2017 Western Conference on Tax Exempt Organizations (WCTEO)

Published on: by Gene Takagi Category:EVENTS, IRS & FEDERAL TAX ISSUES
WCTEO

The Western Conference on Tax-Exempt Organizations (WCTEO), my #1 go-to conference every year for the past 12 years, will be held at the historic Millennium Biltmore Hotel in Los Angeles on Thursday, November 30, and Friday, December 1. NEO Law Group is proud to be a first-time Gold Sponsor of the WCTEO. With a schedule that features panels led by some of the country’s top tax-law experts, I highly recommend the conference to all of my professional colleagues serving or working in the nonprofit sector and am happy to talk with anybody considering attending. If you’re thinking about it, give me a shout!

Agenda

This year’s agenda features sessions on many critically important topics to charities and other nonprofits, including:

  • Washington Update, which will be particularly interesting this year with tax reform and proposed legislation affecting charitable giving and the political activities of charities
  • New Accounting Rules for Nonprofits, which represent a major change in financial reporting and will take effect for annual financial statements issued for fiscal years beginning after Dec. 15, 2017 (see FASB modifies not-for-profit accounting rules, Journal of Accountancy)
  • Profits for Nonprofits: Finding Found Money with New Funding Sources and Structures
  • When Nonprofits, Government, and Foundations Collide: Overhead and the Meaning of Life, which will be presented by CalNonprofits CEO Jan Masaoka, who I’ll have the honor of introducing
  • Repeal, Replace or Repair? How Current U.S. Health Policy Affects Nonprofits
  • Current Issues in Executive Compensation
  • Managing Cybersecurity Threats for Nonprofits
  • Current Developments, always a great session to keep aware of developments in our field
  • State Issues for Nonprofits, which will be co-presented by NEO Law Group Senior Counsel Erin Bradrick
  • Anatomy of a Tax Controversy
  • Being a Nonprofit in the Trump Era

Highlights

Washington Update

  • Check out the IRS TE/GE FY 2018 Work Plan 
  • IRS Form 1023-EZ used by 60% of 501(c)(3) applicants; 3% are randomly selected for greater review ➔ changes to 1023-EZ in Jan 2018
  • IRS Form 1024-A for 501(c)(4) applicants will be released in early 2018. See draft at (Instructions at )
  • “Retroactive revocation [of tax-exempt status] is not just a slap on the wrist; it has real tax consequences.” See CreditGuard case (10/10/17)
  • Check out the Treasury 2017-2018 Priority Guidance Plan (Exempt Organizations section starts on p. 11)
  • Check out Rev. Proc. 2017-53 (regarding foreign grantmaking and equivalency determination)
  • Alexander Reid of Morgan Lewis provided a timely summary and some of his thoughts on tax reform and nonprofits (we’re still in the 5th or 6th inning)
    • Lack of diversity of individuals who can take a charitable deduction (which would be reduced to 5% of individual taxpayers) will influence which charities get hurt the most. As the Washington Post noted: “The end of itemization for most people would likely hit some charities more than others.” No doubt, the wealthy (those who will still take itemized deductions) give differently so it’s likely that the charities depending mostly on the vast majority of non-itemizers

New Accounting Rules for Nonprofits

  • New Accounting Rules for Nonprofits – 1) NFP Presentation, ASU 2016-14; 2) Revenue Recognition from Contracts with a Customer, ASU 2014-09; 3) Leases, ASU 2016-2
  • Surveys show the majority of nonprofits are not prepared for these new rules and need to start preparing to implement the new standards very quickly
  • The elimination of the distinction between the time restriction in donor restricted net assets (i.e., temporarily restricted and permanently restricted) will simplify the balance sheet and income statements.
    • Under new GAAP, the categories of net assets will be “Without Donor Restrictions” or “With Donor Restrictions”, each with increased disclosures
  • New accounting rules will require disclosures of qualitative and quantitative information about liquidity (including availability of current financial assets to meet cash needs for general expenditures next year)
  • Nonprofits will be required to report all expenses per period by Nature and Function and disclosures about methods used to allocate costs
    among program and support functions
  • Core principle of new revenue recognition rules: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services
    • Identify the contract(s) with the customer; Identify the performance obligations; Determine the transaction price; Allocate the transaction price; Recognize revenue when (or as) a performance obligation is satisfied
  • Controversial and major proposal (which may be approved very soon) – most government grants will be accounted for as conditional contributions, not as exchange transactions; and there will be a difference between a “condition” and a “restriction” (this distinction is very familiar to lawyers)
  • The new standard will require organizations that lease assets— referred to as “lessees”—to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases (capital/finance and operating leases)
    • A lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months

Profits for Nonprofits; Finding Found Money with New Funding Sources & Structures

  • It’s okay to make a profit, for the sake of making a profit, even if you have to pay unrelated business income tax (UBIT) … but don’t spend a substantial amount of your organization’s time and/or resources on an unrelated trade or business (operational test violation that could cause revocation of exempt status)
  • Allocating deductions for dual use property (related and unrelated to the organization’s exempt purpose) must be done with a reasonable basis (documentation is key)
    • AICPA Proposes Guidelines to IRS For How to Allocate Expenses by Exempt Organizations for Dual Use Facilities – see AICPA
    • Dual use facilities:
      • Rensselaer Method – [# of days facility used for unrelated business] / [total days facility used for all purposes]
      • IRS Method – [# of days facility used for unrelated business] / [total days facility available for use]
  • Currently, may be challenging to regularly offset income from one unrelated business with losses from another unrelated business (if IRS says no profit motive or that it’s a charitable activity so can’t allocate losses to the first unrelated business)
  • Must be careful of excise tax considerations (tip: keep track of all of your disqualified persons)
    • Private foundations – self-dealing and excess business holdings (note that program-related investments – PRIs – are excluded from the excess business holdings rule)
    • Public charities – excess benefit transactions
  • Huge change in partnership audit regulations will be effective for years after 12/31/17
    • Adjustments of income, gain, loss, deduction, or credit determined at the partnership level and the taxes attributable thereto, will be assessed and collected at the partnership level
    • Partnership Representative (vs. tax matters partner) who doesn’t have to be a partner but has great powers, including the right to make a “PUSH OUT” election (partners for the “reviewed year” pay tax/penalties from underpayment), which can be tempered by the partnership agreement
    • Certain partnerships can elect out of the new rules (those with partners that are individuals, S-corporations, C-corporations, and probably nonprofit corporations)
  • Joint venture where charity does not have control over business (e.g., 25% ownership): IRS will argue that the income from the joint venture is UBIT even if substantively the activities further an exempt purpose of the charity

Repeal, Replace or Repair? How Current U.S. Policy Affects Nonprofits

  • Fundamental issue driving health care policy: costs
    • Health care ultimately consumes 18% of our incomes
    • “If you talk about the world competitiveness of American industry, [health costs are] the biggest single variable where we keep getting more and more out of whack with the rest of the world.” – Warren Buffet, May 2017
    • “It is estimated that 5% of U.S. patients account for nearly half of the country’s health care expenditures.” – AHA
    • Approximately $200 Billion is spent every year on healthcare services in the U.S. that provide “little value” to patients. – Modern Healthcare, October 2017
    • Repeal of the individual mandate is now expected – not popular and little understood – will leave millions left uninsured (13 million according to the CBO), drive insurers out of the public marketplace, and increase premiums
    • Concerns for Nonprofit Health Care and Social Service Providers
      • If Medicaid is cut, demand for charity care will increase, as will use of expensive emergency rooms
      • If government does not fund response to opioid crisis, greater burden will be placed on charitable sector
      • Loosening of health insurance requirements will leave more people with inadequate coverage and a need for charitable assistance
      • Fragmented approach to controlling health care costs increases administrative burden and financial risks
    • Concerns for Nonprofits as Employers
      • Unclear how progress will be made in controlling costs for employee health care
      • Crucial benefit for recruiting and retention but expense remains daunting
      • Small employers lack leverage to negotiate Individual mandate may be repealed, but there is no discussion of repealing employer mandate;  IRS is beginning enforcement

Current Challenges in Executive Compensation Governance

  • Federal laws to be considered: 4941 for private foundations; 4958 for public charities
  • Proposed tax reform may make significant changes to federal laws related to compensation
    • Introduction of new 10% Excess Benefit Transaction Tax on Organization
    • Elimination of Rebuttable Presumption of Reasonableness (procedures become minimal standards of due diligence)
    • Elimination of Protection against 10% Manager Tax Due to Reliance on Professional Advice / Compensation Studies
    • Expands definition of “Disqualified Person” to Include Athletic Coaches and Investment Advisors (not just internal)
    • Extends Section 4958 (Excess Benefit Transactions) to 501(c)(5)s and 501(c)(6)s
    • New 20% Entity-Level Tax on Compensation above $1 million for top 5 employees and on excess parachute payments (present value that exceeds three times the employee’s base compensation)
    • Cap and phase out non-taxable employer-provided housing
  • Some governance best practices
    • Qualified, disinterested compensation committee members,
    • Committee documents, including a conflict of interest policy, a compensation philosophy/strategy, and a committee charter
    • Positions to be reviewed include all disqualified persons
    • Written opinion letter from outside expert
    • Focus on total compensation
    • Full board is briefed at least annually
    • Development of appropriate communications policy

Managing Cybersecurity Threats for Nonprofits

  • Not just about confidentiality, also about integrity and availability – need to balance security and usability
  • A cybersecurity program means preparation for a cybersecurity attack at the enterprise level with Board oversight to reduce the risk of, and prepare for, data breaches, recover from a data breach, loss of business continuity, harm to public, etc.

Current Developments

  • Lots of discussion about the GOP tax bill, which is being considered (and modified) by the Senate as the panel speaks
  • See our previous posts on the tax bills here and here
  • Additional provisions discussed:
    • In the business tax area there is a disallowance of the deduction for certain employee benefits under §274 and §132 (transportation, parking, on site health facilities). Because disallowing the deduction would not have the same effect on tax exempt employers, H.R. 1 imposes unrelated business income tax on the value of these benefits provided by tax exempt employers.
    • Donor-advised fund (DAF) annual disclosures
    • Excess business holdings exception (also discussed by the media with respect to Newman’s Own, but it has broader implications) – Newman’s Own Tax Break (Politico)
    • Repeal of the New Markets Tax Credit (but Senate created Qualified Opportunity Zones similar to NMTC for low income housing through Dept. of Treasury CDFI)
    • Parks Foundation v. Commissioner – reliance only on reasoned opinions (not on conclusory statements)
  • Rev. Proc. 2017-5: An organization exempt under 501(c)(3) that wants to be recognized under a different subsection must dissolve and re-apply
  • Rev. Proc. 2017-53 (Foreign Public Charity Equivalence Determinations): Terrorism safe harbor – Preferred written advice should verify that the grantee has not been designated a terrorist organization by the U.S. government
  • PLR 201719004: Indirect self-dealing ruling
  • TAM 201544025: How much unrelated business income is too much? Substantially all revenue is UBI but no revocation (indicating the test is based on activities, not necessarily on percentage of revenues)

Breakout Session: State (California) Issues for Nonprofits

NEO’s Erin Bradrick and Audrey Rowe from the California Franchise Tax Board spoke about developments in state laws affecting nonprofits in California. We’ll discuss these developments in a separate post.

Anatomy of a Tax Controversy

  • Over 6,000 IRS examinations (including audits) in the tax-exempts area – top 3 areas: Filing, Organizational, and Operational Issues, Employment Tax Issues, and Unrelated Business Issues
  • 2 major types of audits: field audits (on-site) and correspondence audits
  • Non-audit contacts from the IRS: compliance checks, compliance check questionnaires, follow-up reviews (in recent years, IRS has closed audits with “no change” letters containing advisories
  • Audit areas of focus:
    • Exemption issues including non-exempt purpose activity and private inurement – this is the primary regulatory focus
    • Protection of assets including self-dealing, excess benefit transactions and loans to disqualified persons
    • Tax gap issues including employment tax and unrelated business income tax liability
    • International issues including oversight on funds spent outside the United States, including funds spent on potential terrorist activities, exempt organizations operating as foreign conduits and Report of Foreign Bank and Financial Accounts requirements
    • Emerging issues including non-exempt charitable trusts and IRC 501(r) compliance
  • Audits will review organizational websites, Google search results, and the organization’s incorporating documents (including bylaws and exemption letter), copies of recently filed Form 990s along with supporting documentation, copies of board minutes, financial statements and governance policies (e.g., conflict of interest, gift acceptance, whistleblower, document retention and destruction, and joint venture)
  • There is a new Information Document Request (IDR) process that was adopted by the IRS in 2017 which requires a contact with the organization before the IDR is issued (intended to provide for a preliminary discussion)
    • The goal of the IDR process is to: (a) provide for open and meaningful communications between the IRS and the audited organization; (b) reduce the organization’s burden and provide consistent treatment of exempt organizations; (c) allow the IRS to secure more complete and timely responses to IDRs; (d) provide consistent timelines for the IRS to review IDR responses; and (e) provide timely issue resolution
  • Proposed tax adjustments, including any proposed changes to the exempt status of the organization, are summarized on Form 5701, Notice of Proposed Adjustment (NOPA); an explanation of the facts, law and reasons for the proposed tax adjustment is attached to the NOPA
    • The organization may agree, present additional facts, or submit a written protest
  • Upon receipt of a 30-day letter issued by the IRS if the parties cannot resolve the issues, the exempt organization can respond with a formal written protest and request the Appeals Office of the IRS (“Appeals”) to review the issues

Being a Nonprofit in a Trump Era

  • Tax reform – reflects a lack of respect and appreciation of the work of charities and the value of pluralism
  • Weakening or repeal of the Johnson Amendment will result in an estimated loss of $2.1 billion of government revenue over the next 10 years because of  non-deductible contributions to other organizations for political electioneering will be replaced by deductible contributions to charities electioneering
  • With only 5% of taxpayers being itemizers under the GOP Tax Bill, many taxpayers may prefer to give to 501(c)(4) social welfare organizations that can spend on electioneering instead of to 501(c)(3) charities because there would be no more tax advantage to giving to a charity
  • Panelist David Levitt (quoting Soul Asylum) on civil disobedience and valid forms of protest vs. illegal activity: “Trying to do the right thing, play it straight, but the right thing changes from state to state”