The Senate Finance Committee has held several hearings on nonprofit organizations covering abuses, governance, and whether nonprofit hospitals provide sufficient charitable care to justify their tax exemption. The IRS, under pressure from the Senate Finance Committee, is revising and expanding Form 990 with a new Schedule H for nonprofit hospitals and a new Schedule K for nonprofits with tax-exempt bonds outstanding. Over the past few years, the IRS and the Senate Finance Committee have each sent questionnaires to many hospitals on various topics, including charity care. In addition, the IRS has sent questionnaires concerning the compensation of nonprofit executives and after-issuance tax-exempt bond compliance. While the compensation and bond compliance questionnaires were not limited to nonprofit hospitals, a substantial percentage were directed toward nonprofit hospital systems and hospitals. The IRS has also initiated test audits of some nonprofits with respect to their outstanding tax-exempt bonds. The following provides an update on these tax-exempt bond initiatives.
In 2006, the IRS announced the first step of its new audit program in examining tax-exempt bonds issued by §501(c)(3) entities. (See our bulletin at this link.) In November 2007, Christopher Woodin, a tax law specialist in the IRS's Tax Exempt Bonds Office (TEB), reported certain results of this audit initiative. The initiative involved 30 nonprofits, 18 of which were hospitals and the others were housing organizations. Twelve cases have been closed with no changes and no penalties. The IRS, however, has proposed audit adjustments in 10 cases (one-third of the cases) and the audits continue with respect to the remaining eight. The audit adjustments appear to center around record retention problems, excessive private use, and failure to pay arbitrage rebates.
In August 2007, the TEB and the IRS' Exempt Organizations Compliance Area (EOCA) initiated a joint effort to evaluate the policies and procedures used by nonprofit organizations to ensure post-issuance compliance of their tax-exempt bonds. The IRS also released a new Form 13907 "Tax-Exempt Bond Financings Compliance Check Questionnaire," which can be found at this link. Pursuant to this joint effort, the EOCA will send out a letter explaining the questionnaire to selected nonprofits and collect the responses for the TEB to analyze. A copy of the IRS letter can be found at this link. The TEB will analyze the responses to become more familiar with the post-issuance compliance policies and practices of nonprofits and issue a report publicizing the findings and its recommendations for the development of additional outreach and/or compliance initiatives.
This questionnaire has 27 questions covering five areas:
- Post-Issuance Compliance – General
- General Recordkeeping
- Investments and Arbitrage Compliance
- Expenditures and Assets
- Private Business Use
Nonprofit hospitals with exempt bonds should review Form 13907 (see the link above) as it shows the IRS's expectations of what nonprofits must do to demonstrate post-issuance compliance. Nonprofits with tax-exempt bonds outstanding should consider reviewing their recordkeeping, arbitrage compliance, and related matters and have written policies and procedures concerning these matters before the IRS initiates contact.
The IRS sent the first round of letters with the Form 13907 questionnaire to 208 nonprofit organizations with tax-exempt bonds outstanding in 2005 as part of the compliance check. Although the IRS has stated that it anticipates follow-up exams only for the more "egregious" areas of noncompliance, some of the questions may trigger IRS audits of the nonprofit responder. The IRS has now received some of the responses along with significant negative comments concerning the questionnaire and its yes/no answers to complicated questions. The IRS has indicated that the form likely will be revised, but has not provided any specifics. This is a likely signal that more questionnaires will be sent to nonprofits in the future after the current batch of forms is processed. The IRS also will survey the filed Form 8038-T "Arbitrage Rebate" for potential areas of noncompliance and follow-up. As part of the follow-up, rebate calculations will generally be requested and reviewed.
In addition, the proposed new Form 990 includes a new Schedule K dealing with tax-exempt bonds. The new Form 990 is anticipated to be required for the 2008 tax year (i.e. returns to be filed in 2009). The IRS recently indicated that the current proposed draft Schedule K will be revised (with more questions on arbitrage). The IRS also has indicated that many nonprofits will only have to complete Part I of Schedule K for the 2008 year and will not have to deal with Parts II, III and IV involving bond proceeds, private use and compensation of third parties respectively in the inaugural year. In subsequent years, however, all questions will be required to be answered.
With the high rate of perceived noncompliance from the test audits, reviews of filed Form 8038-T, the promised revision of the new tax-exempt bond questionnaire, and the new Form 990 with its Schedule K, it is anticipated the IRS will ramp up its audit activity in this area.
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