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WHAT TO DO IF THE IRS COMES KNOCKING
The Perspectives of a Former Director
Marcus S. Owens
Loeb & Loeb, LLP
Washington, DC
202-618-5014/[email protected]
PART I – INSTITUTIONAL CHANGE
I. Introduction
Since May 2013, the Internal Revenue Service, and the Exempt Organizations
Division in particular, has undergone extraordinary change. For perhaps the first time
in the history of the agency, virtually all senior management responsible for tax
administration in a particular area have been removed, replaced or retired, beginning
with the Acting Commissioner. The developments are clearly having a dramatic
impact on the operations of the function.
II. Historic Rhythm of Government/Exempt Organizations Relations
In view of recent developments, it seems appropriate to provide some context for the
efforts of the IRS to conduct oversight of charities, and other tax-exempt
organizations. As will become clear, the role of government in overseeing tax-
exempt organizations has been part of many significant developments in US history, a
fact that has been echoed in recent developments involving section 501(c)(4)
organizations and politics. While the modern oversight structure only dates from the
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Tax Reform Act of 1969 and the Employment Income Security Act of 1974, the
antecedents of the system reach back into legal history.
One common starting point is the Statute of Charitable Uses, passed by the English
Parliament in 1601. The Statute, whose full name was “An Acte to Redress the
Misemployment of Landes, Goodes and Stockes of Money heretofore Given to
Charitable Uses,” included a preamble setting forth how the Parliament intended the
“misemployment” of charitable resources. In essence, the preamble listed those
activities considered to be charitable in England, circa 1601.
Much later, in the 1940s, the IRS imposed the requirement of an annual information
return, the Form 990, on certain tax-exempt organizations, including charities. In the
wake of aggressive commercial exploitation, including the operation of the Mueller
Macaroni Company as a tax-free mechanism to support New York University Law
School, Congress enacted the Revenue Act of 1950, which incorporated an income
tax on the “business” income of otherwise tax-exempt organizations and also made
the Form 990 a public document. Beginning in the 1950s, the IRS found itself
playing a role in racial desegregation, as reflected in litigation involving Prince
Edward School Foundation, the Little Rock Private School Corporation, and other
examples of “Massive Resistance” to desegregation. By the 1970s, the IRS was
dealing with a permanent injunction against recognizing racially-discriminatory
private schools in Mississippi as tax-exempt, followed by the extraordinary
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procedural history of Bob Jones University v. United States.1 In addition to
desegregation, the IRS became embroiled in anti-Viet-Nam tax protests, mail-order
ministries and the Iran/Contra Affair. The controversy engendered by the Citizens
United decision is only the latest in a long line of matters that cements the link
between tax-exempt organizations and many of the seminal events in US society.
III. Background: The Great Brouhaha of 2013
On May 10, 2013, the Director of the Exempt Organizations Division, Lois Lerner,
announced at an American Bar Association Tax Section that she wanted to apologize
for improper handling of applications for exemption from “tea party” groups.2 The
announcement was followed by the release of a report on May 14 by the Treasury
Inspector General for Tax Administration (“TIGTA”) on the processing of
applications for exemption under section 501(c)(4) of the Internal Revenue Code3
from “tea party,” “tea party patriots,” and “9/12” groups.4 The report was silent on
the extent to which other types of organizations received similar handling. The
request to TIGTA to undertake its review alleged that the IRS was “targeting” certain
organizations and the report, itself, repeated the incoming characterization. Lois
Lerner’s announcement and the TIGTA report triggered a quick and strong reaction
1 461 U.S. 574 (1983).
2 Weisman, I.R.S. Apologizes to Conservative Groups over Application Audits, New York Times, May 11, 2013, at
A11. http://www.nytimes.com/2013/05/11/us/politics/irs-apologizes-to-conservative-groups-over-application-audits.html?action=click&module=Search®ion=searchResults%230&version=&url=http%3A%2F%2Fquery.nyt
imes.com%2Fsearch%2Fsitesearch%2F%23%2Flois%2Blerner%2Bpersonnel%2Bchanges%2F 3 All section references are to the Internal Revenue Code of 1986, and amended (the “Code”), and all regulatory
references are to the Treasury Regulations currently in effect under the Code (the “Regulations”). 4Treasury Inspector General for Tax Administration, Inappropriate Criteria Were Used to Identify Tax-Exempt
Applications for Review, May 14, 2013, Ref. No. 2013-10-053.
http://www.treasury.gov/tigta/auditreports/2013reports/201310053fr.pdf
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from the White House,5 which called for a Department of Justice investigation,
6 and
Congress, which reacted with demands for records and interviews of employees,
followed by days of hearings.7 As the hearings and investigations progressed,
however, it became clear that other groups, including progressive organizations and
non-political groups had also been “targeted” for close review. As the summer drew
to a close, Steven Miller, the Deputy Commissioner, Services and Enforcement, and
Acting IRS Commissioner, Joseph Grant, the Commissioner, Tax Exempt and
Government Entities, Lois Lerner, the Director of the Exempt Organizations
Division, and Holly Paz, the Director of the Rulings & Agreements Office in the
Exempt Organizations Division, had all been replaced, retired, or placed on
administrative leave. The offices were filled with lateral appointments from areas
outside the Tax Exempt and Government Entities function; Heather Maloy was
named Deputy Commissioner, Michael Julianelle was named Commissioner, Tax
Exempt and Government Entities, Kenneth Corbin was named Acting Director of the
Exempt Organizations Division, and Karen Schiller was named Acting Director of
Rulings and Agreements. Daniel Werfel, then at the Office of Management and
Budget, was appointed Acting Commissioner and then Principal Deputy
5 Shear and Wesiman, Obama Dismisses New Benghazi Furor But Condemns I.R.S., New York Times, May 14,
2013, at A1. http://www.nytimes.com/2013/05/14/us/politics/obama-addresses-benghazi-and-irs-controversies.html?pagewanted=1&contentCollection=Homepage&t=qry613%23/lois%20lerner%20obama/365days
/&version&action=click®ion=Masthead&module=SearchSubmit&url=http://query.nytimes.com/search/sitesearch/?action=click&pgtype=Homepage 6Weisman, Acting Chief of I.R.S. Forced Out Over Targeting of Tea Party, New York Times, May 16, 2013, at A1.
http://www.nytimes.com/2013/05/16/us/irs-says-counsel-didnt-tell-treasury-of-tea-party-scrutiny.html?pagewanted=all&action=click&module=Search®ion=searchResults%231&version=&url=http%3A%2F%2Fquery.nytimes.com%2Fsearch%2Fsitesearch%2F%3Faction%3Dclick%26region%3DMasthead%26pgty
pe%3DHomepage%26module%3DSearchSubmit%26contentCollection%3DHomepage%26t%3Dqry613%23%2Flois%2Blerner%2Bobama%2F365days%2Fallresults%2F2%2F 7Testimony of the Honorable J. Russell George, Treasury Inspector General for Tax Administration, Hearing Before
the Committee on Appropriations, Subcommittee on Financial Services and General Government, June 3, 2013. http://www.treasury.gov/tigta/congress/congress_06032013.pdf
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Commissioner upon the resignation of Steve Miller. Werfel quickly developed and
released a series of action papers designed to address delays and other aspects of the
processing of applications for tax exempt status under section 501(c)(4) of the Code –
a group of approximately 80 organizations.8 Shortly thereafter, members of Congress
requested a similar review of the examination process, including the identification of
tax-exempt organizations for audit.
IV. The Winds, Breezes, and Slight Air Puffs of Change
While the IRS went into hibernation in the wake of the Brouhaha, the agency had
been moving in that direction for a number of years, at least with regard to
enforcement. The IRS Data Book for 2014, in Table 13, reports that in FY 2014, the
Exempt Organizations Division closed audits of 2,825 Forms 990, 990-EZ, 990-PF,
1041-A, 1120-POL and 5227. That number does not correspond to the number of
organizations that were reviewed, as often an IRS examination will involve multiple
years. On February 22, 2016 the IRS released exempt organizations enforcement
statistics for FY 2015, together with the same data for the preceding nine years. The
data reflect a steady decline in IRS exempt organizations enforcement activities since
2011.
Up through the 2013 Fiscal Year, the IRS followed a practice of disclosure and
transparency with regard to its enforcement activities. The practice, established
8Internal Revenue Service, Report Outlines Changes for IRS to Ensure Accountability, Chart a Path Forward;
Immediate Actions, Next Steps Outlined, IR 2013-62, June 24, 2013. http://www.irs.gov/uac/Newsroom/Report-Outlines-Changes-for-IRS-To-Ensure-Accountability,-Chart-a-Path-Forward;-Immediate-Actions,-Next-Steps-Outlined
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during the late 1970s, included the public release of the annual official training text
for Exempt Organizations revenue agents and determination specialists. Shortly
thereafter, the IRS began releasing the annual “workplan” for the field offices, then
known as Key District Offices, that had responsibility for exempt organizations
enforcement activity. In the pre-Internet age, the public dissemination was
accomplished by simple step of placing copies of the training publications and the
workplans in the IRS Freedom of Information Reading Room. Until the IRS
reorganization that was a result of the IRS Restructuring and Reform Act of 1998,9
the publicly-released Exempt Organizations workplan consisted of a copy of the
actual memorandum sent by the Exempt Organizations Division in the IRS National
Office to the Key District Offices setting forth instructions regarding the allocation of
enforcement resources by issue or category of tax-exempt organization, and thus
carried a high level of credibility. For example, at various times, audit projects set
forth in the workplan included large private foundations, colleges/universities and
hospitals. The audit projects might also be identified by reference to the Internal
Revenue Code section, e.g., the compliance with the unrelated business income tax
rules by social clubs exempt under section 501(c)(7). The topics addressed in the
annual IRS training materials that were released in conjunction with the workplan
tended to mirror the areas of focus in the workplan, together with other topics deemed
important for revenue agents to know. Both documents were issued internally and
publicly in the early fall during the first month of the new government fiscal year. In
the wake of the implementation of the 1998 Restructuring Act, the workplans that
9 IRS Restructuring and Reform Act of 1998, also known as the Taxpayer Bill of Rights III, Pub. L. 105-206, 112
Stat. 685, enacted July 22, 1998.
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were publicly-released began to shift from the actual “marching orders” for IRS
revenue agents to an overview or summary of key issues and concerns prepared
specifically for public release. The date of release also began to shift, moving closer
to the start of the calendar year. Release of comprehensive training materials ended
with the termination of the production of the annual training text. The last edition
was for the 2004 fiscal year.
V. Management Changes
Since May, 2013 an extraordinary number of management changes have occurred at
the IRS, beginning with the IRS Commissioner and including the following:
A. Personnel10
IRS Commissioner: John Koskinen
Deputy Commissioner for Services & Enforcement: John Dalrymple
Commissioner, Tax Exempt & Government Entities: Sunita Lough
Deputy Commissioner, Tax Exempt & Gov’t Entities: Donna Hansberry Senior Technical Advisor to TEGE Commissioner: Eric San Juan
Director, Exempt Organizations Division: Tamera Ripperda
Director, EO Rulings & Agreements: Jeffrey Cooper
Director, EO Examinations: Margaret Von Lienen - Nan Downing, the current
director, will become Assistant Deputy Commissioner, TE/GE-GE/Shared
Support, which is a new position.
10
http://www.irs.gov/Charities-&-Non-Profits/About-IRS-Exempt-Organizations
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B. Structural Changes – The Disaggregation of EO Tax Administration
In a dramatic change from the historical organizational structure, the new Director
of the Exempt Organizations Division has been relocated to the Cincinnati Office.
This change in location appears to reflect a determination that reducing the
backlog of applications, totally approximately 80,000 as of the end of February,
has been given a high priority.11
In addition, the IRS announced on March 20,
2014, that it will be realigning the EO rulings function within the agency by
moving attorneys currently in the Exempt Organizations Division and the
Employee Plans Division to the Office of the Assistant Chief Counsel, TEGE,12
as
well as restructuring the office of Chief Counsel. That realignment occurred in
January 2015, and is reflected in new set of annual revenue procedures issued on
January 2, 2015 – Revenue Procedures 2015-1 through 2015-5 and 2015-8.
Private letter rulings are now issued by the Office of Chief Counsel (TE/GE) and
subject to the user fee schedule issued by Chief Counsel (currently a private letter
ruling from Chief Counsel requires a user fee of $28,300.
VI. New Kids on the Block – Philosophy of Tax Administration
Starting in the fall of 2014, the IRS began releasing a number of tax administration policy
statements reflecting a considerable amount of strategic planning which is manifesting
itself in the Future State Initiative13
and in a series of pronouncements on tax
enforcement/administration, beginning with a strategic plan and more recently, a
11
Supra at Note 7. 12
Clark, IRS Reorganizes Division at the Center of Controversy, Government Executive, March 21, 2014. http://www.govexec.com/management/2014/03/irs-reorganizes-division-center-controversy/81058/?oref=river 13
https://www.irs.gov/uac/Newsroom/Future-State-Initiative
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document entitled “IRS Enterprise Concept of Operations (CONOPS).”14
The Future
State Initiative is essentially a manifesto of the need to adapt to changing conditions
through the increased incorporation of technology into tax administration. For TE/GE,
the Future State Initiative highlights the Lean Six Sigma review of determination letter
processes in Exempt Organizations and developing web-based solutions for taxpayer
service and outreach.
A. Strategic Plan FY 2014-201715
The Strategic Plan is a 40-page document that sets out very high level
“Objectives,” “Goals” and “Long Term Measures,” beginning with “Strategic
Foundation for Organizational Excellence” composed of six Objectives. The
second Goal is to “Deliver high quality and timely service to reduce taxpayer
burden and encourage voluntary compliance.” The language used includes
phrases such as “seamless, multichannel service environment to encourage
taxpayers to meet their tax obligations” and the “use of a holistic view of taxpayer
interactions to provide a coordinated, consistent experience across all channels.”
Presumably, further details will be eventually forthcoming. The other Goals are
to “deliver high quality and timely service to reduce taxpayer burden and
encourage voluntary compliance,” with seven Objectives, and to “Effectively
enforce the law to ensure compliance with tax responsibilities and combat fraud,”
with six Objectives. The third Objective under the “effectively enforce” Goal is
to “build and maintain public trust by anticipating and addressing the tax-exempt
14
http://www.taxnotes.com/tax-notes-today/tax-system-administration/irs-presentation-describes-future-operations-concepts/2016/02/22/18245431 15
https://www.irs.gov/uac/Strategic-Plan-and-Other-References
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sector’s need for a clear understanding of its tax-law responsibilities.” It appears
that the three paragraphs of this Objective are the only references to tax-exempt
organizations in the Strategic Plan. Notably, the paragraphs do not reference
enforcement or oversight, but rather speak in terms of taxpayer education,
ensuring transparency, expediting and improving issue resolution and addressing
efficiency and productivity in the determination process. That having been said,
the Long Term Measures do attempt to quantify enforcement through
development of an index of enforcement activities that “promote compliance yet
do not focus primarily on increasing tax revenue.” The process is intended to
assess changes in a manner similar to the way the Consumer Price Index reflects
changes in consumer prices. Trends in the IRS’ nonrevenue performance will be
assessed by examining changes in the “nonrevenue enforcement activity index
(“NEAI”). The NEAI will be computed as an index with an average for 2003-
2005 set equal to 100. The NEAI is weighted two-thirds for TE/GE matters and
one-third for Bank Secrecy Act matters, with the index being calculated as the
sum of the number of activities resulting in corrective action x weight x
100/average for FY 2003-2005. The goal is to exceed the 2003-2005 average by
10%.
B. IRS Enterprise Concept of Operations (CONOPS): Overview of SB/SE and
W&I, LB&I, and TE/GE CONOPS16
The CONOPS overview is a 27-page PowerPoint style document that endeavors
to set forth reasons why the IRS is “transforming compliance and services” in
16
IRS Enterprise Concept of Operations (CONOPS) – Overview of SB/SE and W&I, LB&I and TE/GE CONOPS. http://www.taxnotes.com/tax-notes-today/tax-system-administration/irs-presentation-describes-future-operations-
concepts/2016/02/22/18245431
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response to both internal and external factors. The document is dated January 15,
2015, but apparently wasn’t publicly released until late February 2016. The four
factors identified in the document are:
1. Evolving taxpayer expectations.
2. Increasing complexity of tax administration from both the standpoint of
legislative changes and from the proliferation of data.
3. A declining IRS budget, coupled with increasing demands for a “return on
investment” and a stagnant tax gap, are putting pressure on the agency to increase
revenues and lower costs.
4. Increasing incidence of refund fraud schemes and identity theft over the last
three years.
The four factors drive the IRS towards a systematic review of its operations and
essentially a five-year plan to address the concerns identified. Each of the IRS
Business Operating Divisions’ five year plans reflect six themes:
1. Data-Centric Operations
2. Simplified Taxpayer Experience
3. Expanded Partnerships with Tax Community
4. Compliance Risk-Focused Operations
5. Flexible and Well-Supported Workforce
6. Strategic Workload Allocation
The unique challenges presented by TE/GE were identified as “parallel operations
across diverse programs with varied taxpayer groups” and “significant external
stakeholder involvement and public scrutiny.” No surprises here for anyone aware
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of the 29 different bases for federal tax exemption reflected in the subsections
under section 501(c) of the Internal Revenue Code or the disclosure rules
applicable to the Form 990. Finally, the CONOPS identifies three priorities for
TE/GE: 1) A portfolio of “tools, education and partnership opportunities” to
increase taxpayer compliance, 2) A “sharper focus” on significant misconduct and
other aggressive behavior, and 3) Use of “data analytics capabilities to support
including examinations, compliance checks, and office/correspondence audits.
C. IRS TE/GE Concept of Operations (CONOPS)
The TE/GE function has expanded its CONOPS, as set forth in the January 15,
2015 Agency-level summary, and has released its analysis in an 83-page
PowerPoint-style document dated December 31, 2014, but apparently publicly
released in February 2016.17
The TE/GE CONOPS echoes and expands on the themes set forth in the higher-
level agency-focused document. It does expand in interesting directions, and
includes the following descriptions of TE/GE Future Vision:
“E-filing facilitates taxpayer submission of forms online”
“External stakeholder collaboration provides taxpayers with additional
support from external subject matter experts” [note: does this mean that
the IRS will help pay for private attorneys and accountants to help tax-
exempt organizations?]
“Tailored digital information answers specific inquiries quickly”
17
http://www.taxnotes.com/tax-notes-today/tax-system-administration/irs-releases-concept-future-operations-
tege/2016/02/22/18245446
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And finally: “Data analytics enable TE/GE to more precisely identify non-
compliance, limiting the likelihood of examinations for the average
compliant taxpayer”
The TE/GE CONOPS document identifies a number of “gaps” in IRS
capabilities, including:
“TE/GE-wide understanding of its stakeholders and levers/synergies that
could be used to increase engagement”
“Ability to use social media to engage with and gather input from
stakeholders”
At points, the CONOPS document touches on enforcement-related
matters, such as a “work area” that is described as “Sensing and Trend Analysis.”
It is further described as an operating model and process to identify and collect
external data to support TE/GE business decision-making processes, and gather
relevant data through stakeholder interactions and media channels. The CONOPS
also proposes a new “soft notice” called a “compliance risk notice,” or, in the
words of the IRS, “compliance risk notice efforts are directed primarily toward
taxpayers who are considered to be at risk for common or emerging compliance
issues.” Another novel development, apparently inspired by the Transportation
Security Administration’s Pre-Check Program, will be to create a “Trusted
Taxpayer Status” which will be achieved by submitting “additional, TE/GE
identified tax documentation.” TE/GE asserts that the documentation will enable
the agency to quickly assess the probability of the taxpayer’s future compliance
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and determine whether or not they are eligible for “trusted status.” “Trusted
status” will mean that the organization has a lower risk of facing an examination.
In terms of workload management, the TE/GE CONOPS contemplates that cases,
presumably, examination cases, will be “identified centrally,” which the agency
believes will permit it to better focus examination resources on the “next best
case,” presumably, wherever it is geographically located.
The final page of the 83-page document is actually grounded in reality, as it lists
the potential risks to implementation of the CONOPS strategy. The five risks are:
1) IRS executive support for initiatives and work areas may decline or shift over
time, 2) internal stakeholders may not buy-in to the future vision, 3) performance
measures may not be accurate or sufficiently well-defined to measure success, 4)
elements of the change may hinge on legislative changes, and 5) limited funding
may not support new technology investments. The list is prescient, as the risks
have arisen in the past with regard to new initiatives, e.g. quality circles and
market segment studies,
D. TE/GE Program Letter FY 2015
On November 5, the TE/GE Commissioner , notably not the Exempt
Organizations Division Director, issued the “TE/GE Program Letter,” setting
forth the function’s key areas of focus for FY 2015 that will be used to meet the
goals and objectives set forth in the Strategic Plan. The focus areas are:
“Continuous Improvement,” “Knowledge Management,” “Employee Engagement
and Development,” “Data-Driven Decision-Making,” and “Risk Management.” In
essence, the Program Letter appears to be a statement of
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management/administrative philosophy rather than a directive to undertake
specific program activities or address particular tax compliance issues. In that
regard, the TE/GE Program Letter is in contrast to the Criminal Investigation
Annual Business Plan, which is that function’s public statement about how it
intends to meet the Strategic Plan. The Criminal Investigation Business Plan
identifies specific areas of compliance concern, such as identity theft, return
preparer fraud, and questionable refund, as well as the use of virtual currency to
move illegal monies.
E. TE/GE Priorities for FY 201618
The IRS has released its “TE/GE Priorities for FY 2016,” although the actual
date of the document is uncertain, given the current TE/GE practice of not dating
many policy-related releases. The document is essentially an update on the FY
2015 Program Letter, but with the addition of references to particular issues of
concern. As a result, the document is more informative than the FY 2015 version;
it is, however, a very high-level document intended as a public relations tool
rather than an actual directive to TE/GE offices and employees. The TE/GE
Priorities document has, as an appendix, a “workplan briefing” on Exempt
Organizations. The Appendix does contain a single page of developments and
plans for exempt organizations examinations, including discussion of compliance
strategy and a list of five strategic issue areas. The compliance strategy consists
of a three-part plan:
1. Determining the coverage of all major subsections and size of organizations by
stratifying the universe of exempt organizations into major subsections and
18
https://www.irs.gov/Government-Entities/Tax-Exempt-&-Government-Entities-Division-At-a-Glance
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allocating anticipated new examination cases among each subsection and asset
class.
2. Determining issues to focus on through a data-driven approach where we will
identify the highest risk areas of non-compliance through the use of EO return
data and historical information.
3. Identifying areas of high non-compliance risk through stakeholder input,
reliable outside data and public information.
The strategic issue areas are:
1. Exemption: the issues include non-exempt purpose activity and private
inurement, enforced primarily through field examinations.
2. Protection of Assets: the issues include self-dealing, excess benefit
transactions, and loans to disqualified persons, enforced primarily through
correspondence audits and field examinations.
3. Tax Gap: the issues include employment tax and unrelated business income
tax liability, enforced through compliance checks, correspondence audits, and
field examinations.
4. International: the issues include oversight of funds spent outside the US,
including funds spent on potential terrorist activities, exempt organizations acting
as foreign conduits, and Report of Foreign Bank and Financial Accounts (FBAR)
requirements, enforced through compliance reviews, compliance checks,
correspondence audits and field examination; and
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5. Emerging Issues: the issues include non-exempt charitable trusts and IRC
501(r), enforced through compliance reviews, correspondence audits and field
examination.
In addition, EO will review organizations that were recognized as exempt through
the streamlined determination process and the function will begin post-
determination compliance enforcement on organizations that utilized the Form
1023-EZ application to obtain exemption.
C. “Lean Six Sigma” Approach to Organizational Management
The IRS is approaching a redesign of the EO Division and the processes used for
tax administration using “Lean Six Sigma” concepts, a management assessment
protocol that focuses on eliminating waste (known as “muda” – a Japanese term
reflecting the origins of the assessment protocol in Toyota manufacturing
analysis).19
Lean Six Sigma focuses on eliminating what it defines as the eight
kinds of waste: defects, overproduction, waiting, non-utilized talent,
transportation, inventory, motion and extra-processing. Training for employees
implementing Lean Six Sigma concepts also reflects a Japanese influence in that
employees are assigned different “belts” reflecting different skill levels, e.g.
white, yellow, green, black and master black belts, similar to karate.
D. Emerging Issue Committee
In August 2013, the Acting EO Division Director at the time, Kenneth Corbin,
created a new function within the Division to better identify potential issues
19
http://en.wikipedia.org/wiki/Lean_Six_Sigma
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arising from the Division’s operations and make recommendations for an
appropriate response, e.g. training, guidance, coordination with other functions.20
The Committee was formed by expanding the size and role of the former EO
ATAT (Abusive Tax Avoidance Transactions) Committee. While it is not clear
how large the Emerging Issue Committee will be, it will represent a variety of
functions, including EO Examinations, EO Rulings & Agreements, Chief Counsel
TEGE, the TEGE Senior Technical Advisor, the EO Senior Technical Advisor,
the TEGE Fraud Specialist and the TEGE Assistant Promoter Coordinator. The
Committee will serve as the focal point for coordination of the issues within EO,
TEGE, Chief Counsel TEGE, other IRS divisions and other federal and state
agencies. The Committee Charter provides that meetings will occur on the fourth
Tuesday of each month, or more frequently as needed and that minutes will be
kept of the meetings.
VII. Determinations/Rulings Changes
A. General Processing Changes
Since the issuance of the Treasury Inspector General for Tax Administration
(TIGTA) report on the processing of applications for tax-exempt status from
organizations seeking section (c)(4) status, the EO Division has been reviewing its
processes for handling all types of applications, including those from
20
Corbin, The Emerging Issue Committee, Memorandum for all Exempt Organizations Employees, September 30, 2013. http://www.irs.gov/pub/foia/ig/spder/TEGE-07-0913-17%5B1%5D.pdf
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organizations seeking section 501(c)(3) status.21
Historically, the bulk of
applications received by the IRS have been for section 501(c)(3) status; for
example, in FY 2012 , the IRS processed 60,793 applications for tax-exempt
status, of which 51,748 were for section 501(c)(3) status. Of those, 45,029 were
approved, 123 were denied tax-exempt status and 6,596 were withdrawn, returned
as incomplete, failed to provide requested information or where the IRS refused to
rule. The nature of the changes being implemented, and the general status of the
implementation are regularly reported on the EO Division homepage on the IRS
website.22
B. Streamlined Application Processing Guidelines
On February 28, 2014, the EO Division released a memorandum setting forth
revisions to the processing procedures for applications for tax-exempt status that
were developed using Lean Six Sigma Organization concepts.23
The new
streamlined process appears to involve minimal evaluation of applications,
essentially the performance of a triage on the filings, dividing them into a group
of applications considered complete and in compliance with organizational and
operational requirements, a second group in which the information submitted
indicates defects in the organizing documents, for example, in the purposes clause
of articles of incorporation, or inadequate or ambiguous descriptions of planned
operations, but where “there was no clear evidence of an issue that would cause
21
Corbin, Interim Guidance on Initial Classification of Applications, Memorandum for all Employees – Exempt Organizations Determination Unit, September 30, 2013. http://www.irs.gov/pub/foia/ig/spder/TEGE-07-0913-
15%5B1%5D.pdf 22
http://www.irs.gov/uac/Newsroom/IRS-Charts-a-Path-Forward-with-Immediate-Actions 23
Martin, Streamlined Processing Guidelines for All Cases, Memorandum for Exempt Organizations Determinations and Exempt Organizations Determinations Quality Assurance, February 28, 2014. http://www.irs.gov/pub/foia/ig/spder/TEGE-07-0214-02%5B1%5D.pdf
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the organization to be denied exemption,” and a third category where there are
clear indications of noncompliance. Applications in the first category would be
approved without further consideration, applications in the second category would
not be asked to correct and submit revised organizational documents or submit
more detailed descriptions of activities, but would simply be asked to attest in
writing to having made appropriate changes to documents or that activities will be
within the parameters of the Code section for which exemption is requested.
Applications in the third category would be given a more in-depth review and
analysis.
C. Sample Questions for Applications
One focus of the criticism of the IRS processing of applications for exemption
under section 501(c)(4) was the intrusive or irrelevant nature of some of the
questions posed to applicants by the IRS. To help address that particular aspect of
the torrent of criticism the agency faced, a series of “sample” questions organized
around particular topics were released and placed on the IRS website.24
With the
enactment of the PATH Act, section 501(c)(4) organizations can avail themselves
of a simple registration process, although such groups may still file a Form 1024
application in order to receive a formal determination letter.
D. Auto-Revoked Organizations
One result of the wave of Congressional hearings, investigations and demands for
records was to distract the Exempt Organizations Division from its normal work.
The situation was exacerbated by the government budget constraints and the
24
http://www.irs.gov/Charities-%26-Non-Profits/Charitable-Organizations/Exempt-Organization-Sample-Questions
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sequester, which resulted in temporary furloughs of IRS employees. While the
backlog of applications had been building for some time, the distractions in the
summer and fall of 2013 resulted in an unprecedented inventory of unprocessed
applications for tax-exempt status, perhaps approaching 80,000 applications.25
A
significant number of those applications, perhaps 30%, were from organizations
whose tax-exempt status had been automatically revoked for failure to file Form
990 for three consecutive years, pursuant to section 6033(j). Section 6033(j) had
been enacted as part of the Pension Protection Act of 2006, and the impact began
to be felt by the nonprofit sector in 2009. While the most auto-revoked
organizations appear to have actually gone out of business, a substantial number,
over 25,000, are still in existence and filed new applications for exemption, as
required by the IRS.26
As the IRS realized the enormity of the auto-revoked
applications, special streamlined procedures were developed to help reduce the
backlog.27
VIII. Examination Changes
The focus of IRS restructuring and realignment efforts since the summer of 2012 has
fallen primarily on the processing of applications for tax-exempt status. While
application processing is a significant component of the Exempt Organizations
Divison’s responsibilities, most employees in the Division are actually engaged in the
examination function, that is, revenue agents who conduct audits of tax-exempt
25
Kalich and Eley, The IRS Introduces New Leadership and Initiatives to Practitioners in Baltimore,BDO Nonprofit
Standard, March 17, 2014. http://nonprofitblog.bdo.com/index.php/2014/03/17/the-irs-introduces-new-leadership-and-initiatives-to-
practitioners-in-baltimore/ 26
http://www.irs.gov/Charities-&-Non-Profits/Automatic-Revocation-of-Exemption 27
http://www.irs.gov/Charities-&-Non-Profits/Charitable-Organizations/Automatic-Revocation-How-to-Have-
Your-Tax-Exempt-Status-Retroactively-Reinstated
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organizations. In the Division’s Annual Report for FY 2012, the most recent one
available, 516 of the 900 employees in the Division were assigned to the examination
function, compared to 335 involved in the processing of applications, private letter
ruling requests and related operations.28
Recent reports, however, have suggested that
the number of actual revenue agents available to conduct examinations, as
distinguished from personnel involved in examination planning, management and
other activities in support of examinations, fell to 155.29
In recent remarks, the new
TEGE Division Commissioner, Sunita Lough, indicated that there would be no
publicly-released work plan for FY 2014, but that she hoped to issue one for FY
2015.30
IX. Strategies for Dealing with the Current Situation
The IRS administration of the Internal Revenue Code provisions applicable to tax-
exempt organizations is in a period of transition, and with all such periods, new
processes and procedures will require adjustment, as unintended consequences
emerge, particularly as the new organizational structure begins to address its
enforcement responsibilities. In the interim, there are steps that can be taken to both
benefit and protect tax-exempt organizations. Applications for tax-exempt status are
being processed very quickly; under two months even for the long-form Form 1023
filers, and activities that formerly would have been explored by the IRS with requests
for additional information are now being handled without such development. The
Form 1023-EZ filers have essentially a registration process. Given the velocity of the
application process, less rigorous review than in the past, and the fact that private
28
http://www.irs.gov/pub/irs-tege/FY2012_EO_AnnualRpt_2013_Work_Plan.pdf 29
Supra at Note 17. 30
Id.
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letter rulings on proposed transactions are now going to be processed by the Office of
Chief Counsel, with, no doubt, significant evaluation, existing tax-exempt
organizations that are planning to undertake new and substantial activities may want
to house those new activities in a new corporate entity that applies for IRC 501(c)(3)
status on its own, with a description of the new activity in sufficient detail to give rise
to put the IRS on notice and give rise to IRC 7805(b) relief in the event of a
subsequent challenge. Such a process would effectively protect the existing tax-
exempt organization’s status, while giving a sufficient measure of IRS approval to
enable the new activity to be initiated without the time, expense and close scrutiny
that a private letter ruling would entail. Private letter rulings on proposed transactions
will now be handled by the Office of Chief Counsel, TE/GE. Tax-exempt
organizations that request such rulings should expect that their requests will be given
closer scrutiny than that given to applications for tax-exempt status.
X. Next Steps?
The IRS has taken a series of major organizational and procedural steps, clearly
moving as quickly as it can to address the TIGTA Report recommendations and align
the Exempt Organizations Division and the Employee Plans Division with the
organizational structures of the rest of the IRS National Office. A measure of the
perceived urgency by the IRS is reflected in the fact that the changes are being
developed by a new cadre of senior management, many of whom do not have
significant experience in the function or with the tasks that it is required to perform in
administering the relevant sections of the Internal Revenue Code. In view of the huge
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amounts of funds flowing into the nonprofit sector, particularly to social welfare
organizations exempt under section 501(c)(4),31
the sense of urgency is likely well-
founded. The nonprofit sector and practitioners should be alert to developments, as
they are likely to occur quickly, and without an opportunity for public comment and
discussion.
31
Barker, How Nonprofits Spend Millions on Elections and Call it Public Welfare, ProPublica, April 18, 2012.
http://www.propublica.org/article/how-nonprofits-spend-millions-on-elections-and-call-it-public-welfare
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Part II – WASHINGTON UPDATE
A. Senate Developments
1. S. 2750, CHARITY Act (Charities Helping Americans Regularly Throughout the Year)
Provides that it is the sense of the Senate that encouraging charitable giving should be a
goal of tax reform, and Congress should ensure that the value and scope of the deduction
for charitable contributions is not diminished during a comprehensive rewrite of the tax
code. Expands the IRA rollover to include distributions to donor-advised funds. Requires
all tax-exempt organizations to file Form 990 electronically. Authorizes the Treasury
Department to align the standard mileage rate for the charitable contributions deduction
(for using a personal vehicle for volunteer charitable services)with the medical/moving
expenses deduction. Provides an exception from the excess business holding tax on private
foundations for certain philanthropic business enterprises. Excess business tax exception
applies if the philanthropic business enterprise satisfies the following:
-- Exclusive ownership requirement: all ownership interests in the business enterprise are
held by the foundation at all times during the taxable year, and all of foundation’s
ownership interests in the enterprise were acquired by will or trust
-- “All profits to charity” requirement: business enterprise must distribute to the
foundation an amount equal to its net operating income for the taxable year within 120
days of the close of the year
-- Independent operation requirement: prohibits certain interrelatedness between the
foundation and business enterprise
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2. S. 2648, CREATE Act of 2016
Prescribes a special rule to allow a creator of a qualified artistic charitable
contribution (i.e., any literary, musical, artistic, or scholarly composition, or similar
property, or the copyright thereon, or both, contributed to a tax-exempt charitable
organization) to deduct the fair market value of the contribution from gross income.
B. House of Representatives Developments
1. H.R. 4907, Grow Philanthropy Act
Legislation would amend Section 408(d)(8)(B)(i) to permit tax-free distributions from
individual retirement plans to donor-advised funds. Legislation would apply to
distributions made in taxable years beginning after December 31, 2016.
2. H.R. 4706, Interest for Others Act of 2016
Facilitates charitable donations of small amounts of dividends and interest income.
New Code section 139F would exclude from gross income up to $50 of interest and
money market fund dividend income payments donated to charity. Modifies the
requirements relating to the reporting of such payments so that banks are not required to
issue Form 1099- INT reporting on small amounts.
3. H.R. 4311, Protecting Charitable Contributions Act of 2015
Provides that the definitions and regulations in effect on January 1, 2015, relating to the
substantiation of deductible charitable contributions in excess of $250, shall apply on and
after the bill’s enactment date. Provides that the IRS shall not issue, revise, or finalize any
regulation, revenue ruling, or other guidance relating to such definitions and regulations
4. H.R. 4281, Charitable Giving Privacy Protection Act
Amends the Internal Revenue Code to prohibit the IRS from requiring or accepting the
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Social Security numbers of donors of charitable donations from donee organizations when
such organizations are providing substantiation of such donations.
C. President’s FY 2017 Budget Proposals
• Increase funding for the IRS by about $1 billion (9%), targeted to improve taxpayer
services and enforcement activities.
• Implement new requirements for filing returns
-- Require electronic filing for all Forms 8872 and Form 990 series tax and information
returns
-- Assess a $5,000 penalty for failure to comply with e-filing requirements
-- Accelerate the due date for filing Form 1099 and other information returns with the IRS
to January 31 and eliminate extended due date for electronically filed returns
• Impose a single excise tax rate of 1.35% on private foundations
• Consolidate contribution limitations for charitable deductions
-- Retain the 50% limitation for contributions of cash to public charities
-- Apply a 30% deduction limitation for all other contributions
• Extend the carryforward period for excess charitable contribution deduction amounts
from 5 years to 15 years
• Limit itemized deductions to 28% for high-income taxpayers
• Implement a new minimum tax, the “Fair Share Tax” (FST), on high-income taxpayers
-- FST = 30% of adjusted gross income, less a charitable credit of up to 28% of itemized
charitable contributions
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• Disallow the deduction for charitable contributions that are a prerequisite for purchasing
tickets to college sporting events
• Modify the standard mileage rate for automobile use by volunteers
-- Increase from statutory limit of 14 cents/mile to the rate set by the IRS for the medical
and moving expenses deduction, adjusted annually
• Modify the conservation easement deduction and pilot a conservation credit
-- Strengthen minimum requirements for organizations to qualify to receive deductible
contributions of conservation easements
-- Modify definition of eligible “conservation purpose”
-- Require a donor to provide a detailed description of the conservation purpose(s)
furthered by a contribution
-- Modify section 6033 to require electronic reporting and public disclosure of easement
contributions by donee organizations
-- Pilot a non-refundable credit for conservation easement contributions as an alternative
to a deduction
C. IRS and Treasury
1. 2015-2016 IRS Priority Guidance Plan (Second-Quarter Update)
13 projects were outlined for Exempt Organizations in 2015–2016 Plan
The item on proposed regulations under §501(c) (relating to political campaign
intervention) has been annotated to note they are suspended in accordance with
Consolidated Appropriations Act of 2016.
Exempt Organizations items published:
Final regulations on §509(a)(3) supporting organizations – published 12/23/15
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Proposed regulations on requirements for Type I and Type III supporting organizations
published 2/19/16.
Notice on §529A interim guidance regarding certain provisions of proposed
regulations relating to qualified ABLE programs – published 12/07/15
Final regulations under §§4942 and 4945 on reliance standards for making good faith
determinations – published 09/25/15
Notice on investments made for charitable purposes (mission-related) – published
09/28/15
Final regulations under §4944 on program-related investments – published 04/25/15
Notice on §506 notification requirement for new and certain existing section 501(c)(4)
organizations – published 2/08/16
Notice on transition relief for certain §529 Qualified Tuition Programs required to File
Form 1099-Q – published 2/16/19
2. New Regulations for Type I and Type III Supporting Organizations
On February 19, 2016, the IRS published a Notice of Proposed Rulemaking
promulgating proposed amendments to existing regulations for supporting
organizations. Notice and Comment period ends May 19, 2016 .
The regulations cover the following topics:
Type I and Type III organizations – meaning of contribution from “controlling donor”
Type III organizations
Notification requirement
Responsiveness test
Integral part test for functionally-integrated and non-functionally integrated Type III’s
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Type I & Type III organizations – meaning of “control”
A Type I or III supporting organization may not accept contributions from any person
who directly or indirectly controls the governing body of its supported organization, or
from anyone who is related to such a person.
Definition of “control” under NPRM:
The power, either alone or in concert with other related persons, to require governing
body to perform any act that significantly affects its operations, or to prevent the board
from performing such an act
Type III organizations – notification requirement
Supporting organizations must provide certain information to their supported
organizations each year, including the type and amount of support provided.
The NPRM clarifies that the deadline to deliver such information is the last day of the
fifth month of the taxable year after the taxable year in which it provided the support.
Type III organizations – responsiveness test
Supporting organizations must be responsive to the needs or demands of their
supported organizations (must meet relationship test and significant voice test)
NPRM clarifies that a supporting organization must satisfy the responsiveness test
with respect to each of its supported organizations.
New Example 3:
Demonstrates a “cost-effective” means to satisfy the test
E.g., acceptable for a supporting organization to conduct teleconferences jointly
with the officers of all of its supported organizations, where other favorable
factors are present
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Integral part test (functionally-integrated Type III) – parent relationship
Amended definition of “parent”:
A supporting organization and its supported organizations must be part of an
“integrated system,” such as a hospital system.
The supporting organization must engage in activities typical of a parent of an
integrated system in relation to its supported organizations, including, but not limited
to, the following:
---- Coordinating activities
---- Engaging in overall planning
---- Policy development
---- Budgeting
---- Resource allocation
A majority of the officers, directors, or trustees of the supported organization must be
appointed or elected by the governing body, members of the governing body, or
officers (acting in their official capacities) of the supporting organization
Integral part test (functionally-integrated Type III) – governmental supported
organizations
“Governmental supported organization” now defined in reference to existing definitions
in § 170(c)(1) & (2) and (b)(1)(A)
A functionally integrated supporting organization may support more than one
governmental organization, as long as all of the governmental organizations either:
---- Operate within the same geographic region; or
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---- Work in close coordination or collaboration with one another to conduct a
service or program supported by the supporting organization.
---- A “substantial part” of the supporting organization’s total activities must
directly further the exempt purposes of its governmental supported organizations.
Substantial part does not mean “substantially all.”
-- Type III organization in existence on or before February 19, 2016, is treated as
functionally integrated if, subject to certain requirements, it supports one or more
governmental organizations but no more than one non-governmental organization
-- Transition relief under Notice 2014-4 extended
Integral part test (NFI Type III) – distribution requirement
-- An organization may no longer reduce its distributable amount by the amount
of its unrelated business income tax (UBIT) paid in the preceding taxable year.
-- Current list of five items that count towards meeting the distribution
requirement is revised and is made to be exclusive
---- Fundraising expenses generally do not count as distributions.
---- But reasonable and necessary expenses incurred to solicit contributions
received directly by supported organizations do count (as long as the expenses do
not exceed the actual amount of contributions received and the amounts are
substantiated in writing).
Program-related investments (PRIs) do not count.
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3. Trends in the Donor-Advised Fund Sector
IRS Statistics on Income reports growth from tax years 2006 to 2012:
-- Number of organizations sponsoring donor-advised fund (DAF) accounts
increased by 19% (from 1,779 to 2,121)
-- Total number of individual DAFs increased by 56%
-- Total value of all DAFs increased by 55% from 2010 to 2012 (up to approx.
$53 billion)
For 2012, the seven largest sponsoring organizations reported more than $24
billion value in DAFs from over 100,000 individual funds
Median payout rate of sponsoring organizations for 2012: 10% of total value of
funds
4. Industry Issue Resolution Program - Rev. Proc. 2016-19
The IIR Program aims to identify and resolve frequently disputed or burdensome
tax issues that are common to a significant number of entities. The IIR Program
was initially introduced as a pilot program for large and midsized business
taxpayers, and has expanded. Effective April 25, 2016, the IIR Program has been
expanded to entities under the jurisdiction of TE/GE.
• Requesters should generally be an organization or a group of entities that
represents a significant number and cross-section of the entities with a particular
tax issue.
• At least annually, the IRS will make public all IIR Program requests and those
selected.
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• Selected requests may result in published guidance or new administrative
procedures.
• Issues appropriate for consideration under the IIR Program have two or more of
the following characteristics:
1. The proper tax treatment of a common factual situation is uncertain;
2. The uncertainty results in frequent, and often repetitive, examinations of
the same issue;
3. Frequent, and often repetitive, examinations require significant
resources from both the IRS and impacted entities;
4. The issue is significant and impacts a large number of entities;
5. The issue requires extensive factual development; and
6. Collaboration would facilitate proper resolution of the tax issues by
promoting an understanding of entities’ views and business practices.
• IIR Program requests and information submitted will be subject to FOIA.
• IIR Program requests should include an issue statement, a description of why the
issue is appropriate for the IIR Program, an explanation of the need for
guidance, an estimate of the number of entities affected by the issue, a
description of how the requester relates to those entities, and a contact person
for additional information. The submission may also include a recommendation
as to how the issue may be resolved.
• IIR Program requests and information submitted will be subject to FOIA.
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Part III
ESTATE PLANNING
A STUDY IN UNANTICIPATED CONSEQUENCES
I. Section 501(c)(3), Private Foundations and the Gift Tax
The Tax Reform Act of 1969 and the enactment of section 4943 effectively ended the ability of
entrepreneurs to use private foundations as an estate planning tool, at least where the goals of
avoiding the dismantling of the business enterprises, ensuring family, or at least close control, for
the future, and sheltering the assets and resulting income from estate tax or gift tax, and income
tax are concerned. Entrepreneurs were left with gifts to public charities, which often meant a
loss of donor/family control, or the sequential divestiture of control over the fruits of the
entrepreneur’s labor. The presence of the gift tax, section 2501 of the Code, made gratuitous
distributions of interests in the enterprise to family members and friends a significant taxable
event as well. Further complicating the use of private foundations were the array of private
foundation excise taxes in Chapter 42 of the Code, including the mandatory payout requirement
in section 4942, which was problematic for those assets where the value was in the build-up of
the value of the enterprise, rather than in the cash flow.
II. The “Gift Tax Five”
In early 2011, the existence of IRS audits of five donors to one or more section 501(c)(4) for gift
tax liability came to light.
Gifts were made in the wake of the Supreme Court’s decision Citizens United v. FEC.
Influential Republican members of Congress publicly complained to the IRS.
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IRS Deputy Commissioner terminated the audits and suspended any further gift tax audits
of gifts to section 501(c)(4) groups.
Gift tax issue went dormant.
III. PATH Act to the Rescue
Section 408 of the Protecting Americans From Tax Hikes Act of 2015 (the “PATH Act”)
modified section 2501(a) to exempt gifts to organizations exempt under section 501(c)(4),
section 501(c)(5) and section 501(c)(6) from the gift tax.
IV. Why Section 408 is Important for Tax/Estate Planning
Section 501(c)(4) organizations have the following characteristics:
The income of a (c)(4) is exempt from federal income tax
The private foundation excise taxes (Chapter 42 of the Code) do not apply to (c)(4)s
In particular, the limitation on the amount of ownership interests in business
enterprises (section 4943) does not apply
While the excess benefit excise tax in section 4958 does apply to limit related party
transactions, including salaries, the limit is set at fair market value, in contrast to the
prohibition on related party (disqualified person) transactions in section 4941 (self-
dealing).
There is no particular statutorily mandated payout requirement, only a requirement
that the organization actually conduct activities that advance social welfare.\
The charitable contribution deduction is not available.
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V. Bottom Line
For those taxpayers who have amassed wealth that resides in closely-held business
structures, and who are concerned about preserving the integrity of their enterprises and
permitting family members to continue to control/manage the enterprises after the donor retires
or passes away, and for whom charitable deduction is of less importance than preserving that
control, the formation of a section 501(c)(4) organization may be a realistic option. The option
may be particularly useful in situations where a second class of stock or LLC membership
interest that carries an income component, but does not include voting/control rights, can be
donated to a public charity, thus permitting a charitable contribution of some amount.
PART IV – CONCLUSION/QUESTIONS
The IRS, and federal tax administration in general, are undergoing an extraordinary transition.
The impact on tax administration as it affects tax-exemption organizations, in particular, is
undergoing dramatic change, with a trend towards registration as a means of establishing
exemption and significant reductions in enforcement capacity. Various observers, including the
Taxpayer Advocate, have warned that the changes could result in significant tax challenges for
oversight in the future. It behooves tax practitioners to follow events closely, both to understand
the changes and the legitimate tax planning options they provide, and to understand the potential
for a future reaction, or over-reaction, if and when the fisc is adversely impacted.