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At Your Service

By Mark B. Weinberg

Every nonprofit organization, like it or not, must deal at some level with several federal and State administrative agencies. This article discusses common points at which charities encounter the Internal Revenue Service (tax jocks call it the “Service,” newspapers call it the “IRS”) long the most active regulator of the nonprofit community. While my observations are aimed at charities, they set out a method for anticipating and resolving problems that are also encountered by other nonprofits (social action, labor, fraternal and all the other types of organization exempt under Code Section 501(c) of the Internal Revenue Code of 1986 (the “Code”). My goal is to not only relieve the anxiety associated with your dealings with the Service, but open a dialogue among readers on their own views and experience in dealing with this important agency.

Today the Service provides civil and customer-friendly treatment to those with whom it comes in contact more consistently than at any time in my 37 years of practice. At various points in this article, I share “Practical Tips” to make the administrative process work faster and better for you, the customer. These are not legal advice, nor should one follow them blindly in all situations, but they are tried and true rules of thumb that have helped many nonprofits to get reasonable answers from the Service more quickly with less expense.[1]

GROUND RULES - THE UNCHANGING MISSION OF THE SERVICE

The Service exists to collect taxes, but a Code that approaches 10,000 pages in length means these public servants are also implementing policy decisions embedded in that body of laws. Tax laws come and go and the Service reorganizes every few years, but its role in developing and implementing government policy toward nonprofits endures. Periodic efforts to shift this responsibility to other government agencies or a completely new body have had negligible impact upon the Service as the primary government overseer of nonprofit activity.

MOST COMMON CONTACT POINTS WITH THE SERVICE

Getting a TIN: Most charities first deal with the Service by filing form SS-4 to obtain An Employer Identification Number so that they can open bank accounts. [2]

Practical Tip: (1) The Service now issues these numbers immediately over the Internet, cutting out the delay that filing by mail or fax once caused.

Filing Form 1023: Normally, the next contact will be the filing of a Form 1023, Application for Recognition of Exemption. [3]This is normally done within the first 27 months of the group’s creation so a favorable ruling will relate back to the date it came into being. In recent years it has taken as long as a year or more to get a response from this initial application, although efforts by the Service to cut back this time have significantly reduced the average time to a matter of a few months.

Practical Tips: (2) Create a Business Plan for the entity before it is set up to avoid conflicts between what you want to do and what the documents permit.

(3) When incorporating, get a date stamped copy of the Articles from the State, as this must be filed with the Form 1023.

(4) File Form 1023 as soon after the entity is created as possible; the more time between these two events the more there is to explain on the application. A simple application takes less time to process, and you will reveal everything important on forms 990 anyway.

(5) The up front legal, accounting and other costs of creating the charity and filing the 1023 can run $5,000 to $10,000 or more. First choice is to give the money to the new entity. Nothing prohibits the founder of a charity that has reasonable prospects of being publicly supported from advancing the charity the funds for this, but it is most easily explained by making it an interest free advance to avoid inurement questions. If the charity turns out to be a private foundation, the loan could be an act of self-dealing.

(6) The Service prefers at least 3 Directors or Trustees to govern a public charity. Some States require only one director of a corporation, but having 3 permits independent Directors to review salaries of the Directors themselves and transactions with Directors, Officer and major donors. Code §4958 makes this important.

(7) The Service prefers that at least a majority of the Directors be U.S. residents, so that it can easily exert authority over the organization’s leadership. The law does not require this, and clients sometimes insist. Tell them it is likely to delay a favorable ruling, cost more money to argue with the Service and do nothing to protect the entity from the public and government’s right to know what they do.

(8) Forms 1023 are sometimes lost in the mail, separated from your check for the filing fee or the Form 2848, Power of Attorney for your lawyer or other authorized representative. If you and your authorized representative do not receive a letter from the Service saying the application has been received within a month to 6 weeks, call the Service TEGE status line and check out the situation.

Appealing Unfavorable Proposed Determinations: If your group is denied 501(c)(3) status, the Service will state the reasons for this action in a letter. It should also contain literature explaining how this decision can be reviewed. You may send a protest regarding this action to Appeals and request the determination be reversed. You would do this through a Protest that sets out the reasons the Service gave for denying the status and counters with relevant facts and law. Protests must contain specific information that is described in a pamphlet that accompanies the negative Letter from the IRS. [4]

Practical Tips: (9) The Protest should be prepared by a lawyer, CPA or other tax professional authorized to represent you before the Service who has an active practice in tax exempt organization matters. Courts presume the Service is correct if the matter gets through the appeals process without being favorably resolved. While this merely means you must make a solid case, in the event you cannot produce a stronger case than the IRS, the “tie goes to the runner,” in this case, the Service. This is your organization’s last chance to be recognized as exempt without spending thousands of dollars on litigation; invest in solid experience when choosing your advocate for the Appeals process.

(10) There are so many Forms 1023 submitted each year that the Service is constantly adding new people to screen and evaluate them; this is a new process to many of the new staff members. While the Service provides good training for them, understand that your charity’s 1023 could well end up in the hands of someone who does not understand what the group will do and why it is charitable. If you and your tax advisor are not making progress in getting them to understand, don’t be afraid to ask to speak with their supervisor and try to get past the sticking points.

Filing Forms 990: Forms 990 must be filed with the Service’s Ogden, Utah Campus each year. The due date is the 15 th day of the 5 th month following the end of the charity’s taxable year. Groups that normally receive less than $25,000 per year must only file a postcard stating their name, address, TIN and the identity of its leadership. Failure to file the postcard for 3 years running will result in the loss of the charity’s exemption; late filing of Forms 990 can lead to a $20 per day penalty up to a maximum of $20,000 for each 990.

Practical Tips: (11) The Service can and will abate this penalty if there is reasonable cause for the delay but “my accountant failed to file the return” is normally not a reasonable cause.

(12) Filing certified mail, return receipt requested, preparing a sworn affidavit to that effect with a copy of the 990 attached and stapling the return receipt and the green card when it is returned protects against these penalties, even if the person who did the filing dies or cannot be located when a question arises.

Filing Form 8734: A charity is to file Form 8734 within 90 days following the end of the organization’s advance ruling period (the time over which a group’s public support is figured before a final determination of public support status is made). The Service is supposed to send the charity a copy of Form 8734 at the end of the advance ruling period, but the mails sometimes miscarry. If the form is not completed and filed within that 90 day period, the organization is presumed to be a private foundation until the Service rules otherwise based upon the form when it is filed.

Practical Tip: (13)The presumption is only that, not a final conclusion the charity is a private foundation. Even if it has been a year or two since the form was due, prepare it and file it with an explanation as to why it was late. There is no penalty such as that for late filing of a Form 990, and in my experience the Service has made it’s determination effective retroactively.

Private Letter Rulings: A charity can request a Private Letter Rulings (“PLR”) to get reliable advice from the Service that what it plans to do is consistent with its exempt status or will have stated tax results. Once provided as a free service, current rules require the charity to pay the Service an $8700 filing fee when making the request. The Service now publishes checklists that must be completed and accompany the PLR request to eliminate costing communications back and forth about materials that are missing or incomplete.[5] The resulting ruling letter can be seen by the public (after removal of data that would identify the requesting charity) 90 days after the Service mails it to the charity, more than just your case is at stake. While only the charity requesting the PLR can rely upon it, the Service knows that the public will pick up on new solutions to old problems and infer current IRS thinking from these letters. This accounts for the months it takes for even the simplest questions to be answered. Indeed, the Service tries to reduce the need for numerous PLRs by publishing standardized forms for recurring transactions and refusing to rule on certain questions.

Practical Tips: (14) Since you are asking the highest levels of the Service to review your transaction, carefully review all existing authorities. Public authorities with which the Service tries to remain consistent include case law (with the exception of Tax Court cases in which the Service has not acquiesced), revenue rulings, revenue procedures, publications and even form instructions. Most importantly, there are thousands of PLRs that are already open to the public; review these to see what the very offices (if not the very people) you are asking to respond to your request have done in the past. This is no assurance that the Service will rule as you wish, or even that they will take a position you consider to be consistent with published matter, but know your reader.

(15) Service rules and the large filing fee discourage “comfort rulings” (advice on situations clearly covered in published rulings upon which all taxpayers can rely). If your request is particularly complex or novel, Rev. Proc. 2008-4 permits you to request a “pre-submission conference” to explain the nuances behind your request including new ways of looking at old problems. The Service may choose not to grant such a meeting, but if it occurs, listen carefully to the Service Representatives for aspects of the matter they consider to be important. You should tweak your request to cover these before filing submitting it.

(16) Your written request should always contain a request to meet with the Service if they contemplate a negative ruling. Misunderstandings as to the facts or the nature of your argument can be ironed out this way.

Audits: Your organization will normally learn that it is being audited by a letter from the Service. In a Correspondence Audit, either this initial letter or an Information Document Request (“IDR”) accompanying the letter or following it by a short time will ask for one or two pieces of information to be provided by mail. Always consult your tax advisor before responding, but correspondence audits often are efforts to make sense out of seemingly inconsistent filings the organization has made. Field Audits, in which the Service Revenue Agent (“Agent”) will want to inspect the entity’s records is a signal of greater potential danger. Once again, call your tax advisor immediately upon receipt of this letter and any IDR.

If newspapers or committees of Congress are investigating your charity or the kind of work it does that other charities do, your audit may be part of a larger industry-wide audit (such as that experienced by Credit Counseling Agencies in the mid-2000s) and/or it may be a coordinated Team Audit in which multiple Agents with special training will spend a good deal of time looking at your operations. While one normally contacts their CPA to deal with a Correspondence or routine Field Audit (at least until numerous IDRs, troubling letters or an Revenue Agent’s Report is received), if you believe that either an Industry-wide or Team Audit has been commenced, you should bring in a seasoned tax lawyer experienced in such audits at the outset. They may not wish to deal directly with the Service, but should interpret all communications from the IRS and review all proposed responses before they go out.

Practical Tips: (17) Meet with the Agent before the audit begins to understand what he, she or they are looking for so that you can give them everything for which they reasonably ask but nothing to which they are not entitled.

(18) It is your right to minimize disturbance of your charity’s workplace operations, and the Service will normally comply with reasonable requests, such as meeting in the CPA’s or lawyers offices so long as all fairly requested items are brought to them, and that the charity’s tax advisor be present if the Agent is to interview staff members. The single biggest mistake taxpayers make is giving the Agent the run of the office and its files. This prevents the charity and its advisors from knowing what the Service has seen reducing or precluding any chance to put them in context. Coffee pot chit-chat and rumor spawn inquiries that are often baseless and would not otherwise have arisen and is in most cases the harmless griping common to offices everywhere. Materials culled from files and copied without at least a copy of each being made by the charity or its tax advisor will prevent those items from being put in context early on so as to deflect irrelevant inquiries before they become part of a Revenue Agent’s Report (“RAR”) or IDR that becomes part of the file and can dog the case for months or years.

RAR: When the agent has developed a position regarding the tax status and/or liability of the charity, he or she will issue a RAR setting out the factual and legal basis underlying these. Recently, the Service has begun sending a draft R ar so that any factual or legal disagreements can be worked out before it is formally issued. This can be very good, as a final RAR is usually accompanied by a “30 Day Letter” saying the charity must either file a protest with Appeals within 30 days. If such a meeting is not arranged within that period, a “90 Day Letter” or Notice of Deficiency will issue that permits the charity to take advantage of the Court review options discussed above if the matter relates to the continued exemption of the organization. If it instead merely deals with unrelated business income tax or excises taxes under Code §§4958 or the Private Foundation rules, the charity can file a petition with the Tax Court, or pay the tax, file for a refund, and if it is not granted, sue in U.S. District Court or the U.S. Court of Federal Claims.

Appeals: Appeals Officers are among the most experienced examiners of tax issues the Service has to offer. They also can take into account the litigation hazards that an Agent or Supervisor cannot. Agents and their Supervisors are limited in their review to determining facts and applying current IRS positions on case law to those facts. At Appeals, matters that create risks in litigation are taken into account. For example, if your charity is located in a state where appeals from court cases go to a Circuit Court of Appeals that has ruled in the taxpayer’s favor on the point at issue, Appeals will be far more likely to settle on favorable terms than the Agent would have been. Practical Tip: (19) It is always cheaper for the charity and easier upon its staff if the matter can be resolved at Appeals rather than going to court.

Termination: Charities go out of business and when they do, they must file a final Form 990 with the Internal Revenue Service. If the organization is a private foundation, it must get the approval of the Service to terminate its private foundation status without repaying the tax benefits associated with that status. This is normally done by distributing all of its net assets to an organization that has been publicly supported for at least 60 months ending with the date of the distribution. Practical Tip: (20) Taxes are not the only concern for nonprofits that go out of business. One must make sure that all Payroll Taxes (FICA, FUTA and Income Tax Withholding from employees salaries) are paid before distributing all of the charity’s assets. Those having signature authority over the charity’s bank accounts and even its Board of Directors can be held personally liable for any Payroll Taxes that the charity fails to pay. Some jurisdictions also require the Board to dissolve a corporation to stop the accrual of corporate filing fees. Consult you counsel on these and other corporate points.

SUMMARY

This Article discusses the diverse ways in which charities interact with the Service. Should you wish to discuss a situation concerning your particular situation, posting to the CHARITYLAW forum can produce useful insights (though not legal advice). If you seek legal advice on specific issues relating to dealings between your organization and the Service, you may contact the author off-list at PaladinJ@WJLAW.COM.

 

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1. A good supplement for information contained in this article is the Life Cycle of a Public Charity/ Private Foundation on the IRS web site. http://www.irs.gov/charities/charitable/article/0,,id=136459,00.html. Life Cycle for Exempt Organizations is available at http://www.irs.gov/charities/article/0,,id=169727,00.html

2. https://sa2.www4.irs.gov/modiein/individual/index.jsp

3. Other nonprofits normally file a form 1024 if they wish to obtain recognition of their tax exemption; as a general rule, charities other than churches are required to file a 1023 to be exempt under Code §501(c)(3).

4. Publication 5, Your Appeal Rights and How To Prepare a Protest If You Don't Agree.

5. The checklists and precise procedures are published annually as one of the first Revenue Procedures and are available online at IRS.GOV. This year these and related rules were published on January 8th and appear in Rev. Proc. 2008-4; http://www.irs.gov/irb/2008-01_IRB/ar09.html.

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