CURRENT AFFAIRS & OPINION   IRS & FEDERAL TAX ISSUES

12 Things Nonprofits Should Know About Proposed Tax Reform

change ahead

On February 26, 2014, Rep. Dave Camp (R-MI), the Chairman of the Ways and Means Committee, released a draft proposal for comprehensive tax reform. The almost 1,000 page document contains significant changes that will affect individuals, for-profit corporations, and tax-exempt entities.  Camp’s proposals will likely be debated throughout the year, but it is imperative that nonprofits stay alert to the possible ramifications of the bill’s lengthy provisions regarding charitable giving, tax exemption, and tax obligations. The discussion draft imposes the following changes:

  1. AGI Percentage Limitations  Adjusted gross income (AGI) limits on charitable giving will be altered to 40% for contributions to public charities and 25% to private foundations. This lowers the percentage limit for cash contributions, but simplifies the rules by no longer making the distinction of whether the contribution is cash or capital gain property.
  2. Two-percent Floor for Charitable Giving – A two-percent floor will be imposed for charitable donations to qualify for a deduction. This means that taxpayers may only deduct the amount of their charitable giving that exceeds two percent of their AGI.  A 2011 study by the Congressional Budget Office determined that this type of two-percent floor would likely cut charitable giving by approximately $3 billion.
  3. Excise Tax on Excessive Executive Compensation – Any compensation in excess of $1 million paid to any of the five highest compensated employees of any tax-exempt organization will incur a 25% excise tax. The compensation cap includes both salary and benefits. The rationale behind this provision is to ensure resource accountability of an organization receiving tax exemption by the Federal government.
  4. Unrelated Business Income Tax – Currently under the law, tax-exempt organizations may calculate unrelated business income tax (UBIT) based on the gross income of all business activities, minus the deductions connected with carrying on those activities. Losses generated by one activity can be used to offset the gains from another. However, under the Camp legislation, organizations will have to calculate UBIT separately for each business activity. This means that the loss from one unrelated business activity will no longer be used to offset the income from another unrelated trade or business activity. Furthermore, any sale or licensing by a tax-exempt organization of its name or logo (including any related trademark or copyright) will be treated as an unrelated trade or business.
  5. Expansion of Excess Benefit Transaction Rules – Excess benefit transaction rules will be expanded to apply to both 501(c)(5) and (c)(6) organizations (e.g., unions and trade/professional associations, respectively), and a 10% tax will be imposed on an organization whenever the excess-benefit excise tax is imposed on a disqualified person of that organization. Furthermore, the safe-harbor rebuttable presumption of reasonableness will be eliminated.
  6. Expansion of Self-dealing and Simplification of Private Foundation Excise Tax  The draft legislation imposes a new excise tax of 2.5% on private foundations for each act of self-dealing discovered within the organization and eliminates the professional advice safe harbor for foundation managers.  Additionally, excises taxes on private foundation investment income will be changed to a flat 1%.
  7. Payout Requirement for Donor Advised Funds – Donor advised funds will be required to distribute all contributions within 5 years of receipt or otherwise face a 20% excise tax on the amount not distributed.
  8. Private Operating Foundations Subject to Distribution Requirements – Private operating foundations will face the same minimum distribution rules currently imposed on private non-operating foundations.
  9. Type II and Type III Supporting Organizations – Type II and III supporting organizations will be eliminated. Thus, any current Type II or III supporting organization will have to qualify as a Type I supporting organization, another classification of public charity, or a private foundation by 2016.
  10. Social Welfare Organization Changes – Section 501(c)(4) organizations will need to notify the IRS within 60 days of formation and may seek declaratory judgments in the same manner as 501(c)(3) organizations. Furthermore, social welfare organizations will be required to list on Schedule B of Form 900 each donor contributing $5,000 or more, who is either an officer, director, or one of the organization’s five highest compensated employees.
  11. Repeal of Tax-Exempt Status for Professional Sports Leagues – While amateur sports leagues may still become tax-exempt under 501(c)(6), professional sports leagues will no longer be permitted to seek exemption.
  12. Electronic Filing of Form 990-series – Most nonprofit organizations will have to file their IRS Form 990 information returns electronically.

Although it is unclear which, if any, of these provisions will be adopted into law, nonprofit organizations should continue to monitor the debate and contemplate how these proposed changes could affect them.

For additional information:

Committee on Ways and Means

-        Comprehensive Tax Reform Site

-        Discussion Draft [Full]

-        Section-by-Section Summary

Independent Sector: Tax Reform

Nonprofit Quarterly: Draft Tax Reform Act of 2014 Proposes Profound Impact on Tax-Exempt Organizations

CURRENT AFFAIRS & OPINION   IRS & FEDERAL TAX ISSUES

IRS Deadline: March 1, 2014 – Who is Your Responsible Party?

 

Me 

Do you know who your organization has reported to the IRS as its responsible party? Your organization should make sure the IRS has the current information by the February 28, 2014 deadline.

According to the Instructions to IRS Form 8822-B:

Beginning January 1, 2014, any entity with an EIN [Employer Identification Number] must file Form 8822-B to report the latest change to its responsible party. Form 8822-B must be filed within 60 days of the change. If the change in the identity of your responsible party occurred before 2014, and you have not previously notified the IRS of the change, file Form 8822-B before March 1, 2014, reporting only the most recent change.

For a nonprofit organization, "the “responsible party” is the person who has a level of control over … the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets." Typically, this will be the organization's executive or president.

The person who has accepted the role of being the responsible party may have greater responsibility and therefore greater exposure to personal liability for failure to pay withholding (payroll) taxes. Internal Revenue Code Section 6672(a) provides in pertinent part:

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

While there is no direct reference to "responsible party" in Section 6672, it might be difficult for a person identifying herself or himself as the responsible party to claim she or he was not the party responsible for collecting, accounting for, and paying over withholding taxes. The term "person" in Section 6672 explicitly includes officers and employees, and Section 6672 does not from penalties volunteer board members unless they solely serve in an honorary capacity, do no participate in day-to-day or financial operations of the organization, and do not have actual knowledge of the failure to collect, truthfully account for, and/or pay withholding taxes, and so long as someone else can be held liable for the penalty.

It's important to note that nonprofit organizations may have identified a responsible party when it first applied for an EIN (see the organization's Form SS-4 or online filing records). If the individual listed as the responsible party has since changed, a nonprofit organization must file Form 8822-B by no later than February 28, 2014 to report such change.

Here are additional resources on withholding taxes and possible personal liability:

Not Paying Your Taxes? Your Board Could Be Personally Liable (Nonprofit Quarterly)

Yes Virginia, Nonprofit Directors Really Can be Held Liable for An Insolvent Nonprofit’s Debts (Charity Lawyer Blog)

 

CURRENT AFFAIRS & OPINION   EVENTS

Top 10 Events in 2013

 

  Top 10

Here is a list of our top 10 events of 2013 affecting the American nonprofit sector:

  1. IRS Exempt Organizations Division controversy
    IRS Issues Initial Report And Action Plan Following Tax Exempt Organization Scandal, Forbes;
    IRS Controversy: scrutiny of tax exempt applications, Independent Sector.
  2. Federal government shutdown
    Government Shutdown Hurting Nonprofits, GuideStar Blog;
    Federal Government Shutdown and Effects on Nonprofits, National Council of Nonprofits.
  3. Affordable Care Act rollout
    Obamacare Rollout, Huffington Post;
    The Affordable Care Act and Charitable Nonprofits – FAQs, National Council of Nonprofits.
  4. Supreme Court decisions paving way for gay marriage
    Court Overturns DOMA, Sidesteps Broad Gay Marriage Ruling, NPR;
    IRS Ruling on Same-Sex Marriage Has Implications for Nonprofits, Leaffer Law.
  5. Snowden/NSA leaks
    10 most shocking NSA revelations of 2013, CNN Money;
    Edward Snowden, after months of NSA revelations, says his mission’s accomplished, Washington Post.
  6. Pope Francis actions signaling a change in the Catholic Church
    Person of the Year, Time;
    Is Pope Francis Bullish on Poverty Eradication and against Capitalism? Nonprofit Quarterly
  7. Death of Nelson Mandela
    The Nonprofit Sector Remembers Nelson Mandela, The Nonprofit Times;
    On Nelson Mandela's Passing, Nonprofit Quarterly.
  8. Malala's advocacy for education and women's rights
    Malala's year: Shot for defying Taliban, now considered for Nobel, L.A. Times;
    Extended Interview: Malala Yousafzai, The Daily Show.
  9. Civil war escalation in Syria
    Crisis in Syria, New York Times;
    The Nonprofit Stake in the Possible U.S. Military Action against Syria, Nonprofit Quarterly.
  10. Federal Food Stamp Program Cut
    Food stamps will get cut by $5 billion this week — and more cuts could follow, Washington Post WonkBlog;
    SNAP (Food Stamps): Facts, Myths and Realities, Feeding America.
CURRENT AFFAIRS & OPINION

Holiday Thanks!

 

Christmas Tree

Thank you to all our readers. We wish you a very happy holiday season!

Here are just a few tips on giving thanks:

  1. Make sure your “thank you” receipts to donors are in the form they need to take a deduction.
  2. If you make commitments when giving thanks, make sure you honor them.
  3. If you give substantial gifts when giving thanks, understand whether you’ll reduce the amount of a donor’s charitable contribution deduction or cause a recipient to recognize taxable income.
  4. If you give holiday bonuses to executives, consider whether the board should approve the total compensation, including the bonus, pursuant to the rebuttable presumption of reasonableness procedures.
  5. Thank your donors, volunteers, employees, suppliers, and supporters throughout the year.
CURRENT AFFAIRS & OPINION   IRS & FEDERAL TAX ISSUES

Proposed Guidance for 501(c)(4) Social Welfare Organizations

 

Treasury

On November 29, 2013, a Notice of Proposed Rulemaking by the Internal Revenue Service was published in the Federal Register containing proposed regulations that provide guidance to tax-exempt social welfare organizations on political activities related to candidates that will not be considered to promote social welfare.

A 501(c)(4) social welfare organization must be operated exclusively for the promotion of social welfare. Under the current regulations, it meets this standard if it is “primarily engaged in promoting in some way the common good and general welfare of the people of the community." The Treasury Department and the IRS are considering, and seeking public comment on, whether the current section 501(c)(4) regulations should be modified to provide more precision with respect to the meaning of the term "primarily engaged" if the “primarily” standard is retained. 

The current regulations also provide that "[t]he promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office." The proposed regulations would replace the term “participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office” with a new term—“candidate-related political activity”—to differentiate the proposed Section 501(c)(4) rule from the standard employed under Section 501(c)(3).

Under the proposed guidelines, candidate-related political activity includes:

1. Communications:

  • Communications that expressly advocate for a clearly identified political candidate or candidates of a political party.
  • Communications that are made within 60 days of a general election (or within 30 days of a primary election) and clearly identify a candidate or political party.
  • Communications expenditures that must be reported to the Federal Election Commission.

2. Grants and Contributions:

  • Any contribution that is recognized under campaign finance law as a reportable contribution.
  • Grants to section 527 political organizations and other tax-exempt organizations that conduct candidate-related political activities (note that a grantor can rely on a written certification from a grantee stating that it does not engage in, and will not use grant funds for, candidate-related political activity).

3.  Activities Closely Related to Elections or Candidates:

  • Voter registration drives and “get-out-the-vote” drives.
  • Distribution of any material prepared by or on behalf of a candidate or by a section 527 political organization.
  • Preparation or distribution of voter guides that refer to candidates (or, in a general election, to political parties).
  • Holding an event within 60 days of a general election (or within 30 days of a primary election) at which a candidate appears as part of the program.

Here are some additional provisions we found interesting:

  • The Treasury Department and the IRS request comments on whether any particular activities conducted by section 501(c)(4) organizations should be excepted from the definition of candidate-related political activity as voter education activity and, if so, a description of how the proposed exception will both ensure that excepted activities are conducted in a non-partisan and unbiased manner and avoid a fact-intensive analysis.
  • The Treasury Department and the IRS request comments on whether, and under what circumstances, material posted by a third party on an interactive part of the organization's Web site should be attributed to the organization for purposes of this rule.

Thumbs Up Down

The proposed guidlines have generated much discussion already. Check out the following:

Alliance for JusticeTreasury, IRS proposal endangers citizen participation in democracy

Adler & Colvin (Nonprofit Law Matters): Just Released Proposed 501(c)(4) Regulations: A Good Start, But Rough …

CURRENT AFFAIRS & OPINION   IRS & FEDERAL TAX ISSUES

Hearing on the IRS Exempt Organizations Division Post-TIGTA Audit

 

WaysAndMeans

The House Ways and Means Oversight Subcommittee held a hearing on September 18 to review the audit of the Internal Revenue Service Exempt Organizations Division and question the acting chief of the IRS Danny Werfel. Here are some links and excerpts of articles covering the hearing:

Rep. (R-LA) Charles Boustany Opening Statement

In May, the Treasury Inspector General for Tax Administration [TIGTA] released an audit exposing the Internal Revenue Service’s practice of targeting applicants for tax-exempt status based on name and policy position. The audit confirmed what many feared – that the IRS was treating applicants differently based on their beliefs by subjecting them to endless delays and intrusive information requests.  Today we want to bring that disinfecting sunshine to the audit branch of the IRS as well.

Highlights from the House Ways & Means Committee IRS Exempt Orgs Hearing (Sustainable Law Group)

A few years ago Lois Lerner told an audience at Duke University that the IRS Exempt Organizations Division can use the tax return examination process to take a closer look at advocacy groups.  As a result, the Subcommittee has expanded its investigation to include whether the IRS improperly targeted conservative advocacy groups for reviews and audits.

Acting IRS Chief Touts Progress in Reforming Exempt Organizations Processes (Government Executive)

Ranking Member Rep. John Lewis, D-Ga., though agreeing that the IRS tax exempt organizations unit needed reforms, said, “Unfortunately, my friends on the other side of the aisle continue to frame this issue as a partisan one — as only affecting conservative groups. Time and time again the facts have shown that both Republican-leaning and Democratic-leaning groups were singled out during the application process. We know why we are here today — for Republicans to distract us from their lack of a positive legislative agenda to improve the economy, create jobs and fund the government.”

News of interest for startup nonprofits:  There is currently a backlog of over 65,000 exemption applications from 501(c)(3) and 501(c)(4) organizations.

Also see this article published in The Nonprofit Quarterly the day before the hearing: Update on IRS Scandal.

 

CURRENT AFFAIRS & OPINION

Delaware Public Benefit Corporation Signed Into Law

Delawaresign

Yesterday, Delaware Governor Jack Markell signed Senate Bill 47, creating a new corporate form called the public benefit corporation. Delaware is the 19th state to enact benefit corporation legislation, which enables business leaders to consider public interest and societal impact in addition to profit when making business decisions. Delaware public benefit corporations must identify one or more specific public benefits in their certificate of incorporation, which include but are not limited to, artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific and technical.

The founders of B Lab, a nonprofit organization dedicated to using the power of business to solve social and environmental problems, believe this legislation has unparallel implications:

“The benefit corporation legal structure is a new and useful tool for everyone.  For policy makers and the public interest, it combats the plague of short termism.  For business leaders, it helps attract the best talent and turn customers into evangelists.  For customers, it offers greater transparency to protect against pretenders.  For employees, it promises higher quality jobs where they can bring their whole selves to work every day.  And for investors, it mitigates risk, reduces transaction costs, creates additional rights to hold management accountable, and  accelerates the growth of a big market opportunity to meet the needs of people who want to invest to both make money and make a difference.”

Delaware corporations are eligible to form or transform into public benefit corporations beginning August 1, 2013.

 

Additional Resources:

BOARDS / GOVERNANCE   CURRENT AFFAIRS & OPINION   FUNDRAISING & CHARITABLE GIVING

Overhead Myth: Thoughts from a Nonprofit Attorney

 



Myth

On June 17, 2013, the CEOs of GuideStar, Charity Navigator, and BBB Wise Giving Alliance signed a letter to the Donors of America denouncing the “overhead ratio” as a valid indicator of nonprofit performance. Leading commentators applauded the move even while some noted that charity ratings organizations, like some of the signatories to the letter, were in no small part responsible for perpetuating the "overhead myth." Meanwhile, nonprofit executives and Dan Pallotta collectively said, "It's about time."

What is overhead?

Overhead generally refers to an organization's administrative and fundraising expenses. Overhead Ratio is the ratio of overhead expenses to total expenses. A 30% overhead ratio indicates that 30% of an organization's total expenses went to overhead; the corollary is that 70% went to program expenses.

Why do donors want to fund programs instead of overhead?

Understandably, donors have equated funding programs with impact. But investments in infrastructure and public education/support may have as much to do with impact as investments in the direct provision of goods and services. Donors want to see their dollars produce the most charitable impact possible. It is overly simplistic, and in most cases, flat out wrong, that the more dollars that go to programmatic expenses, the bigger the charitable impact. This is best explained with a simple example:

Charity A spends 10% on overhead and 90% on programmatic expenses to provide charitable services to children with cancer and their families. With a $1 million budget, Charity A helps 90 families with 8 hours/month of direct services. Charity A's programs, and donor base have remained relatively static for the past ten years, but it has suffered from frequent turnover of managers, low employee morale, outdated technology, and weak systems.

Charity B pursues the same mission as Charity A but last year spent 40% on overhead and 60% on programmatic expenses. With its $1 million budget, Charity B helps 200 families with 20 hours/month of direct services. Charity B has strong leadership, makes smart use of outside experts, and invests in infrastructure and technology to leverage continued growth. As a result, Charity B is rapidly expanding its operations with a much broader and engaged group of donors and funders, and sharing and collaborating with other organizations to create greater impact beyond the communities it directly serves.

Charity A may have a much lower overhead ratio than Charity B, but a donor's investment in Charity B will result in a much greater impact on the lives of children with cancer, their families, and the braoder community.

Does the law have anything to say about overhead?

Not explicitly. But 501(c)(3) organizations are required to be operated primarily to further one or more 501(c)(3) exempt ("charitable") purposes. Additionally, they must not be operated to benefit private interests, except incidentally in furthering the public's interest. If a 501(c)(3) organization is using a high percentage of its resources on activities that are not charitable, the IRS may charge that the organization is not using charitable assets in a manner that is commensurate with its charitable purposes and revoke its 501(c)(3) status. The underlying rationale is that such use of charitable assets is evidence that the organization is not operated primarily for charitable purposes and likely operated with the primary intent to benefit private interests (like those of a commercial fundraiser or highly paid insiders).

What are our thoughts on overhead?

The amount of overhead and the ratio of overhead to programmatic expenses are by themselves poor measures of a charity with few exceptions. As we noted above, the overhead ratio may have little to do with impact. This is not to say, however, that the overhead ratio should not be considered at all. Particularly when looked at over a period of years in relation to several other impact-related factors, the overhead ratio may indicate whether or not an organization is making good use of its funds, is well managed, and is serving primarily public rather than private interests. Consider the following example:

Charity C has spent 70% on overhead for each of the last 5 years but its overall revenues, net assets, persons served, infrastructure, programs, and public outreach have remained static and uninspired the entire time. Charity C pays its founder/CEO top dollar (to the extent permissible), engages in costly fundraising efforts that produce relatively small amounts of net revenue, and has a board that is composed solely of the founder's close friends and business associates.

Charity C may not be the ideal organization for a donor wanting his or her contribution to have the greatest impact possible. Its high overhead ratio doesn't appear to be justified by progress in its performance or impact, and its leadership doesn't inspire confidence that these factors will improve.

Other Resources

It's Time for Real Talk About Real Nonprofit Overhead Costs – HuffPost Impact

Getting Clear About Overhead – The Center for Effective Philanthropy

CURRENT AFFAIRS & OPINION   SOCIAL ENTERPRISE

All Eyes on Delaware’s Public Benefit Corporation Legislation

 

Delaware Division of Corporations

Last month, with great fanfare, Delaware’s governor Jack Markell introduced legislation providing for the creation of public benefit corporations. Enjoying broad, bipartisan support, the new law is expected to be quickly approved and put into effect as early as August 1, 2013.

That Delaware has decided to legislatively sanctify public benefit corporations is a huge step forward on the path toward broad-based acceptance of this new corporate form. Consider this — over 1 million business entities call Delaware their legal home, including more than 50% of all U.S. publicly traded companies and nearly 2/3 of Fortune 500 companies. Delaware’s courts have a long and deep corporate jurisprudence. The state even has its own court – the Court of Chancery – for settling corporate disputes and its decisions are often relied on by judges in other states.

Perhaps because it is the granddaddy of corporate jurisdictions, Delaware wasn’t content to mirror other states’ benefit corporation statutes. Its legislation differs in 4 notable ways:

  1. higher shareholder voting thresholds to approve the switch from a traditional to a public benefit corporation;
  2. a different mix of priorities for directors;
  3. greater clarity and specificity in the formation document as to the public benefit at the corporation’s heart; and
  4. relaxed public reporting requirements.

In Delaware, at least 90% of a corporation’s voting shareholders will have to approve the transition to a public benefit corporation. In contrast, most states require only 2/3 of the voting shareholders’ approval.

And unlike other states, which require only that the benefit corporation act to promote a general public benefit, Delaware requires the public benefit corporation to identify in its corporate documents a specific benefit to be promoted. (A public benefit is defined a positive effect or reduction of negative effects to persons, entities, communities, or interests other than stockholders in the capacities as stockholders. This includes, but is not limited to effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.)

The law also places a different set of priorities on directors – requiring them to balance the stockholder’s pecuniary interests, the interests of those materially affected by the corporation’s conduct and the identified public benefit(s) by the corporation in their business decisions. In contrast, other states only require directors to consider other factors, such as environmental and social impact.

Finally, Delaware’s reporting requirements are much more relaxed. Most benefit corporation states require an annual report assessing the overall social and environmental performance of the benefit corporation against a third-party standard, which is made available to the public. But in Delaware, reporting need occur only every other year, the report does not have to be made public, and no third party standard for measuring public benefit is required.

Although the reporting requirements are not the most ideal from an outsider’s perspective, it is hard to deny that Delaware’s endorsement of public benefit corporations is a landmark step in allowing a corporation to pursue both profits and promote social good. It will also provide important assurances to entrepreneurs and investors still cautious of this new corporate form.

Resource: http://www.legis.delaware.gov/LIS/LIS147.NSF/vwLegislation/SB+47?Opendocument

- Michelle Baker

Michelle Baker is a San Francisco-based attorney interested in social enterprises.

CURRENT AFFAIRS & OPINION   IRS & FEDERAL TAX ISSUES   STARTING A NONPROFIT

Treasury Inspector General Report on IRS “Scandal”

 

Treasury IG

On May 14, 2013, the Treasury Inspector General for Tax Administration released its report on the IRS targeting of conservative groups in reviewing applications for exemption under Section 501(c)(4) of the Internal Revenue Code. The report, Inappropriate Criteria Were Used to Identify Tax-Exemption Applications for Review, and problems will continue to be dissected over the coming months. 

One section of interest described follow-up questions to exemption applications that the IRS should not have asked:

Seven Questions Identified As Unnecessary by the EO Function

  1. Requests the names of donors.
  2. Requests a list of all issues that are important to the organization and asks that the organization indicate its position regarding such issues.
  3. Requests 1) the roles and activities of the audience and participants other than members in the activity and 2) the type of conversations and discussions members and participants had during the activity.
  4. Asks whether the officer, director, etc., has run or will run for public office.
  5. Requests the political affiliation of the officer, director, speakers, candidates supported, etc., or otherwise refers to the relationship with identified political party–related organizations.
  6. Requests information regarding employment, other than for the organization, including hours worked.
  7. Requests information regarding activities of another organization – not just the relationship of the other organization to the applicant.