activities substantially relate to an exempt purpose. www.scottpractice.com
  • 18. ONTARGET Is This Unrelated Business Income? Three conditions must be met before the tax exempt organization’s activity will be construed as unrelated business activity.  The activity must be a trade or business;  The trade or business must be regularly carried on; and  The trade or business must substantially unrelated to the entity’s tax exempt purpose. www.scottpractice.com
  • 19. ONTARGET Is This Unrelated Business Income? If all three conditions are present, then under IRC 513(a) (1) and Regs. 1.513- (e)(1) we look to see if an exception applies: • Volunteer Labor • Convenience Exception • Donated Merchandise www.scottpractice.com
  • 20. ONTARGET Example of Volunteer Labor Exception Joseph Farms of Indiana v. Commissioner, 85 T.C. 9 (1985), www.scottpractice.com
  • 21. ONTARGET IRS NONPROFIT REPORTING Form 990 and Tax Compliance www.scottpractice.com
  • 22. ONTARGET Form 990 Most 501(c)(3) tax exempt organizations must file an information return called a Form 990. Purpose of Form 990:  promote public transparency  tax compliance Format of 990:  various interview formats  close ended yes or no questions  open ended descriptive narratives www.scottpractice.com
  • 23. ONTARGET Types of Informational Returns • Return of Organization Exempt from Income TaxFORM 990 • Short Form Return of Organization Exempt from IncomeFORM 990-EZ •Electronic Notice (e-Postcard)FORM 990-N Most public charities file annually one of these informational returns. Form 990 must be filed on or before the 15th day of the 5th month following the end of the organization’s tax year. Some tax exempt organizations such as churches and certain church-affiliated organizations. www.scottpractice.com
  • 24. ONTARGET Data Source 32% 60% 8%8% Categories of Tax-Exempt Entities Other 501(c )(3) 501(c )(4) Source: GAO analysis of IRS data as of September 30, 2006. Note: The 501(c)(3) organizations are the public charities and foundations; (501)(c)(4) are social welfare organizations. www.scottpractice.com
  • 25. ONTARGET Form 990 must be filed on or before the 15th day of the 5th month following the end of the organization’s tax year. Some tax exempt organizations such as churches and certain church-affiliated organizations. Form 990 Filing Requirements Gross Receipts and Asset Thresholds Form Type Required Gross Receipts ≤ $50,000 990-N Gross Receipts > $50,000 and < $200,000 and Total Assets < $500,000 990 - EZ Gross Receipts ≥ $200,000 or Total Assets > $500,000 990 Unrelated Trade or Business Income ≥ $1000 990 - T www.scottpractice.com
  • 26. ONTARGET Penalty for Form 990 Noncompliance In the event Form 990 or Form 990 –EZ: A. Is not timely filed; B. Shows incomplete information; or C. Provides incorrect information IRS may assess penalties on the organization of $20 per day not to exceed the lessor of $10,000 or 5 percent of the organizations gross receipts. For larger organizations with over $1 million in gross receipts, the IRS can fine the organization up to a maximum of $50,000. www.scottpractice.com
  • 27. ONTARGET Penalty for Form 990 Noncompliance If an organization fails to file Form 990, Form 990-EZ or Form 990-N for 3 consecutive years its tax exempt status will automatically be revoked as of the filing due date of the third return. If an organization is suffers automatic revocation, it must apply for reinstatement. www.scottpractice.com
  • 28. ONTARGET Streamlined Retroactive Reinstatement Process For Form 990 –N and 990-EZ Filers www.scottpractice.com
  • 29. ONTARGET FORM 990 LINE ITEMS Form 990 and Tax Compliance
  • 30. ONTARGET Review of the Following Sections of Form 990 Most questions under Form 990 concern tax compliance under the principal that funds should not be transferred to those who control the organization. This principal is known as the nondistribution constraint – meaning that controlling persons of the nonprofit organization are constrained from distributing funds to “insiders” in exchange for special tax, legal and regulatory treatment. Part IV & Schedule A • Self-Dealing Transactions Form 990 Part V • Compliance Form 990 Part VI • Governance Form 990 Part VII • Compensation www.scottpractice.com
  • 31. ONTARGET www.scottpractice.com
  • 32. ONTARGET www.scottpractice.com
  • 33. ONTARGET www.scottpractice.com
  • 34. ONTARGET www.scottpractice.com
  • 35. ONTARGET www.scottpractice.com
  • 36. ONTARGET Closer Look at Executive Compensation & Nonprofit Expenses Financial Analysis www.scottpractice.com
  • 37. ONTARGET QUESTIONS It’s Time For www.scottpractice.com