Non-Profit Update #3
December 12, 1996
Shortly before adjourning, Congress enacted a number of tax provisions which affect exempt organizations (non-profits). These changes were primarily contained (some would say buried) in three bills: (1) Taxpayer Bill of Rights 2; (2) the Small Business Protection Act of 1996; and (3) the Health Insurance Portability and Accountability Act. These bills, which have various effective dates, are summarized below. In addition, I have also briefly summarized selected IRS policy documents which were issued this year. There have been other developments of interest to the non-profit community which I will summarize in future correspondence.
TAXPAYER BILL OF RIGHTS 2
Intermediate Sanctions: New penalty excise taxes are imposed with respect to excessive compensation or other "excess benefit transactions" involving public charities or section 501(c)(4) organizations, generally effective retroactively to transactions occurring on or after September 14, 1995. The taxes apply to the person receiving the excess benefit if that person is in a position to exercise substantial influence over the exempt entity, and to organization managers who knowingly participated in "excess benefit transactions." These "intermediate sanctions" are intended to apply in lieu of revoking the organizationís exempt status.
Relief From Employment Tax Penalties for Volunteer Board Members: Volunteer board members of tax-exempt organization are exempt from the 100-percent penalty for the organizations wilful failure to pay withholding or FICA taxes if they serve in an honorary capacity, do not participate in day-to-day financial affairs and do not have actual knowledge of the failure to collect and pay over taxes. The IRS was also directed to develop materials to better inform board members of their potential liability as responsible persons.
Private Inurement Prohibited for Section 501(c)(4) Organizations: Under prior law, there was no explicit provision for the IRS to revoke the exemption of a section 501(c)(4) social welfare organization which engaged in private inurement. A prohibition against private inurement was adopted for 501(c)(4) organizations which is very similar to that applicable to 501(c)(3) organizations.
Disclosure of Exempt Organization Returns: Tax-exempt organizations (other than private foundations) that have been required to allow the public to inspect their annual information returns (Forms 990) and exemption applications at their offices generally also will have to furnish copies of those documents upon request, with a reasonable fee allowed for copying expenses. (Private foundations must furnish copies of their exemption applications.) This new requirement becomes effective 60 days after the IRS publishes regulations. Additional reporting requirements for Form 990, regarding certain excise taxes, are imposed on certain tax-exempt organizations, and penalties relating to reporting and disclosure noncompliance are increased.
SMALL BUSINESS PROTECTION ACT OF 1996 & HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996
Section 401(k) Plans: Charities, social welfare organizations, labor unions, trade associations, and other tax-exempt organizations may now establish section 401(k) plans for their employees. This change allows tax-exempt organizations to offer their employees an opportunity to contribute to retirement plans with pre-tax dollars.
Contributions to Stock to Private Foundations: The special rule contained in section 170(e)(5), which allows a deduction for the fair market value of "qualified appreciated stock" contributed to a private foundation, has been reinstated for contributions of qualified appreciated stock to private foundations made during the period July 1, 1996 through May 31, 1997. (From 1994 to July 1, 1996 donors could deduct only their basis in the contributed stock, with no deduction allowed for the value of the stock attributable to long term appreciation.)
Associate Member Dues to Agricultural or Horticultural Organizations: The IRS has generally been successful in arguing that associate member dues constitute UBIT. This section carves out a narrow exception. For taxable years beginning after 1986, annual membership dues not exceeding $100 per member received by agricultural or horticultural organization, as described in section 501(c)(5), are exempt from the unrelated business income tax (UBIT). (These changes are a benefit to Farm Bureaus.)
Employee Housing Provided by Academic Health Centers: Certain academic health centers are considered "educational institutes" for purposes of section 119(d), which states that employees of certain educational institutes do not have to include in income the fair market value of campus housing. The list of eligible employers is expanded to include academic health centers that engage in basic and clinical research and have a regular facility. Certain state university systems now also qualify.
Nonprofits May Now Hold S Corporation Stock: Organizations exempt from income tax under sections 401(a) and 501(c)(3) are now allowed to be shareholders in S corporations (i.e. donors may now give S Corporation stock to qualified nonprofits). The S corporation income or loss will flow-through to the qualified tax-exempt shareholder as unrelated business taxable income (UBIT), as will the gain or loss on the sale or other disposition of the S Corporation stock.
Tax Exemption Extended to State Prepaid Tuition Plans: The IRS has historically contended that state prepaid tuition funds were not exempt from federal income taxes. This section, which includes many restrictions, grants tax exemption to "qualified state tuition programs."
Charitable Risk Pools: Qualified charitable risk pools are eligible for tax-exempt status for taxable years beginning after August 1, 1996. A qualified charitable risk pool is an organization which is organized and operated solely to pool certain insurable risks (other than medical malpractice) of its members (all of whom are 501(c)(3) organizations), and to provide information to its members with respect to loss control and risk management. Presumably such pooling arrangements have the potential to lower the cost of insurance for the pool members.
Income Tax Exemption Extended to State-Sponsored Health Insurance and Workersí Compensation Organizations: State-sponsored organizations providing health coverage for high-risk individuals, State-sponsored worker compensation reinsurance organizations, and State prepaid tuition programs are all now eligible for tax-exempt status if certain requirements are met.
Section 457 Plans: The legislation makes certain changes to section 457 plans.
Section 403(b) Plans: Previously, the rules applicable to Section 403(b) plans (also known as tax sheltered annuities) were extremely rigid. The rules applicable to cash or deferred elections under section 401(k) will now apply to 403(b) plans in determining the frequency that an employee is permitted to enter into a salary reduction agreement. Certain other changes were made to 403(b) plans. These changes were designed to make 403(b) plans more consistent with 401(k) plans, so as to make them easier to understand and administer.
Qualified Plan Excise Taxes: The penalty tax provided for in section 4975(a), which imposes an excise tax on each prohibited transaction between a qualified plan and a disqualified person, is increased.
Subpart F Insurance Income: Certain subpart F insurance income received from a controlled foreign corporation by a tax-exempt organization is subject to the unrelated business income tax (UBIT).
SINGLE AUDIT ACT
The new law makes several important changes to the Single Audit Act of 1984, which established audit requirements for state and local governments which receive federal financial assistance. The new law extends the Actís jurisprudence to non-profits.
Political Expenditures - T.D. 8628, 1995-52 I.R.B.9: This document containing final regulations amends Regs. 53.4855-1, 53-6011-1, 53.6012-1, 53-6091-1, 301.6852-1, 301.6861-1, 301.6863-2, concerning excise taxes, filing returns, and accelerated tax assessments relating to certain political expenditures of charitable organizations, and injunctions to prevent certain political expenditures made by charitable organizations. This Treasury Decision implements changes made to the Code by OBRA Ď87.
Church Auxiliaries - T.D. 8640, 1996-2 I.R.B. 10: This document contains final regulations that exempt certain integrated auxiliaries of churches from filing information returns. These regulations incorporate the rules of Rev. Proc. 86-23 (1986-1 C.B. 564), into the regulations defining integrated auxiliary for purposes of determining what entities must file information returns. The new definition focuses on the sources of an organizationís financial support in addition to the nature of the organizationís activities.
Self Dealing by Private Foundations - T.D. 8639, 1996-5 I.R.B. 12: This document contains final regulations that clarify the definition of self-dealing for private foundations. These regulations modify the application of the self-dealing rules to the provision by private foundation of directorsí and officersí liability insurance to disqualified persons. In general, these regulations provide that indemnification by a private foundation or provision of insurance for purposes of covering the liabilities of the person in his-her capacity as a manager of the private foundation is not self-dealing. Additionally, the amounts expended by the private foundation for insurance or indemnification generally are not included in the compensation of the disqualified person for purposes of determining whether the disqualified person for purposes of determining whether the disqualified personís compensation is reasonable.
IRS RULINGS AND PROCEDURES
Churches - Rev. Proc. 96-15, I.R.B. 1996-3: The purpose of this revenue procedure is to list a class of organizations, affiliated with church or convention or association of churches and exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code, that is not required to file an annual information return on Form 990, Return of Organizations Exempt from Income Tax.
Valuing Artwork - Rev. Proc. 96-15, I.R.B. 1996-3: This revenue procedure informs taxpayers how to request from the Internal Revenue Service a Statement of Value that can be used to substantiate the value of art for income, estate, or gift tax purposes.
Conforming with FASB 116 - Ann. 96-3, I.R.B. 1996-20.: The purpose of this Notice is to provide relief from filing Form 3115, Application for Change in Accounting Method, to organizations described in section 501(c) of the Internal Revenue Code that are changing their methods of accounting for Federal Income tax purposes to comply with the provisions of Statement of Financial Accounting Methods Standards No. 116, Accounting for Contributions Received and Contributions Made. By way of background, three recent Financial Accounting Standards Board Statements significantly change the way which non-profits prepare external financial statements. These statements are FASB Statement no. 116, Accounting for Contributions Received and Contributions Made; Statement No. 117, Financial Statements of Not-for-Profit Organizations; and Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations.
Taxpayer Bill of Rights - Notice 96-47: The IRS has invited the public to submit comments on law changes enacted by Taxpayer Bill of Rights 2, which amended Code Sec. 501(c)(4) to expressly prohibit inurement of any part of the net earnings of an entity otherwise described in that section to the benefit of any private shareholder or individual.
Taxpayer Bill of Rights - Notice 96-48: This notice summarizes certain aspects of Taxpayer Bill of Rights 2 related to (1) inspection requirements for exempt organizations and (2) increases in certain penalties on exempt organizations