Session 3A. Current Tax Developments
Bethany J. Bridgham
Diara M. Holmes, Caplin & Drysdale
Sean Scally, Vanderbilt University
Lorry Spitzer, Ropes & Gray
Current Tax Law Developments Roadmap
1. IRS Mishandling of 501(c)(4) Applications – Fallout, Next Steps,
Silver Lining?
2. IRS College & University Compliance Project -- Recap
• Results and Implications for UBIT, Executive Compensation, and
Employment Tax
3. 403(b) Plans
4. Final Regulations re: Supporting Organizations
5. Charitable Giving
6. Assorted Recent Developments
2
The Elephant in the Room
IRS Apology and the Resulting Firestorm
• May 10: EO Director Lois Lerner apologized for IRS mishandling of Tea
Party and other groups’ 501(c)(4) exemption applications in Cincinnati
(EO Determinations).
• May 14: TIGTA report re: IRS mismanagement of these cases
• Attorney General has called for FBI/DOJ criminal investigation
• Governors call for Special Prosecutor
• May 17: House Ways & Means Hearing
• Senior level departures (Miller, Lerner, Paz), with “acting” EO officials
in place for now.
• Silver lining: Will we see meaningful guidance re: c4 “primary” test?
3
IRS College & University Compliance Project Recap
Step 1: Questionnaire
• Sent to 400 colleges and universities in
October 2008.
• Issues included: executive compensation,
endowment funds, UBIT, controlled
organizations.
• High (“voluntary”) response rate (97%)
4
C&U Compliance Project
Interim Report
Step 2: Interim Report
• Released in May 2010
• Presented preliminary findings on respondents’
organizational structures, demographics, exempt and
unrelated business activities, endowments, executive
compensation and governance practices.
• Answers showed potentially conflicting responses –
e.g., schools reported controlling entities, engaging
in rental activities, and receiving corporate
sponsorships, yet few reported such activities on
Form 990-T.
5
C&U Compliance Project
Selective Audits
Step 3: Selective examinations of 34 institutions
• 31 exams have closed; 3 remain open.
• Not a statistically valid sample.
• Organizations selected because questionnaire responses
and Form 990s indicated potential noncompliance in the
areas of UBI and executive compensation.
• IRS examined 990, 990-T, employee plan return, excise tax
returns, employment tax returns.
• 24 institutions received written advisories.
• (So far) no “excess benefit transactions” leading to 4958
tax
6
C&U Final Report Signals Continued IRS
Focus on UBIT and Compensation
Step 4: Final Report
“ …the IRS plans to look at UBI reporting more
broadly, especially at recurring losses and the
allocation of expenses, and to ensure, through
education and examinations, that tax-exempt
organizations are aware of the importance of
using appropriate comparability data when
setting compensation.”
7
C&U Final Report -- UBTI
Outcomes:
• Increases to UBTI for 90% of institutions examined,
totaling about $90 million
• Over 180 changes to the amounts of UBTI reported
on Form 990-T
• Disallowance of more than $170 million in losses
and NOLs, which could amount to more than $60
million in assessed taxes.
8
C&U Final Report – UBIT
Primary reasons for UBTI Adjustments
• Disallowed expenses (losses) that were not
connected to unrelated business activities
• lack of profit motive (no “trade or business”)
• improper expense allocations
• Errors in calculations or substantiation
• Reclassified activities from exempt to unrelated
9
C&U Final Report – UBIT
Lack of Profit Motive
• IRS disallowed losses and NOLs for lack of
profit motive in 70% of the exams. These
disallowances amounted to more than
$150 million of the total losses and NOLs
disallowed in the C&U exams.
10
C&U Final Report – UBIT Advice
• 20% of institutions sought outside advice about potential unrelated
business activities.
• In 40% of those cases where an institution had obtained an outside
opinion, the IRS disagreed with the opinion when the issue came
up on examination.
Of Form 990-Ts examined:
• 13% were reviewed by outside counsel before filing.
• 57% were reviewed by independent accountants before filing.
• 50% were reviewed before filing by the Board or a Board
committee.
11
C&U Final Report – UBIT
Over 180 adjustments to UBTI reporting on C&U
returns, from more than 30 different activities.
Majority of these adjustments came from:
•
•
•
•
•
Fitness, recreation centers and sports camps
Advertising
Facility rentals
Arenas
Golf Facilities
12
C&U Final Report – UBIT
Recommendations
• Document Business Purpose: Particularly Important when
the Activity Results in Gain/Loss Over Multiple Years
• Document Expense Allocations: (1) Maintain Good
Records; (2) Substantiate Allocation of Expenses Between
Related and Unrelated Activity; (3) Document and Record
Detail to Support NOLs for carrybacks
• Perform UBIT Analysis on All Income Streams and Revenue
Producing Activity to ensure compliance with “Related”
Income Standards
C&U Final Report – UBIT
Recommendations
• Dual Use of Facilities – Allocation Methodology (Available not
Actual Use Basis): Use 24-hour-day/12-month year period, with
an allocation ratio of hours used for unrelated activity over the
total number of hours in the year. PLR 9149006;
• Direct Expenses/Costs AND Indirect Expenses (Personnel
Salaries/General Overhead) – Allocation On a Reasonable and
Proportional Basis. Treas. Reg. 1.512(a)-1, referencing the
‘ordinary and necessary’ business deduction standard per IRC
162; Disabled Amer. Veterans v US, 704 F.2d 1570 (Fed. Cir.
1983).
C&U Final Report – Executive
Compensation
• For
private
colleges,
IRC
section
4958
analysis
• In these audits, ODTKEs were “disqualified persons.”
[Query….]
• 2006-2008 tax years examined. The 2008 Form 990 was
the first time organizations were required to report about
their
compensation
practices
and
policies.
• 20% of the private institutions examined failed to meet
the “rebuttable presumption” standard because of
problems with their comparability data.
15
Problems with Comparability Data
• LBI Engineers went behind compensation studies and found
that 20% of the private schools included institutions in their
data set that were not similarly situated.
• Engineers looked to factors such as: type (e.g., private or
public; liberal arts, research university, etc.), size of
undergraduate enrollment, faculty size, location (urban,
rural, suburban; region of the US), endowment size, tuition
and cost to attend, selectivity (SAT ranges, etc.) and age of
the institution (year founded).
16
Problems with Comparability Data
• Peer Institutions not similarly situated, based on at least one of
the following factors: location, endowment size, revenues,
total net assets, number of students, and selectivity
• Compensation studies failed to document selection criteria for
peers, and failed to explain why those schools were deemed
comparable to the school relying on the study.
• Surveys did not specify whether amounts reported included
only salary or other types of compensation, as required by
section 4958.
17
C&U Final Report – Executive
Compensation
• Highest paid non-ODTKEs: Sports Coaches, Investment Managers,
Head of Departments, Faculty and Administrative/Managerial.
• Sports Coaches ($884,746 ) and Investment Managers ($894,214 )
received the highest average compensation at the colleges and
universities examined.
• In the remaining non-ODTKE categories, compensation differed
based on whether or not the individual was a medical doctor.
18
C&U Final Report – Employment Tax
• IRS looked at employment tax returns in 11 of the exams, all of
which have resulted in adjustments.
• increases in taxable wages of $35.5 million
• over $7 million in employment taxes
• $167,243 in penalties
• Reasons for wage adjustments:
• failure to include value of the personal use of automobiles,
housing, social club memberships and travel
• misclassification of employees as independent contractors
• failure to withhold taxes for wages paid to non-resident aliens
• failure to include value of certain graduate tuition waivers and
reimbursements.
19
National Research Project
Employment Tax
• Announced in November 2009. Specific areas of interest:
worker classification, officer compensation, fringe
benefits, employee expense reimbursements, and nonfilers.
• 6,000 randomly selected organizations examined, including 1,500 EOs.
• Audits commenced in February 2010, with 2 goals:
• Obtaining statistically valid information to compute “Employment Tax
Gap”.
• Determining compliance characteristics to facilitate IRS enforcement.
• Final report forthcoming.
20
Voluntary Classification Settlement
Program IRS Anns. 2012-45 and 2012-46
• Allows employers that currently treat workers (or a class or group of
workers) as independent contractors or other nonemployees to
prospectively treat them as employees.
• To participate, employer must have consistently treated the workers as
independent contractors /nonemployees, and must have filed all required
Forms 1099 for past 3 years.
• Modified and expanded in December 2012
• Orgs that are under audit, other than employment tax audit, may participate
in VCSP.
• Org may not participate if it is contesting in court the classification of the class
or classes of workers from a previous audit by the IRS or DoL.
• Orgs no longer required to agree to extend the SOL as part of the VCSP closing
agreement.
• Members of an affiliated group are not eligible to participate in the VCSP if any
member of the affiliated group is under employment tax audit.
• Orgs that have not filed 1099s for 3 years may participate through June 30,
2013.
21
C&U Final Report
Retirement Plan Issues
Reasons for Wage adjustments:
• IRS looked at retirement plan reporting in 8 of the exams,
and found problems at half of those institutions.
• Results: deferred compensation-related wage adjustments
on Forms 941 and 1040 of $1,115,007, generating
$201,298.00 in taxes and $12,036.74 in penalties.
• contributions that had to be taken into income in current
years because the payments were not conditioned upon the
future performance of substantial services sufficient to
convey a substantial risk of forfeiture under section IRC
457(f)(3)(B).
22
C&U Final Report
Retirement Plan Issues
Reasons for Wage adjustments:
• loans from 403(b) plans exceeded IRC 72(p) limits so that
deemed distributions were included in gross income.
• deferrals for a 403(b) plan exceeded IRC 402(g) limits.
• additions to a 403(b) plan exceeded IRC 415(c) limits.
• is your institution fulfilling its affirmative duty to test for
the aggregated IRC 415(c) limits?
23
IRS Finalizes Program for
Pre-Approval of 403(b) Plan Documents
• On March 28, 2013, the IRS finalized the program for
pre-approval of prototype and volume submitter
403(b) plan documents first announced in 2009.
• See Rev. Proc. 2013-22; IRS Announcement 2009-34
• Vendors who expect a plan to be adopted by at least
30 employers may submit the applicable plan
document(s) to the IRS for pre-approval, beginning
on June 28, 2013.
24
Update re Supporting Organizations
• On December 28, 2012, IRS issued final and temporary
regs re: requirements to qualify as a Type III SO that is
“operated in connection with” one or more supported
organizations.
• The IRS also issued a Notice of Proposed Rulemaking,
withdrawing portions of the one published in September
2009, regarding the payout requirements for nonfunctionally
integrated
(NFI)
Type
III
SOs.
• NFI Type III SOs must annually distribute the greater of 85% of
adjusted net income or 3.5% of the FMV of the SO’s non-exemptuse assets. Final regs allow set-asides approved in advance by IRS
to count toward the distributable amount.
25
IRS Confirms Deductibility of
Contributions to
Domestic Disregarded LLCs
• On July 31, 2012, the IRS confirmed that donors may
claim charitable deductions for their contributions to
domestic disregarded LLCs that are wholly owned and
controlled by U.S. charities.
• The Service remains silent on the issue with respect to
disregarded entities organized under foreign law, leaving
the treatment of those entities to be determined under
the existing regulations.
• IRS Notice 2012-52
26
Charitable Solicitation
Check List
• Changing Landscape
• Increase in use of social media
• Changes in the manner of giving
• Increase in the number of individuals reached
• State-by-State Registration Requirements
• Unified Registration Statement(URS) –
http://www.multistatefiling.org
• Discussion Handout – summary of state-by-state requirements
• National State Attorneys General Program at Columbia
Law School
• Charities Oversight and Regulation Project
27
Assorted Recent Developments (ARD)
• PLR 201306023 – Cap Gain Exclusion for Condo Sales per IRC
512(b)(5)
• US v Quality Stores IRS files Cert Petition to USSC over 6th Circuit
loss that severance pay not “wages” for FICA
• PLR 201251019 – No UBIT on ticket sales to read-aloud events for
(c)(3) reading/literacy EO; detailed IRC 513 analysis
• Notice 2012-52 – Charitable deduction allowed to SMLLC
• IRS Pub 598, Tax on Unrelated Business Income of Eos
• O’Connor v Commr TCM 2012-317 – Pay to clinical trial/med study
participants properly reported on Form 1099-MISC
ARD
• PLRs 201311032/201311036 – Endowment Unit/Trust
Arrangement: No UBIT for (1) making/receiving unit
payments; (2) holding/redeeming units
• IRS INFO Ltr 2013-0001 (1/15/13) – EOs use of Internet for
Fundraising OK; reference IRS Pub 4221-PC, Compliance
Guide
• Villareale v Commr TCM 2013-74 – charitable ded disallowed
for failure to substantiate $250/more per IRC 170(f)(8)
• IRS Pub 526 (Rev’d 2012), Charitable Contributions
• IRS Pub 571 (Feb 2013), Tax Sheltered Annuity Plans For
Public Schools/TE Orgs under IRC 403(b)
ARD
• PLR 201222040 – No UBIT for Xsactions between Supporting and
Supported Orgs/Asset, Personnel, Facilities and Services
• PLR 201222043 – No UBIT for EO/Labor Union (c5) offering
pharmacy benefit program to members
• PLR 201250025 – No UBIT for Income from Clinical DB operation
for a Regional Health Information Exchange AND No Private
Inurement/Benefit for Merit Based Comp to Drs.
• Mohamed v Commr, TCM 2012-152 – Real Prop donation to
CRUT disallowed if Donor Performs “Qualified” Appraisal
• PLR 201224036 – Marijuana Dispenser Cannot be (c)(3)
Joint Ventures Revisited
• Defn: Partnership between/among two or more parties in
which each party contributes assets and/or expertise.
• Four JV Types: Ancillary (limited portion of assets/services
of EO); Whole Venture (all or subtantially all of the assets of
the EO); Exempt-Only Arrangements (between/among
EOs); Investment-Type (EO in a limited/passive capacity).
• IRS Administrative Guidance: Rev. Rul. 2004-51 – LLC with
equal (50/50) EO/Taxable Ownership to conduct “distance
learning” program; “Control” of the JV by the EO is not as
critical as the EO’s control of the educational activity (the
activity that furthers the EO’s purpose) See, also, PLR
200610022 (Scholarly Journal/For Profit Publisher – No
UBIT)
JVs
• Prior Case Law:
Redlands Surgical Services, Inc.
(9th Cir) – EO must maintain effective control of the JV;
• St. David’s Health Care System v. US, (5th Cir) – EO will
lose exempt status “if it cedes control to the for-profit
entity.”
• Beware the MOOCs! Consider the terms of the
Participation
Arrangement
to
Evaluate
Tax
Consequences
Questions?
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