Tax-Exempt Advisory

A number of inquiries and initiatives instigated by the IRS in 2008 focused on the amount of resources charities are expending to further their exempt activities. The published results of studies and the filing of the redesigned IRS Form 990 by tax-exempt organizations could result in new legislation from Capitol Hill and further oversight by the states and IRS.

  • The most significant change in 2008 for charities and other tax-exempt organizations is the redesigned Form 990, which must be filed for the 2008 tax year, unless the organization meets the filing threshold for Form 990-EZ. For 2008, the thresholds for using Form 990-EZ are gross receipts under $1 million and total assets under $2.5 million. The form includes eleven pages to provide a general overview of the organization and sixteen schedules requiring additional details. We recommend that every organization allow for a significant amount of time to collect the information required to complete the form. Our July 2008 Tax-Exempt Advisory discussed the changes to the form in detail. Please let us know if you would like a copy of that advisory or further guidance on the redesigned form.
  • In a number of public speeches and interviews with the media, Steven T. Miller, IRS Commissioner, Tax Exempt and Government Entities, indicated that the IRS would make greater use of the "commensurate test" to ensure that organizations are spending an appropriate amount of their resources on their charitable activities. Pursuant to Rev. Rul. 64-182, 1964-1 C.B. 186, a 501(c)(3) organization will meet the primary purpose test if it can be shown that its charitable program is "commensurate in scope" with its financial resources. According to a report by BNA, IRS officials will focus on unusual levels of fund raising or the reporting of unrelated business activity compared to low levels of program service expenditures. The report indicates that IRS attempted to include a measurement of efficiency and effectiveness on the redesigned Form 990 but removed it after members of the tax-exempt community complained that such a measurement may not accurately reflect an organization's charitable activities. IRS has said that it will continue to look for examples of private benefit and private inurement, which indicate that the assets are not used exclusively for charitable purposes.
  • State courts are also examining appropriate measures for determining the amount of charitable activity required to establish that an organization is operated exclusively for charitable purposes. In Provena Covenant Med. Ctr. v. Dep't of Revenue, 894 N.E.2d 452 (Ill. App. 2008), the Illinois Appellate Court held that a hospital was not entitled to exemption from property taxes for a variety of reasons including that it did not dispense charity care to all who needed it, but the court rejected calls to establish a fixed percentage by which to measure charity care. In November 2008, the Illinois Supreme Court agreed to hear the hospital's appeal.
  • The results of an IRS study of 500 tax-exempt hospitals, which included an inquiry about executive compensation and charity care policies, are expected in the coming months. Reports of excessive compensation gleaned from the study led to some exams in 2008. Additionally, it has been reported that Senate Finance Committee ranking minority member, Chuck Grassley, R-Iowa, may introduce legislation in 2009 requiring that tax-exempt hospitals dedicate a mandatory percentage of expenditures to charity care.
  • In the past, Sen. Grassley has also proposed that there should be a mandatory payout of endowments held by educational institutions. Meanwhile, federal and state legislators have encouraged continued spending of endowments for financial aid by educational institutions despite the economic downturn. In 2008, college and universities were also the subject of an IRS compliance project, similar to the review of tax-exempt hospitals. In addition to executive compensation, the questionnaire focused on endowment fund management, unrelated business income, and affiliated organizations, including joint ventures.
  • The IRS strove to maintain a meaningful enforcement presence during the 2008 election cycle with the Political Activities Compliance Initiative ("PACI"), which also operated during the 2004 and 2006 political campaign seasons. The initiative focused on Internet-based campaign intervention. The IRS educated candidates and charities with letters to national political party committees, a letter to candidates in the Federal Election Commission's monthly newsletter, news releases to churches and charities, and additional information on the Web site of the IRS. A number of factors were used to determine if impermissible campaign intervention occurred, including whether there was a link between the organization's Web site and that of a site favoring or opposing a candidate. Another factor under consideration was the electronic proximity or number of "clicks" required to obtain objectionable material. The agents were directed to distinguish cases involving links to unrelated organizations and those involving related organizations. A study of the effects of PACI is expected in March.
  • A much-publicized example of campaign intervention may have occurred with the Pulpit Freedom Initiative, an effort designed by The Alliance Defense Fund to provoke the IRS to act and challenge the prohibition in court. The initiative, known as "Pulpit Freedom Sunday," called for clergy to give sermons on September 28, 2008, discussing candidates' positions. It was criticized by both tax-exempt professionals as well as approximately 100 clergy members, who delivered sermons a week earlier in support of the separation of church and state. Many tax professionals do not believe that litigation will result from the initiative because courts have ruled in the past that the prohibition on campaign intervention does not violate First Amendment free speech protections.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.