The House Ways and Means Oversight Subcommittee held a hearing Wednesday to examine tax compliance issues surrounding public charities, the rules governing their profit-making activities, and whether the newly redesigned Form 990 is promoting increased compliance and transparency.
“Over the last several decades, public charities have become increasingly complex organizations,” said Rep. Charles Boustany, R-La., who chairs the subcommittee. “While universities and hospitals are notable examples of this, complexity has not been limited to these types of organizations. A number of factors have driven this trend, including federal tax law itself and the expansion of the types of exempt and commercial activities that public charities engage in.”
He noted that a decade ago, there was growing recognition that the Form 990 used by most tax-exempt organizations to report on their income was not collecting the kind of information needed by the IRS or the public to understand the activities of the increasingly complex nonprofit sector. To ensure a greater level of transparency across the sector, the IRS substantially redesigned the Form 990, rearranging how information is reported and expanding the amount of the information requested to focus on issues such as related-party transactions, governance and commercial activities.
Steven T. Miller, deputy commissioner for services and enforcement at the IRS, noted that the Form 990 took effect in tax year 2008 after the IRS solicited input from various stakeholders and released a draft version. However, he added that the redesign is still evolving.
“We recognized that the transition from the old to the new Form 990 would change the way some organizations capture and track data needed to complete the form,” he said in his prepared testimony. “To give small and mid-sized organizations with fewer legal, accounting, and administrative resources more time to adapt to the redesigned form, we provided transition relief.”
The IRS implemented a three-year phase-in period to give organizations time to enable their internal systems to respond progressively to the new requirements. But the redesign of the Form 990 remains an ongoing and continuing process that will continue as the IRS monitors levels of compliance, shareholder needs, and changes to the law, Miller noted.
Eve Borenstein, a partner in the Borenstein and McVeigh Law Office in Minneapolis, said the IRS needs to do a better job of educating charities about the Form 990. “There is a need for education of the reporting community as to the meaning of key semantics the form employs,” she said. “There is also a need to foster an understanding that the IRS definitions for the form are not necessarily the same used by others for other purposes, and that in many instances what appears to be negative reporting on the form does not mean that the organization is doing anything improper.”
For example, the insider transactions reporting on Schedule L requires an organization to disclose many transactions that are commonplace and advantageous to the organization, she noted.
Borenstein pointed out that many organizations have an easier time understanding how to do the form than even CPA firms, which oftentimes do the forms simply as a courtesy to charitable groups and their for-profit clients.
“Self-preparers have had a much easier time in adjusting to the new form than has the paid preparer community,” she said. “Their learning curve progress has been advanced by the fact that in most cases the staff that does internal preparation actually reads the instructions. My first teaching tip on the redesigned form is to “read the instructions.” Furthermore, they can apply what they find in the instructions based on their firsthand knowledge of their own organization.”
She noted that many preparers do not fully read the instructions even when they do look at them. “In teaching CPAs I always get a big laugh when I tell people not to stop reading when they get the answer they want,” she said.
Political and Business Activities
Rep. John Lewis, D-Ga., the ranking Democrat on the subcommittee, questioned how some charities are branching out into for-profit businesses, and tax-exempt organizations are increasingly lobbying Capitol Hill and raising campaign funds on behalf of political candidates.
“As public charities become larger and more complex, I am concerned that they may be engaging in activities that are not part of their charitable mission,” Lewis said in his opening statement. “Some may be using for-profit subsidiaries to engage in business that is not related to their charitable mission. Some may be using related organizations to engage in certain activities indirectly that they could not engage in directly. As we move toward tax reform, we should consider whether these rules are working as intended.”
Donald Tobin, associate dean at the Ohio State University Moritz School of Law, noted that the IRS is not set up to be a campaign watchdog. “Public charities are increasingly using complex arrangements with other tax-exempt organizations to increase the charity’s involvement in certain political activities, including lobbying and campaign advocacy,” said Tobin in his prepared testimony. “In addition, other tax-exempt organizations involved in lobbying or campaign advocacy are using complex arrangements so that they can maximize the benefits of tax-deductible contributions while still engaging in lobbying or election advocacy. Specifically a public charity may set up a Section 501(c)4 social welfare organization to engage in unrestricted lobbying, and the social welfare organization may set up a segregated fund under Section 527, which governs political organizations, to engage in electioneering activities.”
John Colombo, a professor at the University of Illinois College of Law, pointed to some examples of increasingly complex nonprofit organizations. “Commercial activity by charities seems to be an entrenched and growing phenomenon,” he said. “Yet the income tax rules surrounding commercial activity are confused and contradictory, based on regulations issued in 1959 that no longer serve either tax policy or the exempt organizations community.”
He believes the IRS needs to better define the role of the private benefit doctrine in policing exempt organizations, particularly in the area of revenue-generating activities carried on in partnership with for-profit organizations or private investors.
“Unfortunately, the current provisions of the [Internal Revenue Code] regarding commercial activity by charities and the IRS’s and courts’ interpretations of those provisions have created needless confusion and uncertainty, particularly regarding the effects of commercial activity on exempt status,” he added. Colombo believes it is time for Congress to undertake a comprehensive review of these rules and enact provisions with clear lines demarking appropriate and inappropriate activities.
Thomas K. Hyatt, a partner at the law firm SNR Denton, discussed the increasing complexity of many charities. “There can be no denying that these large nonprofit public charities are more complex in their structures and operations than they were, say, 40 years ago,” he said. “Today it is not uncommon to have multiple business entities operating within an integrated system. They may have a central parent organization charged with strategic oversight of the system; brother-sister companies; subsidiaries; and subsidiaries of subsidiaries. These entities may include nonprofit corporations, taxable for-profit corporations, nonprofit taxable corporations, limited liability companies, limited and general partnerships, and joint ventures.”
He noted that the increasing complexity is a necessary consequence of the efforts of large public charities to operate effectively and with economic sustainability in the modern nonprofit sector, and to comply with multiple federal and state regulatory schemes and third-party standards in their operations. “Important and largely effective checks and balances, as well as the oversight of the nonprofit sector itself, are present to keep this level of complexity from becoming a problem under the law,” said Hyatt. “Nevertheless, continued emphasis on transparency regarding these structures is critical, and continued scrutiny is warranted.”
