Historically, compliance in the exempt organization area has not been a high priority for the IRS. Few organizations were audited, and the Service rarely used its available tools (such as the imposition of intermediate sanctions). Certainly, the IRS pledged a greater focus on perceived abuses by the exempt-organization sector. And for a number of years, practitioners have routinely advised exempt-organization stakeholders of the latest IRS concerns and assertions of enforcement and preached that the pressure was mounting to ensure that organizations were complying. However, the exempt community noted that there was little enforcement and so did not heed the IRS or the practitioners.
Action Replacing Rhetoric
Recently, however, the IRS has begun communicating the areas on which it will focus, followed by plan implementation. Commissioner Mark W. Everson has stated: “We’ve placed renewed attention and added resources in the charitable arena to help protect the integrity and maintain faith in the charitable sector.…[W]e are taking important steps to combat abuse in exempt organizations.” He noted in the Service’s Fiscal Year 2006 Enforcement and Service Results that audits of exempt organizations were at their highest level since 2000 (see www.irs.gov/newsroom/article/0,,id=164435,00.html).
Why the Change in Approach?
The change in activity can be attributed to at least three factors that have provided the IRS with the tools it needs to mount an effective compliance campaign:
A Congress that has been much more rigorous in its approach to curbing perceived abuses in the charitable-organization sector.
The development of modern tools to allow for more efficient inquiries and examination efforts.
Electronic filing can provide electronic data to support efforts in a manner heretofore not available.
Congress and the IRS as Co-Players
Both Congress and the Service have over the past several years focused on creating transparency within exempt organizations (charities in particular) and curbing perceived abuses by the exempt-organization sector. Improving the nonprofit sector’s accountability, governance, oversight and ethical conduct is a primary focus of the IRS, the Senate Finance Committee, the Joint Committee on Taxation and state officials. Senate Finance Committee Chairman Max Baucus, D-MT, and committee member Senator Charles Grassley, R-IA, have played major roles in placing renewed emphasis on compliance and other issues affecting tax-exempt organizations.
Legislative initiatives: Abuse in various areas prompted provisions in the Pension Protection Act of 2006 (PPA ’06) relative to exempt organizations; many of the changes to the 2006 Form 990, Return of Organization Exempt from Income Tax, were a direct result of these provisions. The PPA ’06 provided for the doubling of certain fines, including excess-benefit transaction penalties, and required that Form 990-T be made available for public inspection. Key provisions of PPA ’06 that resulted in additional Form 990 information reporting include:
Transactions between controlling and controlled organizations must be reported on Form 990.
Supporting organizations must file Form 990 and report their Type I, II or III non-private foundation status, along with a list of their supported organizations and the amount of support provided.
Exempt organizations with donor-advised funds must report contributions to the funds, grants paid from the funds and total number of funds owned and aggregate value at year end, among other items.
For tax periods beginning after 2006, exempt organizations with gross revenue of less than $25,000 (which were previously not required to file returns) must file Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ (an electronic notice advising the IRS of their status). Failure to file this notice for three consecutive years will result in revocation of tax-exempt status.
Focus on governance: In addition, good governance by exempt organizations is now being stressed, just a few years after the Enron scandal made it mandatory for public companies. Form 990 now asks if organizations’ boards maintain a conflict-of-interest policy. The Service also published “suggested governance guidelines” to ensure that exempt organizations remain ethical and are focused on using assets for exempt purposes. Organizations following these good governance guidelines should satisfy regulators, the IRS and the public with their transparency.
Specific compliance initiatives: Another major focus of the Service since 2004 has been compensation. The IRS sent compliance check letters to more than 1,200 exempt organizations whose Forms 990 or 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation, were missing information relative to executive compensation. Approximately one-third of these organizations amended their forms. The Service conducted almost 800 examinations, requesting that organizations establish a rebuttable presumption of reasonable compensation for their executives. Although the IRS found problems with only 25 of the organizations examined, the proposed excise tax assessments amounted to more than $21 million. The third prong of the Service’s study focused on executive loans. Results of these examinations are expected soon.
Tax-exempt hospitals have also been receiving attention from the IRS, which has sent compliance check questionnaires to more than 500 randomly selected hospitals. The questionnaire focuses primarily on community benefit and charity care policies and practices as well as compensation. Although the Service has yet to publish official results, it appears that increased scrutiny will be placed on community benefit and charity care, to the point of revising Form 990 or creating a new form to include such specific information. Many states will also be looking to disallow exemption from real estate taxes based on charity-care criteria.
Development of Efficient Compliance Processes
In 2004, the IRS Exempt Organization Division developed two important new units: the Exempt Organization Compliance Unit (EOCU) and the Data Analysis Unit (DAU). The EOCU was initially established to review Form 990s and make appropriate contact with exempt organizations regarding any areas of noncompliance. The EOCU uses nontraditional compliance contacts and has been instrumental in EO Division efforts with respect to the hospital questionnaire, the executive compensation questionnaire, and compliance efforts aimed at credit counseling agencies. Prior to 2004, the Service was not in a position to perform any of these compliance contacts. In fiscal year 2006 alone, the number of compliance checks completed by the IRS numbered more than 5,000.
The DAU consists of economists, statisticians and research analysts who use the Internet and other sources to assess trends and gather research data to enable audit units to be more strategic with respect to both the entities that they plan to audit and the issues on which they will focus their audit efforts. The DAU research and analysis are key in making certain that the most appropriate targets are selected for audit and enforcement.
What Can the Exempt Community Expect Next?
Each year the IRS issues its year in review and its agenda for the upcoming year in its Implementing Guidelines publication. The most recent guidelines, issued in November 2006, stated the Service’s areas of focus for the exempt organization sector for 2007 (see www.irs.gov/charities/article/0,,id=164214,00.html). Compliance efforts will focus on the following areas:
|Critical Initiatives||New Projects|
|Credit counseling||Employment taxes|
|Executive compensation||Telephone excise tax|
|Tax-exempt hospitals||Supporting organizations|
|Down-payment assistance||College and university unrelated business income tax (UBIT) project|
Given the increased scrutiny from the IRS, regulators and the public, exempt organizations should be proactive in reviewing their policies and documentation procedures. Stakeholders of charities and other exempt organizations should assess their organizations. All should review the Senate Finance Committee and Independent Sector proposals, as well as the IRS Implementing Guidelines, and determine where their organizations fall short. Organizations should consider instituting the Service’s good governance practices and focus on the IRS hot topics of the past few years. All exempt organizations—not just hospitals or colleges and universities—should be documenting a rebuttable presumption for their executive compensation and reviewing their activities for potential unrelated business income issues. All Form 990 items should be completed and answered with a view toward transparency. With websites such as www.guidestar.org providing the public with information about nonprofits, the whole world may be watching.