On July 25, 2012, the House Ways and Means Subcommittee on Oversight held its second hearing on tax exempt organizations.
The hearing focused on Internal Revenue Code (IRC) section 501(c)(3) organizations, including their complex structures, unrelated business activities and whether the new Form 990 promotes increased compliance and transparency. Among the panelists was the IRS Deputy Commissioner for Services and Enforcement, Steve Miller; two attorneys and two law professors.
On the same day, the Senate Finance Committee held a hearing on education tax incentives and tax reform. http://www.finance.senate.gov/hearings/hearing/?id=16f8c6bf-5056-a032-52e8-40c42f7c9a5f. The focus of the Senate hearing was higher education, one of the largest segments of the nonprofit sector. Although the hearings had different specific focuses, it is significant that both branches of Congress are looking closely at tax exempt organizations, their role in the overall economy and how to sculpt a new tax code that will address some of the concerns in this sector.
Difficulties in Regulating Tax Exempt Organizations
IRS Deputy Commissioner Steve Miller spoke at the House hearing about the diverse growth of the tax exempt sector. Specifically, he cited the more than 50,000 applications for exemption per year, as well as the diminishing exempt organization resources of the IRS. He indicated that one of the reasons that the area is difficult to regulate is because there are not many bright line tests, especially when it comes to unrelated activities and the expenses.
According to panelists, there are two major issues associated with unrelated business income. First, the net income is subject to tax; and second, if there is too much unrelated business activity an organization could lose its tax exempt status. Both issues present unique challenges. Determining whether an activity is related or unrelated is often a question of facts and circumstances. The question of, “how much is too much” when it comes to unrelated activity is an area where there are no clear rules. Organizations with too much unrelated trade or business activity risk losing their exempt status; yet current law does not clearly define a limit. Having only such a draconian measure as revocation to use for enforcement adds to the difficulty in this area.
One hearing witness suggested that organizations should be able to engage in unlimited unrelated activities so long as the profits went to further exempt purposes and the organization’s charitable program was commensurate with its resources.
Complexity of Exempt Organizations and Form 990
Prior to the 2008 revision, the Form 990 had not been revised comprehensively since 1979, but the tax exempt sector had changed radically since that time. Although many exempt organizations still operate as a single 501(c)(3) entity, many organizations are part of multi-entity groups that include tax exempt parents, taxable subsidiaries, limited liability companies, partnerships, etc. Many 501(c)(3) organizations also have related tax exempt affiliates including 501(c)(4), (5) and (6) organizations that can engage in unlimited lobbying and political activity, if it is not a primary purpose. In addition, some groups have related Section 527 political organizations or PACs.
The IRS revision of the Form 990 is an attempt to make some of the above listed relationships more transparent. The new Form 990 attempts to provide information related to the complex structures and operations of exempt organizations. Panelists agreed that the new Schedule R (Related Organizations) has made these complex structures more transparent.
Panelists were asked to discuss whether the desired results of transparency have been achieved, and whether the form was overly burdensome. Witnesses indicated that the amount of resources and the time needed to fill out the form has increased, but the IRS and the public do have more information. Recommendations offered by the panel included simplifying Schedule L, Transactions with Interested Persons, streamline or eliminate Schedule F (Statement of Activities Outside the United States), because the utility of the information being provided was burdensome and of questionable value; and also to eliminate the requirement to breakdown functional expenses into categories of program, fundraising and management, and general because the categorization is so subjective, and again, may not provide value.
Congress’ simultaneous evaluation of tax reform and tax exempt organizations is a daunting task. However, these actions are important steps towards updating the rules that impact effective regulation of tax exempt organizations.