The International Journal
of Not-for-Profit Law

Volume 6, Issue 4, September 2004

By Milton Cerny*

Responding to a numerous media reports alleging misbehavior at charitable and other organizations exempt from tax under section 501, Congress and the IRS are taking aggressive steps to address such behavior. At the same time, the IRS and the media are closely watching the political activities of exempt organizations in this presidential election year.

Proposed Restrictions on Charities and Other Exempt Organizations. On June 22, 2004, the Senate Finance Committee held hearings on “Keeping Bad Things from Happening to Good Charities.” For the hearing, committee staff prepared a comprehensive set of proposals for changing the laws that govern charities and other tax-exempt organizations. Proposed changes included prohibiting loans and certain other types of transactions between charities and their directors and officers, requiring all exempt organizations to essentially reapply for tax-exempt status every five years, requiring CEOs to certify annually that procedures and processes are in place to ensure the accuracy of the information reported to the IRS on Form 990, and imposing additional duties on directors.

Senator Charles Grassley (R-Iowa), Chairman of the committee, stated that he plans to introduce legislation implementing these reforms in the fall of 2004. Passage of legislation during this election year is unlikely, but Senator Grassley has stated he will also introduce even more comprehensive legislation in 2005.

Restrictions on Donations and Charitable Giving Incentives. Both the House and the Senate have passed legislation that would reduce the deductions donors of intellectual property and vehicles to charities could claim. Passage of these provisions in some form is likely. At the same time, the CARE Act and its House counterpart that would provide incentives for charitable giving, such as non-itemizer deduction and IRA rollover provisions, continue to remain stalled, with passage unlikely.

Increased IRS Audit Activity. Responding to congressional pressure, the IRS exempt-organizations division has stepped up its audit activities. Specific targets are private foundations, with the IRS planning to audit 400 of them this year, and compensation, with a new IRS special compliance unit reviewing Forms 990 specifically for possibly excessive compensation.

The IRS is also continuing its “market segment studies,” audits of a statistically valid sample of particular types of exempt organizations. Segments currently targeted include section 501(c)(3) organizations that raise funds for other organizations, private schools, and non-exempt charitable trusts, as well as private foundations, community foundations, universities, and hospitals.

IRS Warns About Political Activity and Issues New Guidance. The IRS has issued both its regular warning about political activity by charities and a new warning to all of the national political parties to respect the prohibitions on political activities by charities. The IRS also issued a new ruling on issue ads at the very end of 2003. Revenue Ruling 2004-6 provides a detailed set of criteria for determining whether issue ads that mention an incumbent politician who is also a candidate represent partisan political activity.

IRS Issues Guidance on Ancillary Joint Ventures. The IRS issued a ruling this spring on when an ancillary joint venture between a charity and a for-profit party will be considered a related activity for the charity. Revenue Ruling 2004-51 describes a situation where a university and a for-profit entity form an educational joint venture for which each has a 50 percent ownership interest and the university retains exclusive control over the curriculum, training materials, instructors, and the standards for successful completion of the seminars. The IRS concluded that given these facts, the joint venture is a related activity of the university, so the university’s income from the joint venture would not be subject to unrelated business income tax.

Notes

* Milton Cerny, a former official of the Internal Revenue Service, is an attorney with Caplin & Drysdale in Washington, D.C.