Here are a few other annual filing reminders and traps for the unwary that we have gleaned through our experiences as legal counsel for nonprofit organizations.

Traps for the Unwary:

• If your organization fails to file its annual return for three consecutive years, your organization will automatically lose its federal tax-exempt status. This rule doesn’t just affect small start-ups that fail to file the e-Postcard (see the third bullet point below); it can affect organizations with more complex organizational structures, too!

• Even if your organization is not required to apply to the IRS for tax-exempt status (for example, if it is a “self-declared” 501(c)(4), 501(c)(5) or 501(c)(6) tax-exempt organization), your organization still has an obligation to meet these annual filing requirements.

• With very few exceptions, most small tax-exempt organizations with gross receipts that are normally $50,000 or less (the threshold was $25,000 for tax years ending on or after December 31, 2007 and before December 31, 2010) must file the IRS Form 990-N (e-Postcard). NOTE: Organizations may not request an extension to file the e-Postcard.

• If your organization is a newly formed entity and its IRS Form 1023 application is pending with the IRS, your organization still must meet the applicable filing requirements. We recommend you work with a tax professional or nonprofit lawyer to help enter your organization into the e-Postcard filing system.

• The first 3-month extension is granted automatically. If you need another extension, submit it in advance so that if it is not approved, you can still file a timely return.

• Even if you have obtained a filing extension, any tax due on an IRS Form 990-T is due on the original filing deadline, and the IRS imposes penalties and interest on the failure to timely pay the tax. This rule tends to nail newer leaders in the nonprofit sector.

• If sending returns to the IRS by mail, send them by U.S. Mail certified return receipt requested. Keep all copies and records of documents sent and your date-stamped proof of mailing.

• Remember, an incomplete return is treated the same as a late return. If your organization files a return with missing information or required schedules penalties could apply. Review your return before submitting, and if you have questions, contact a nonprofit lawyer or tax professional before submitting to the IRS.

• Don’t include personal information, such as social security numbers and bank account numbers, on returns. The IRS is required to publicly disclose information returns, attachments filed with the return, and correspondence with the IRS about the filing. Therefore, don’t include personal information in any of those filings.

According to the report, the top compliance issues for colleges and universities concern 1) the reporting of unrelated business taxable income (UBTI) and 2) compensation practices. Here are the highlights . . .

Expect More Scrutiny

Congressman Charles W. Boustany, Jr., M.D., (R-LA), Chairman of the Subcommittee on Oversight of the Committee on Ways and Means, announced on May 1 that the Subcommittee will hold a hearing on the report.

Boustany noted that “it is critical that the Subcommittee continue its review of this segment of the tax-exempt sector… The Subcommittee has an obligation to explore the root of these alarming findings. . . This hearing is an excellent opportunity to discuss the results of the compliance project and examine areas for improvement in oversight, with an eye toward comprehensive tax reform.” [emphasis added] (Click here for the press release.)

UBTI Issues

The IRS reports that its examinations of colleges and universities led to an increase in the amount of unrelated business taxable income (UBTI) for 90% of the colleges and universities examined – the uptick in taxable income totalled about $90 million.

Note: because – as the IRS notes – these examinations were not randomly conducted, and instead colleges and universities were chosen for examinations based on their responses to the questionnaires and their IRS Forms 990, these results are not necesarily representative of other colleges and universities. Even so, the IRS seems intent on focusing on these issues for future examinations of colleges and universities, and on the exempt sector at large (see parting words below).

In its report, the IRS explains the issues that generally led to the adjustments: 1) the colleges and universities were deducting expenses that were not connected to unrelated business activities; 2) the colleges and universities were making computation and substantiation errors; and 3) the colleges and universities were improperly taking the position that certain actvities were related activities (and therefore could not give rise to UBTI).

Not surprisingly, the adjustments occurred mostly with respect to the following activities: fitness, recreation centers, and sports camps; advertising; facilty rentals; arenas; and golf.

Compensation Practices

The IRS notes in its executive summary of the report that most of the private colleges and universities examined made attempts to meet the rebuttable presumption standard (this is the standard that allows private colleges and universities to follow certain procedures when setting compensation for officers, directors, trustees, and key employees so that they may shift the burden on the IRS to prove that compensation set by the college or university is unreasonable for purposes of IRC 4958, the section of the Internal Revenue Code that imposes penalties on those who receive and approve unreasonable compensation).

Despite efforts made, about 20% of private colleges and universities failed to meet the rebuttable presumption standard, generally because of problems related to their comparability data, documentation, and lack of attention to detail.

The executive summary to the report also notes that the IRS looked at employment tax returns for about a third of the colleges and universities examined and at the retirement plan reporting of about a quarter of the colleges and universities examined – the IRS noted that all of the completed exams have resulted in adjustments in wages, leading to assessment of tax (and in some cases penalties) and that there were also retirement plan reporting problems at about half of the colleges and universities examined.

Parting Words (Where the IRS is headed)

The executive summary to the report gives a clear indication of where the IRS focus remains for colleges and universities and the rest of the exempt sector:

“The examinations of college and universities identified some significant issues with respect to both UBI and compensation that may well be present elsewhere across the tax-exempt sector. As a result, the IRS plans to look at UBI reporting more broadly, especially at recurring losses and the allocation of expenses, and to ensure, through education and examinations, that tax-exempt organizations are aware of the importance of using appropriate comparability data when setting compensation.” [emphasis added]

The purpose of the questionnaire is to learn more about self-declared tax-exempt organizations and to determine whether they are currently complying with the law; it is also meant to educate organizations and encourage voluntary compliance.  An organization that receives the questionnaire has 60 days from the date of the cover letter to respond.  An additional 30 days may be granted if needed.  After the questionnaires have been collected and reviewed, the IRS may choose to commence formal examinations of a number of the organizations that completed questionnaires.  For more information about the difference between a compliance check and an IRS examination (or audit), see IRS Publication 4386.  After the examination period, the IRS will quantify its data and release the findings to the public.

The questionnaire consists of a wide range of questions relating to the operations of your organization, including its lobbying activities, revenue sources, and compensation to officers and directors.  Many of the questions seem straight-forward; however, the questionnaire does include traps for the unwary.  Receiving the questionnaire offers the opportunity for your organization to reconnect with legal counsel to better understand your organization’s compliance obligations.  An attorney with experience  in nonprofit law can guide you through the questions, point out what the IRS is looking for, and help you avoid traps that could lead to an in-depth IRS examination.

The questionnaire is voluntary and failure to complete it will not automatically result in the loss of exempt status.  However, the IRS may choose to pursue an examination of any organization that chooses not to complete the questionnaire.   More information about the questionnaire can be found here on the IRS website.

But before calling the IRS, collect your documentation and consider the information below. It will help you determine your options and your next move and can help you make the most of your legal resources.  And of course, if, after reviewing the information, you believe that your organization’s tax-exempt status was revoked in error, you should contact the IRS Consumer Account Services by calling (877) 829-5500.

How fast does your organization need to act?

You should begin to address the issue of revocation as soon as you receive an IRS notice of revocation, see your organization’s name on the IRS revocation list, or if you know your organization has not filed IRS Forms 990 for three consecutive years.

Small organizations may save money on the reinstatement process if they file an application for reinstatement on or before the December 31, 2012 deadline– see more about this below about this cost-saving deadline.

For a brief introduction:

Watch this brief IRS video about revocation.

For additional background:

On the basics about exemption revocation, visit the National Council of Nonprofits.

On how to reinstate tax-exempt status, visit the IRS page on Reinstatement.

For details:

On transitional relief for small organizations, see IRS Notice 2011-43.

Also for thought:

Consider fiscal sponsorship as an alternative to reinstatement, or as an interim step. Greg Colvin’s Fiscal Sponsorship: 6 Ways to Do it Right is a great resource for learning more about fiscal sponsorship.

Consider donor relations issues, set out nicely by the National Council of Nonprofits with links to other helpful IRS resources.

Information to collect before calling legal counsel:

Collecting the information below before you consult with a qualified exempt organization lawyer about your organization’s options can help save you time and money.

Note: Going through this exercise will be productive for your organization’s future. You should store all of these documents in an accessible spot – so that you can locate them in less than five minutes, as the need arises (and it always arises). Your organization is required by law to make the following documents available to the public upon request.

1. Determination Letter. If it has one, your organization’s IRS determination letter (this is the letter recognizing your organization’s exemption from federal income tax). If you cannot find your organization’s determination letter, you can request it from the IRS directly by filing IRS Form 4506-A.
2. IRS Form 1023. If filed, the Application for Tax-Exempt Status submitted by your organization (this is either IRS Form 1023 or IRS Form 1024 depending on whether or not your organization is a 501(c)(3) organization). If you do not have a copy of your organization’s exemption application, you can request it from the IRS by filing IRS Form 4506-A.  Just know, the IRS may not have it, and it could take some time to obtain it as the IRS searches its records.
3. IRS Forms 990.  Any copies of your organization’s IRS Forms 990 (as they were filed, with signatures) and proof of their filing dates. If you do not have copies of the IRS Forms 990, you can check your organization’s filing history and obtain copies at the Economic Research Institute. You can also request copies from the IRS by filing IRS Form 4506-A, and can request a transcript to obtain information about filing dates from the IRS by calling 1-866-860-4259 x4.

What legal counsel wants to know:

Providing your exempt organization lawyer with the following information (along with the documentation above, if it is available) can help legal counsel provide an expedient review of your organization’s situation, which can save you time and money (and can help ensure that the issues are thoroughly considered).

1. The basis for your organization’s exemption (religious, charitable, trade association, etc.)
2. The fiscal date or calendar year end of the organization.
3. The years in which returns were not filed.
4. The amount of the annual gross receipts that your organization received beginning in 2007.  Was it less than $25, 000 in each of the following years: 2007, 2008, and 2009?
5. The filing date of the third IRS Form 990 in the three-year period that was required to be filed.
6. Reason(s) why the forms were not filed, or filed timely.  (Organizations must demonstrate reasonable cause in order for reinstatement to take effect retroactively.)
7. If your organization had an advance ruling period, the start date and end date of the advance ruling period.  Whether your organization is in the midst of its advance ruling period, and whether it completed IRS Form 8734 if the period has ended.
8. Any other reason(s), aside from non-filing that the IRS has presented as a basis
9. Whether any donations have been made (or are expected) from the effective date of revocation through reinstatement.

Parting words:

Think of the revocation notice as a chance to get your organization back in shape when the health of your organization matters most.  For many organizations, a fit life may mean fiscal sponsorship or winding down.

Please note: This article is provided only for informational purposes and for community benefit.  It is not legal advice. Please consult a qualified exempt organization lawyer for advice on your particular situation.