On Wednesday, November 8, the Internal Revenue Service (IRS) released its Exempt Organizations Implementing Guidelines for Fiscal Year 2007, in which it announced major new projects and initiatives with respect to tax-exempt organizations for the coming year. Noteworthy items from the 2007 Guidelines include the following:
The IRS has completed the nearly 800 single-issue examinations that arose from its 2004-2005 Executive Compensation Compliance Initiative, and it expects to issue a report on its findings by the end of 2006. This report could be highly illustrative of potentially problematic executive compensation practices. For fiscal year 2007, the IRS will focus on issues related to loans to officers, excess benefit transactions, and the process by which exempt organizations set and determine executive compensation.
In addition to attention that may otherwise be applied to the executive compensation initiatives (above), the IRS plans on focusing on how to differentiate for-profit hospitals from nonprofit hospitals with respect to the appropriateness of continued tax-exempt status. In particular, the IRS will analyze the data received from the Community Benefit Compliance Check Questionnaires, which it sent in summer 2006 to over 500 different hospitals and health systems. From that analysis, the IRS may proceed with additional education, guidance, examinations and/or further compliance check activity.
The IRS has been concerned that some organizations classified under the Internal Revenue Code as Section 509(a)(3) supporting organizations are controlled by their founders and established to avoid the more strict regulations governing private foundations, particularly the self-dealing rules that are more restrictive than the excess benefit rules that apply to Section 509(a)(3) supporting organizations. From the IRS perspective, these problematic supporting organizations are relatively inactive and do not provide meaningful support to the public charity they were created to support. Accordingly, in fiscal year 2007 the IRS intends to continue with a cross-functional examination effort with respect to these supporting organizations, in addition to issuing guidance on the new restrictions imposed on supporting organizations by the Pension Protection Act of 2006. Many tax-exempt hospitals and health systems maintain affiliates (e.g., parent organizations, fund-raising foundations and self-insurance trusts) that are supporting organizations. While the IRS’s efforts are not necessarily directed to supporting organizations affiliated with health systems, it is possible that hospital/health system supporting organizations could be affected.
The IRS is expected to finalize proposed regulations under the intermediate sanctions penalty excise tax provisions of Code Section 4958. These new, final regulations are expected to address the relationship between multiple excess benefit transactions and loss of an organization’s tax-exempt status. The final rules are also expected to emphasize the importance of tax compliance activity within an organization’s corporate compliance program.
Pension Protection Act Guidance
The IRS also expects to be active in terms of providing education, guidance and outreach to the tax-exempt community with respect to the many charity-related provisions of this significant 2006 federal legislation. Indeed, earlier this week the IRS issued guidance on how a public charity can seek reclassification of its public charity status, something that many public charities may wish to consider in light of the Pension Protection Act’s new restrictions on supporting organizations and donor-advised funds.
The IRS expects to begin a compliance project related to community foundations, focused primarily upon compliance with the terms of tax-exempt status. The compliance project will seek information on the organization and operation of these foundations, which the IRS notes have grown significantly in terms of number, size and complexity. It is conceivable that this project could include a review of those foundations formed with the proceeds from the sale of local community hospitals to for-profit purchasers if they characterize themselves as "community foundations."
Other IRS Priorities
The IRS also announced a series of "priorities" for the coming year. Of great importance, the IRS indicated it expects to release the long-awaited revised Form 990 and instruction to Form 990 in draft form for comments in 2007. With respect to determinations of tax-exempt status, the IRS has introduced a new "three-tiered" review system in the Cincinnati office to speed up the determination process. Under this new procedure, applications for exemption are divided into three broad categories: cases that can be closed without any development by the IRS; cases that can be closed with minor development; and complex cases that need research and development. This new system replaces the former "two-tiered" screening system that had been in place for some time.
The Implementing Guidelines can be accessed at http://www.irs.gov/pub/irs-tege/fy07_implementing_guidelines.pdf.