Dedon on Estate Planning

Monitoring Tax Exempts

The November 21, 2008 Daily Tax Report published by BNA, reported on IRS Commissioner Steve Miller’s comments at the annual Western Conference on Tax Exempt Organizations held in Los Angeles on November 20^th.  Miller’s theme was full disclosure and transparency regarding tax exempt organizations’ operations.

According to Commissioner Miller, the revised Form 990, which is the annual tax return filed by tax exempt organizations, and greater information required at the creation of the organization, as required by Form 1023, will facilitate the IRS monitoring these organizations. Miller was quoted as saying "[w]e intend to let the sun shine" on governance issues. Thus, it will become increasingly important to have the board of directors actively review key decisions and document those decisions in Minutes.

The Daily Tax Report quoted Miller as saying the IRS will focus on the following:

• The composition and independence of the board

• Internal financial controls

• Compensation

• Conflict of Interest policies

Annual Compliance for Public Charities

In its continuing effort to better police and monitor tax exempts, the IRS in August issued the instructions to the newly revised Form 990. For the first time since 1979, the IRS changed Form 990, which is the compliance return public charities file each year. The Form 990, as well as a charity’s organizational documents, are public documents available to anyone who desires to review them.

Charities will begin using the new Form 990 for the 2008 year. The form was released in December 2007, and can be found at the IRS web site, www.IRS.gov/eo.com. It consists of 11core pages and 16 schedules. According to the IRS, the initial draft garnered 3,000 pages of written comments that were considered before the final draft.

From the IRS’ perspective, "the revised form will give the IRS and the public a much better view of how exempt organizations operate." IRS Commissioner Doug Shulman continued, "the improved transparency provided by these changes will also benefit the tax-exempt community."

From the charitable community’s perspective as well as its return preparers, new Form 990 adds detail and complexity to an already thorough return. However, this is the price to pay in response to abuses that had developed in the charitable area after a period of relative IRS neglect. The IRS is now devoting more resources and greater attention to tax exempts, and the revised Form 990 is one illustration of that new policy.

Tax Exemption Under Section 501(c)(3)

Internal Revenue Code Section 501(c)(3) affords organizations tax exemption if certain requirements are satisfied.  These organizations must accomplish a charitable purpose. Such purposes include conducting scientific, religious, educational, or literary activities. At least one of these purposes must be set forth in the organization’s Articles of Organization. This post focuses on educational and scientific purposes.

An educational purpose includes not only "instruction or training of individuals for the purpose of improving or developing his capabilities" but also "the instruction of the public on subjects useful to the individual and beneficial to the community." Treas. Reg. Section 1.501(c)(3)-1(d)(3). For example, the IRS has determined that an organization whose purpose was to educate the public about the accuracy and fairness of news coverage was eligible for tax exemption. Rev. Rul. 74-615, 1974-2 C.B. 165.

Supporting Organizations

Supporting Organizations ("SO") are charities created under Section 501(c) (3) of the Internal Revenue Code. Donations are deductible as charitable contributions. SO’s have been utilized by wealthy individuals who otherwise would be limited by creating a private foundation. These well-advised individuals (or their advisors) mastered the arcane and complicated tax provisions authorizing SO’s, and thereby created SO’s to obtain greater tax advantages compared to private foundations. The advantages arise because SO’s are treated as public charities. (The February 25, 2008 Post discussed these advantages.)

As often the case in other areas of the tax law, creative but misguided taxpayers and advisors used SO’s to obtain tax benefits beyond those intended by Congress. Congress pushed back with substantial changes to SO’s. These changes affect primarily "Type III" SO’s, which are the type most often used by individuals seeking the greatest autonomy and control over their charity. In contrast to Type I and Type II SO’s, where the supported public charity effectively controls the SO, Type III SO’s resemble private foundations with greater control for the taxpayer. It is for this reason that Type III SO’s were targeted by Congress as requiring the greatest reform.