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WHAT TO DO IF THE IRS COMES KNOCKING

The Perspectives of a Former Director

Marcus S. Owens

Loeb & Loeb, LLP

Washington, DC

202-618-5014/mowens@loeb.com

PART I – INSTITUTIONAL CHANGE

I. Introduction

Since May 2013, the Internal Revenue Service, and the Exempt Organizations

Division in particular, has undergone extraordinary change. For perhaps the first time

in the history of the agency, virtually all senior management responsible for tax

administration in a particular area have been removed, replaced or retired, beginning

with the Acting Commissioner. The developments are clearly having a dramatic

impact on the operations of the function.

II. Historic Rhythm of Government/Exempt Organizations Relations

In view of recent developments, it seems appropriate to provide some context for the

efforts of the IRS to conduct oversight of charities, and other tax-exempt

organizations. As will become clear, the role of government in overseeing tax-

exempt organizations has been part of many significant developments in US history, a

fact that has been echoed in recent developments involving section 501(c)(4)

organizations and politics. While the modern oversight structure only dates from the

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Tax Reform Act of 1969 and the Employment Income Security Act of 1974, the

antecedents of the system reach back into legal history.

One common starting point is the Statute of Charitable Uses, passed by the English

Parliament in 1601. The Statute, whose full name was “An Acte to Redress the

Misemployment of Landes, Goodes and Stockes of Money heretofore Given to

Charitable Uses,” included a preamble setting forth how the Parliament intended the

“misemployment” of charitable resources. In essence, the preamble listed those

activities considered to be charitable in England, circa 1601.

Much later, in the 1940s, the IRS imposed the requirement of an annual information

return, the Form 990, on certain tax-exempt organizations, including charities. In the

wake of aggressive commercial exploitation, including the operation of the Mueller

Macaroni Company as a tax-free mechanism to support New York University Law

School, Congress enacted the Revenue Act of 1950, which incorporated an income

tax on the “business” income of otherwise tax-exempt organizations and also made

the Form 990 a public document. Beginning in the 1950s, the IRS found itself

playing a role in racial desegregation, as reflected in litigation involving Prince

Edward School Foundation, the Little Rock Private School Corporation, and other

examples of “Massive Resistance” to desegregation. By the 1970s, the IRS was

dealing with a permanent injunction against recognizing racially-discriminatory

private schools in Mississippi as tax-exempt, followed by the extraordinary

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procedural history of Bob Jones University v. United States.1 In addition to

desegregation, the IRS became embroiled in anti-Viet-Nam tax protests, mail-order

ministries and the Iran/Contra Affair. The controversy engendered by the Citizens

United decision is only the latest in a long line of matters that cements the link

between tax-exempt organizations and many of the seminal events in US society.

III. Background: The Great Brouhaha of 2013

On May 10, 2013, the Director of the Exempt Organizations Division, Lois Lerner,

announced at an American Bar Association Tax Section that she wanted to apologize

for improper handling of applications for exemption from “tea party” groups.2 The

announcement was followed by the release of a report on May 14 by the Treasury

Inspector General for Tax Administration (“TIGTA”) on the processing of

applications for exemption under section 501(c)(4) of the Internal Revenue Code3

from “tea party,” “tea party patriots,” and “9/12” groups.4 The report was silent on

the extent to which other types of organizations received similar handling. The

request to TIGTA to undertake its review alleged that the IRS was “targeting” certain

organizations and the report, itself, repeated the incoming characterization. Lois

Lerner’s announcement and the TIGTA report triggered a quick and strong reaction

1 461 U.S. 574 (1983).

2 Weisman, I.R.S. Apologizes to Conservative Groups over Application Audits, New York Times, May 11, 2013, at

A11. http://www.nytimes.com/2013/05/11/us/politics/irs-apologizes-to-conservative-groups-over-application-audits.html?action=click&module=Search&region=searchResults%230&version=&url=http%3A%2F%2Fquery.nyt

imes.com%2Fsearch%2Fsitesearch%2F%23%2Flois%2Blerner%2Bpersonnel%2Bchanges%2F 3 All section references are to the Internal Revenue Code of 1986, and amended (the “Code”), and all regulatory

references are to the Treasury Regulations currently in effect under the Code (the “Regulations”). 4Treasury Inspector General for Tax Administration, Inappropriate Criteria Were Used to Identify Tax-Exempt

Applications for Review, May 14, 2013, Ref. No. 2013-10-053.

http://www.treasury.gov/tigta/auditreports/2013reports/201310053fr.pdf

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from the White House,5 which called for a Department of Justice investigation,

6 and

Congress, which reacted with demands for records and interviews of employees,

followed by days of hearings.7 As the hearings and investigations progressed,

however, it became clear that other groups, including progressive organizations and

non-political groups had also been “targeted” for close review. As the summer drew

to a close, Steven Miller, the Deputy Commissioner, Services and Enforcement, and

Acting IRS Commissioner, Joseph Grant, the Commissioner, Tax Exempt and

Government Entities, Lois Lerner, the Director of the Exempt Organizations

Division, and Holly Paz, the Director of the Rulings & Agreements Office in the

Exempt Organizations Division, had all been replaced, retired, or placed on

administrative leave. The offices were filled with lateral appointments from areas

outside the Tax Exempt and Government Entities function; Heather Maloy was

named Deputy Commissioner, Michael Julianelle was named Commissioner, Tax

Exempt and Government Entities, Kenneth Corbin was named Acting Director of the

Exempt Organizations Division, and Karen Schiller was named Acting Director of

Rulings and Agreements. Daniel Werfel, then at the Office of Management and

Budget, was appointed Acting Commissioner and then Principal Deputy

5 Shear and Wesiman, Obama Dismisses New Benghazi Furor But Condemns I.R.S., New York Times, May 14,

2013, at A1. http://www.nytimes.com/2013/05/14/us/politics/obama-addresses-benghazi-and-irs-controversies.html?pagewanted=1&contentCollection=Homepage&t=qry613%23/lois%20lerner%20obama/365days

/&version&action=click&region=Masthead&module=SearchSubmit&url=http://query.nytimes.com/search/sitesearch/?action=click&pgtype=Homepage 6Weisman, Acting Chief of I.R.S. Forced Out Over Targeting of Tea Party, New York Times, May 16, 2013, at A1.

http://www.nytimes.com/2013/05/16/us/irs-says-counsel-didnt-tell-treasury-of-tea-party-scrutiny.html?pagewanted=all&action=click&module=Search&region=searchResults%231&version=&url=http%3A%2F%2Fquery.nytimes.com%2Fsearch%2Fsitesearch%2F%3Faction%3Dclick%26region%3DMasthead%26pgty

pe%3DHomepage%26module%3DSearchSubmit%26contentCollection%3DHomepage%26t%3Dqry613%23%2Flois%2Blerner%2Bobama%2F365days%2Fallresults%2F2%2F 7Testimony of the Honorable J. Russell George, Treasury Inspector General for Tax Administration, Hearing Before

the Committee on Appropriations, Subcommittee on Financial Services and General Government, June 3, 2013. http://www.treasury.gov/tigta/congress/congress_06032013.pdf

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Commissioner upon the resignation of Steve Miller. Werfel quickly developed and

released a series of action papers designed to address delays and other aspects of the

processing of applications for tax exempt status under section 501(c)(4) of the Code –

a group of approximately 80 organizations.8 Shortly thereafter, members of Congress

requested a similar review of the examination process, including the identification of

tax-exempt organizations for audit.

IV. The Winds, Breezes, and Slight Air Puffs of Change

While the IRS went into hibernation in the wake of the Brouhaha, the agency had

been moving in that direction for a number of years, at least with regard to

enforcement. The IRS Data Book for 2014, in Table 13, reports that in FY 2014, the

Exempt Organizations Division closed audits of 2,825 Forms 990, 990-EZ, 990-PF,

1041-A, 1120-POL and 5227. That number does not correspond to the number of

organizations that were reviewed, as often an IRS examination will involve multiple

years. On February 22, 2016 the IRS released exempt organizations enforcement

statistics for FY 2015, together with the same data for the preceding nine years. The

data reflect a steady decline in IRS exempt organizations enforcement activities since

2011.

Up through the 2013 Fiscal Year, the IRS followed a practice of disclosure and

transparency with regard to its enforcement activities. The practice, established

8Internal Revenue Service, Report Outlines Changes for IRS to Ensure Accountability, Chart a Path Forward;

Immediate Actions, Next Steps Outlined, IR 2013-62, June 24, 2013. http://www.irs.gov/uac/Newsroom/Report-Outlines-Changes-for-IRS-To-Ensure-Accountability,-Chart-a-Path-Forward;-Immediate-Actions,-Next-Steps-Outlined

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during the late 1970s, included the public release of the annual official training text

for Exempt Organizations revenue agents and determination specialists. Shortly

thereafter, the IRS began releasing the annual “workplan” for the field offices, then

known as Key District Offices, that had responsibility for exempt organizations

enforcement activity. In the pre-Internet age, the public dissemination was

accomplished by simple step of placing copies of the training publications and the

workplans in the IRS Freedom of Information Reading Room. Until the IRS

reorganization that was a result of the IRS Restructuring and Reform Act of 1998,9

the publicly-released Exempt Organizations workplan consisted of a copy of the

actual memorandum sent by the Exempt Organizations Division in the IRS National

Office to the Key District Offices setting forth instructions regarding the allocation of

enforcement resources by issue or category of tax-exempt organization, and thus

carried a high level of credibility. For example, at various times, audit projects set

forth in the workplan included large private foundations, colleges/universities and

hospitals. The audit projects might also be identified by reference to the Internal

Revenue Code section, e.g., the compliance with the unrelated business income tax

rules by social clubs exempt under section 501(c)(7). The topics addressed in the

annual IRS training materials that were released in conjunction with the workplan

tended to mirror the areas of focus in the workplan, together with other topics deemed

important for revenue agents to know. Both documents were issued internally and

publicly in the early fall during the first month of the new government fiscal year. In

the wake of the implementation of the 1998 Restructuring Act, the workplans that

9 IRS Restructuring and Reform Act of 1998, also known as the Taxpayer Bill of Rights III, Pub. L. 105-206, 112

Stat. 685, enacted July 22, 1998.

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were publicly-released began to shift from the actual “marching orders” for IRS

revenue agents to an overview or summary of key issues and concerns prepared

specifically for public release. The date of release also began to shift, moving closer

to the start of the calendar year. Release of comprehensive training materials ended

with the termination of the production of the annual training text. The last edition

was for the 2004 fiscal year.

V. Management Changes

Since May, 2013 an extraordinary number of management changes have occurred at

the IRS, beginning with the IRS Commissioner and including the following:

A. Personnel10

IRS Commissioner: John Koskinen

Deputy Commissioner for Services & Enforcement: John Dalrymple

Commissioner, Tax Exempt & Government Entities: Sunita Lough

Deputy Commissioner, Tax Exempt & Gov’t Entities: Donna Hansberry Senior Technical Advisor to TEGE Commissioner: Eric San Juan

Director, Exempt Organizations Division: Tamera Ripperda

Director, EO Rulings & Agreements: Jeffrey Cooper

Director, EO Examinations: Margaret Von Lienen - Nan Downing, the current

director, will become Assistant Deputy Commissioner, TE/GE-GE/Shared

Support, which is a new position.

10

http://www.irs.gov/Charities-&-Non-Profits/About-IRS-Exempt-Organizations

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B. Structural Changes – The Disaggregation of EO Tax Administration

In a dramatic change from the historical organizational structure, the new Director

of the Exempt Organizations Division has been relocated to the Cincinnati Office.

This change in location appears to reflect a determination that reducing the

backlog of applications, totally approximately 80,000 as of the end of February,

has been given a high priority.11

In addition, the IRS announced on March 20,

2014, that it will be realigning the EO rulings function within the agency by

moving attorneys currently in the Exempt Organizations Division and the

Employee Plans Division to the Office of the Assistant Chief Counsel, TEGE,12

as

well as restructuring the office of Chief Counsel. That realignment occurred in

January 2015, and is reflected in new set of annual revenue procedures issued on

January 2, 2015 – Revenue Procedures 2015-1 through 2015-5 and 2015-8.

Private letter rulings are now issued by the Office of Chief Counsel (TE/GE) and

subject to the user fee schedule issued by Chief Counsel (currently a private letter

ruling from Chief Counsel requires a user fee of $28,300.

VI. New Kids on the Block – Philosophy of Tax Administration

Starting in the fall of 2014, the IRS began releasing a number of tax administration policy

statements reflecting a considerable amount of strategic planning which is manifesting

itself in the Future State Initiative13

and in a series of pronouncements on tax

enforcement/administration, beginning with a strategic plan and more recently, a

11

Supra at Note 7. 12

Clark, IRS Reorganizes Division at the Center of Controversy, Government Executive, March 21, 2014. http://www.govexec.com/management/2014/03/irs-reorganizes-division-center-controversy/81058/?oref=river 13

https://www.irs.gov/uac/Newsroom/Future-State-Initiative

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document entitled “IRS Enterprise Concept of Operations (CONOPS).”14

The Future

State Initiative is essentially a manifesto of the need to adapt to changing conditions

through the increased incorporation of technology into tax administration. For TE/GE,

the Future State Initiative highlights the Lean Six Sigma review of determination letter

processes in Exempt Organizations and developing web-based solutions for taxpayer

service and outreach.

A. Strategic Plan FY 2014-201715

The Strategic Plan is a 40-page document that sets out very high level

“Objectives,” “Goals” and “Long Term Measures,” beginning with “Strategic

Foundation for Organizational Excellence” composed of six Objectives. The

second Goal is to “Deliver high quality and timely service to reduce taxpayer

burden and encourage voluntary compliance.” The language used includes

phrases such as “seamless, multichannel service environment to encourage

taxpayers to meet their tax obligations” and the “use of a holistic view of taxpayer

interactions to provide a coordinated, consistent experience across all channels.”

Presumably, further details will be eventually forthcoming. The other Goals are

to “deliver high quality and timely service to reduce taxpayer burden and

encourage voluntary compliance,” with seven Objectives, and to “Effectively

enforce the law to ensure compliance with tax responsibilities and combat fraud,”

with six Objectives. The third Objective under the “effectively enforce” Goal is

to “build and maintain public trust by anticipating and addressing the tax-exempt

14

http://www.taxnotes.com/tax-notes-today/tax-system-administration/irs-presentation-describes-future-operations-concepts/2016/02/22/18245431 15

https://www.irs.gov/uac/Strategic-Plan-and-Other-References

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sector’s need for a clear understanding of its tax-law responsibilities.” It appears

that the three paragraphs of this Objective are the only references to tax-exempt

organizations in the Strategic Plan. Notably, the paragraphs do not reference

enforcement or oversight, but rather speak in terms of taxpayer education,

ensuring transparency, expediting and improving issue resolution and addressing

efficiency and productivity in the determination process. That having been said,

the Long Term Measures do attempt to quantify enforcement through

development of an index of enforcement activities that “promote compliance yet

do not focus primarily on increasing tax revenue.” The process is intended to

assess changes in a manner similar to the way the Consumer Price Index reflects

changes in consumer prices. Trends in the IRS’ nonrevenue performance will be

assessed by examining changes in the “nonrevenue enforcement activity index

(“NEAI”). The NEAI will be computed as an index with an average for 2003-

2005 set equal to 100. The NEAI is weighted two-thirds for TE/GE matters and

one-third for Bank Secrecy Act matters, with the index being calculated as the

sum of the number of activities resulting in corrective action x weight x

100/average for FY 2003-2005. The goal is to exceed the 2003-2005 average by

10%.

B. IRS Enterprise Concept of Operations (CONOPS): Overview of SB/SE and

W&I, LB&I, and TE/GE CONOPS16

The CONOPS overview is a 27-page PowerPoint style document that endeavors

to set forth reasons why the IRS is “transforming compliance and services” in

16

IRS Enterprise Concept of Operations (CONOPS) – Overview of SB/SE and W&I, LB&I and TE/GE CONOPS. http://www.taxnotes.com/tax-notes-today/tax-system-administration/irs-presentation-describes-future-operations-

concepts/2016/02/22/18245431

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response to both internal and external factors. The document is dated January 15,

2015, but apparently wasn’t publicly released until late February 2016. The four

factors identified in the document are:

1. Evolving taxpayer expectations.

2. Increasing complexity of tax administration from both the standpoint of

legislative changes and from the proliferation of data.

3. A declining IRS budget, coupled with increasing demands for a “return on

investment” and a stagnant tax gap, are putting pressure on the agency to increase

revenues and lower costs.

4. Increasing incidence of refund fraud schemes and identity theft over the last

three years.

The four factors drive the IRS towards a systematic review of its operations and

essentially a five-year plan to address the concerns identified. Each of the IRS

Business Operating Divisions’ five year plans reflect six themes:

1. Data-Centric Operations

2. Simplified Taxpayer Experience

3. Expanded Partnerships with Tax Community

4. Compliance Risk-Focused Operations

5. Flexible and Well-Supported Workforce

6. Strategic Workload Allocation

The unique challenges presented by TE/GE were identified as “parallel operations

across diverse programs with varied taxpayer groups” and “significant external

stakeholder involvement and public scrutiny.” No surprises here for anyone aware

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of the 29 different bases for federal tax exemption reflected in the subsections

under section 501(c) of the Internal Revenue Code or the disclosure rules

applicable to the Form 990. Finally, the CONOPS identifies three priorities for

TE/GE: 1) A portfolio of “tools, education and partnership opportunities” to

increase taxpayer compliance, 2) A “sharper focus” on significant misconduct and

other aggressive behavior, and 3) Use of “data analytics capabilities to support

including examinations, compliance checks, and office/correspondence audits.

C. IRS TE/GE Concept of Operations (CONOPS)

The TE/GE function has expanded its CONOPS, as set forth in the January 15,

2015 Agency-level summary, and has released its analysis in an 83-page

PowerPoint-style document dated December 31, 2014, but apparently publicly

released in February 2016.17

The TE/GE CONOPS echoes and expands on the themes set forth in the higher-

level agency-focused document. It does expand in interesting directions, and

includes the following descriptions of TE/GE Future Vision:

“E-filing facilitates taxpayer submission of forms online”

“External stakeholder collaboration provides taxpayers with additional

support from external subject matter experts” [note: does this mean that

the IRS will help pay for private attorneys and accountants to help tax-

exempt organizations?]

“Tailored digital information answers specific inquiries quickly”

17

http://www.taxnotes.com/tax-notes-today/tax-system-administration/irs-releases-concept-future-operations-

tege/2016/02/22/18245446

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And finally: “Data analytics enable TE/GE to more precisely identify non-

compliance, limiting the likelihood of examinations for the average

compliant taxpayer”

The TE/GE CONOPS document identifies a number of “gaps” in IRS

capabilities, including:

“TE/GE-wide understanding of its stakeholders and levers/synergies that

could be used to increase engagement”

“Ability to use social media to engage with and gather input from

stakeholders”

At points, the CONOPS document touches on enforcement-related

matters, such as a “work area” that is described as “Sensing and Trend Analysis.”

It is further described as an operating model and process to identify and collect

external data to support TE/GE business decision-making processes, and gather

relevant data through stakeholder interactions and media channels. The CONOPS

also proposes a new “soft notice” called a “compliance risk notice,” or, in the

words of the IRS, “compliance risk notice efforts are directed primarily toward

taxpayers who are considered to be at risk for common or emerging compliance

issues.” Another novel development, apparently inspired by the Transportation

Security Administration’s Pre-Check Program, will be to create a “Trusted

Taxpayer Status” which will be achieved by submitting “additional, TE/GE

identified tax documentation.” TE/GE asserts that the documentation will enable

the agency to quickly assess the probability of the taxpayer’s future compliance

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and determine whether or not they are eligible for “trusted status.” “Trusted

status” will mean that the organization has a lower risk of facing an examination.

In terms of workload management, the TE/GE CONOPS contemplates that cases,

presumably, examination cases, will be “identified centrally,” which the agency

believes will permit it to better focus examination resources on the “next best

case,” presumably, wherever it is geographically located.

The final page of the 83-page document is actually grounded in reality, as it lists

the potential risks to implementation of the CONOPS strategy. The five risks are:

1) IRS executive support for initiatives and work areas may decline or shift over

time, 2) internal stakeholders may not buy-in to the future vision, 3) performance

measures may not be accurate or sufficiently well-defined to measure success, 4)

elements of the change may hinge on legislative changes, and 5) limited funding

may not support new technology investments. The list is prescient, as the risks

have arisen in the past with regard to new initiatives, e.g. quality circles and

market segment studies,

D. TE/GE Program Letter FY 2015

On November 5, the TE/GE Commissioner , notably not the Exempt

Organizations Division Director, issued the “TE/GE Program Letter,” setting

forth the function’s key areas of focus for FY 2015 that will be used to meet the

goals and objectives set forth in the Strategic Plan. The focus areas are:

“Continuous Improvement,” “Knowledge Management,” “Employee Engagement

and Development,” “Data-Driven Decision-Making,” and “Risk Management.” In

essence, the Program Letter appears to be a statement of

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management/administrative philosophy rather than a directive to undertake

specific program activities or address particular tax compliance issues. In that

regard, the TE/GE Program Letter is in contrast to the Criminal Investigation

Annual Business Plan, which is that function’s public statement about how it

intends to meet the Strategic Plan. The Criminal Investigation Business Plan

identifies specific areas of compliance concern, such as identity theft, return

preparer fraud, and questionable refund, as well as the use of virtual currency to

move illegal monies.

E. TE/GE Priorities for FY 201618

The IRS has released its “TE/GE Priorities for FY 2016,” although the actual

date of the document is uncertain, given the current TE/GE practice of not dating

many policy-related releases. The document is essentially an update on the FY

2015 Program Letter, but with the addition of references to particular issues of

concern. As a result, the document is more informative than the FY 2015 version;

it is, however, a very high-level document intended as a public relations tool

rather than an actual directive to TE/GE offices and employees. The TE/GE

Priorities document has, as an appendix, a “workplan briefing” on Exempt

Organizations. The Appendix does contain a single page of developments and

plans for exempt organizations examinations, including discussion of compliance

strategy and a list of five strategic issue areas. The compliance strategy consists

of a three-part plan:

1. Determining the coverage of all major subsections and size of organizations by

stratifying the universe of exempt organizations into major subsections and

18

https://www.irs.gov/Government-Entities/Tax-Exempt-&-Government-Entities-Division-At-a-Glance

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allocating anticipated new examination cases among each subsection and asset

class.

2. Determining issues to focus on through a data-driven approach where we will

identify the highest risk areas of non-compliance through the use of EO return

data and historical information.

3. Identifying areas of high non-compliance risk through stakeholder input,

reliable outside data and public information.

The strategic issue areas are:

1. Exemption: the issues include non-exempt purpose activity and private

inurement, enforced primarily through field examinations.

2. Protection of Assets: the issues include self-dealing, excess benefit

transactions, and loans to disqualified persons, enforced primarily through

correspondence audits and field examinations.

3. Tax Gap: the issues include employment tax and unrelated business income

tax liability, enforced through compliance checks, correspondence audits, and

field examinations.

4. International: the issues include oversight of funds spent outside the US,

including funds spent on potential terrorist activities, exempt organizations acting

as foreign conduits, and Report of Foreign Bank and Financial Accounts (FBAR)

requirements, enforced through compliance reviews, compliance checks,

correspondence audits and field examination; and

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5. Emerging Issues: the issues include non-exempt charitable trusts and IRC

501(r), enforced through compliance reviews, correspondence audits and field

examination.

In addition, EO will review organizations that were recognized as exempt through

the streamlined determination process and the function will begin post-

determination compliance enforcement on organizations that utilized the Form

1023-EZ application to obtain exemption.

C. “Lean Six Sigma” Approach to Organizational Management

The IRS is approaching a redesign of the EO Division and the processes used for

tax administration using “Lean Six Sigma” concepts, a management assessment

protocol that focuses on eliminating waste (known as “muda” – a Japanese term

reflecting the origins of the assessment protocol in Toyota manufacturing

analysis).19

Lean Six Sigma focuses on eliminating what it defines as the eight

kinds of waste: defects, overproduction, waiting, non-utilized talent,

transportation, inventory, motion and extra-processing. Training for employees

implementing Lean Six Sigma concepts also reflects a Japanese influence in that

employees are assigned different “belts” reflecting different skill levels, e.g.

white, yellow, green, black and master black belts, similar to karate.

D. Emerging Issue Committee

In August 2013, the Acting EO Division Director at the time, Kenneth Corbin,

created a new function within the Division to better identify potential issues

19

http://en.wikipedia.org/wiki/Lean_Six_Sigma

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arising from the Division’s operations and make recommendations for an

appropriate response, e.g. training, guidance, coordination with other functions.20

The Committee was formed by expanding the size and role of the former EO

ATAT (Abusive Tax Avoidance Transactions) Committee. While it is not clear

how large the Emerging Issue Committee will be, it will represent a variety of

functions, including EO Examinations, EO Rulings & Agreements, Chief Counsel

TEGE, the TEGE Senior Technical Advisor, the EO Senior Technical Advisor,

the TEGE Fraud Specialist and the TEGE Assistant Promoter Coordinator. The

Committee will serve as the focal point for coordination of the issues within EO,

TEGE, Chief Counsel TEGE, other IRS divisions and other federal and state

agencies. The Committee Charter provides that meetings will occur on the fourth

Tuesday of each month, or more frequently as needed and that minutes will be

kept of the meetings.

VII. Determinations/Rulings Changes

A. General Processing Changes

Since the issuance of the Treasury Inspector General for Tax Administration

(TIGTA) report on the processing of applications for tax-exempt status from

organizations seeking section (c)(4) status, the EO Division has been reviewing its

processes for handling all types of applications, including those from

20

Corbin, The Emerging Issue Committee, Memorandum for all Exempt Organizations Employees, September 30, 2013. http://www.irs.gov/pub/foia/ig/spder/TEGE-07-0913-17%5B1%5D.pdf

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organizations seeking section 501(c)(3) status.21

Historically, the bulk of

applications received by the IRS have been for section 501(c)(3) status; for

example, in FY 2012 , the IRS processed 60,793 applications for tax-exempt

status, of which 51,748 were for section 501(c)(3) status. Of those, 45,029 were

approved, 123 were denied tax-exempt status and 6,596 were withdrawn, returned

as incomplete, failed to provide requested information or where the IRS refused to

rule. The nature of the changes being implemented, and the general status of the

implementation are regularly reported on the EO Division homepage on the IRS

website.22

B. Streamlined Application Processing Guidelines

On February 28, 2014, the EO Division released a memorandum setting forth

revisions to the processing procedures for applications for tax-exempt status that

were developed using Lean Six Sigma Organization concepts.23

The new

streamlined process appears to involve minimal evaluation of applications,

essentially the performance of a triage on the filings, dividing them into a group

of applications considered complete and in compliance with organizational and

operational requirements, a second group in which the information submitted

indicates defects in the organizing documents, for example, in the purposes clause

of articles of incorporation, or inadequate or ambiguous descriptions of planned

operations, but where “there was no clear evidence of an issue that would cause

21

Corbin, Interim Guidance on Initial Classification of Applications, Memorandum for all Employees – Exempt Organizations Determination Unit, September 30, 2013. http://www.irs.gov/pub/foia/ig/spder/TEGE-07-0913-

15%5B1%5D.pdf 22

http://www.irs.gov/uac/Newsroom/IRS-Charts-a-Path-Forward-with-Immediate-Actions 23

Martin, Streamlined Processing Guidelines for All Cases, Memorandum for Exempt Organizations Determinations and Exempt Organizations Determinations Quality Assurance, February 28, 2014. http://www.irs.gov/pub/foia/ig/spder/TEGE-07-0214-02%5B1%5D.pdf

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the organization to be denied exemption,” and a third category where there are

clear indications of noncompliance. Applications in the first category would be

approved without further consideration, applications in the second category would

not be asked to correct and submit revised organizational documents or submit

more detailed descriptions of activities, but would simply be asked to attest in

writing to having made appropriate changes to documents or that activities will be

within the parameters of the Code section for which exemption is requested.

Applications in the third category would be given a more in-depth review and

analysis.

C. Sample Questions for Applications

One focus of the criticism of the IRS processing of applications for exemption

under section 501(c)(4) was the intrusive or irrelevant nature of some of the

questions posed to applicants by the IRS. To help address that particular aspect of

the torrent of criticism the agency faced, a series of “sample” questions organized

around particular topics were released and placed on the IRS website.24

With the

enactment of the PATH Act, section 501(c)(4) organizations can avail themselves

of a simple registration process, although such groups may still file a Form 1024

application in order to receive a formal determination letter.

D. Auto-Revoked Organizations

One result of the wave of Congressional hearings, investigations and demands for

records was to distract the Exempt Organizations Division from its normal work.

The situation was exacerbated by the government budget constraints and the

24

http://www.irs.gov/Charities-%26-Non-Profits/Charitable-Organizations/Exempt-Organization-Sample-Questions

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sequester, which resulted in temporary furloughs of IRS employees. While the

backlog of applications had been building for some time, the distractions in the

summer and fall of 2013 resulted in an unprecedented inventory of unprocessed

applications for tax-exempt status, perhaps approaching 80,000 applications.25

A

significant number of those applications, perhaps 30%, were from organizations

whose tax-exempt status had been automatically revoked for failure to file Form

990 for three consecutive years, pursuant to section 6033(j). Section 6033(j) had

been enacted as part of the Pension Protection Act of 2006, and the impact began

to be felt by the nonprofit sector in 2009. While the most auto-revoked

organizations appear to have actually gone out of business, a substantial number,

over 25,000, are still in existence and filed new applications for exemption, as

required by the IRS.26

As the IRS realized the enormity of the auto-revoked

applications, special streamlined procedures were developed to help reduce the

backlog.27

VIII. Examination Changes

The focus of IRS restructuring and realignment efforts since the summer of 2012 has

fallen primarily on the processing of applications for tax-exempt status. While

application processing is a significant component of the Exempt Organizations

Divison’s responsibilities, most employees in the Division are actually engaged in the

examination function, that is, revenue agents who conduct audits of tax-exempt

25

Kalich and Eley, The IRS Introduces New Leadership and Initiatives to Practitioners in Baltimore,BDO Nonprofit

Standard, March 17, 2014. http://nonprofitblog.bdo.com/index.php/2014/03/17/the-irs-introduces-new-leadership-and-initiatives-to-

practitioners-in-baltimore/ 26

http://www.irs.gov/Charities-&-Non-Profits/Automatic-Revocation-of-Exemption 27

http://www.irs.gov/Charities-&-Non-Profits/Charitable-Organizations/Automatic-Revocation-How-to-Have-

Your-Tax-Exempt-Status-Retroactively-Reinstated

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organizations. In the Division’s Annual Report for FY 2012, the most recent one

available, 516 of the 900 employees in the Division were assigned to the examination

function, compared to 335 involved in the processing of applications, private letter

ruling requests and related operations.28

Recent reports, however, have suggested that

the number of actual revenue agents available to conduct examinations, as

distinguished from personnel involved in examination planning, management and

other activities in support of examinations, fell to 155.29

In recent remarks, the new

TEGE Division Commissioner, Sunita Lough, indicated that there would be no

publicly-released work plan for FY 2014, but that she hoped to issue one for FY

2015.30

IX. Strategies for Dealing with the Current Situation

The IRS administration of the Internal Revenue Code provisions applicable to tax-

exempt organizations is in a period of transition, and with all such periods, new

processes and procedures will require adjustment, as unintended consequences

emerge, particularly as the new organizational structure begins to address its

enforcement responsibilities. In the interim, there are steps that can be taken to both

benefit and protect tax-exempt organizations. Applications for tax-exempt status are

being processed very quickly; under two months even for the long-form Form 1023

filers, and activities that formerly would have been explored by the IRS with requests

for additional information are now being handled without such development. The

Form 1023-EZ filers have essentially a registration process. Given the velocity of the

application process, less rigorous review than in the past, and the fact that private

28

http://www.irs.gov/pub/irs-tege/FY2012_EO_AnnualRpt_2013_Work_Plan.pdf 29

Supra at Note 17. 30

Id.

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letter rulings on proposed transactions are now going to be processed by the Office of

Chief Counsel, with, no doubt, significant evaluation, existing tax-exempt

organizations that are planning to undertake new and substantial activities may want

to house those new activities in a new corporate entity that applies for IRC 501(c)(3)

status on its own, with a description of the new activity in sufficient detail to give rise

to put the IRS on notice and give rise to IRC 7805(b) relief in the event of a

subsequent challenge. Such a process would effectively protect the existing tax-

exempt organization’s status, while giving a sufficient measure of IRS approval to

enable the new activity to be initiated without the time, expense and close scrutiny

that a private letter ruling would entail. Private letter rulings on proposed transactions

will now be handled by the Office of Chief Counsel, TE/GE. Tax-exempt

organizations that request such rulings should expect that their requests will be given

closer scrutiny than that given to applications for tax-exempt status.

X. Next Steps?

The IRS has taken a series of major organizational and procedural steps, clearly

moving as quickly as it can to address the TIGTA Report recommendations and align

the Exempt Organizations Division and the Employee Plans Division with the

organizational structures of the rest of the IRS National Office. A measure of the

perceived urgency by the IRS is reflected in the fact that the changes are being

developed by a new cadre of senior management, many of whom do not have

significant experience in the function or with the tasks that it is required to perform in

administering the relevant sections of the Internal Revenue Code. In view of the huge

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amounts of funds flowing into the nonprofit sector, particularly to social welfare

organizations exempt under section 501(c)(4),31

the sense of urgency is likely well-

founded. The nonprofit sector and practitioners should be alert to developments, as

they are likely to occur quickly, and without an opportunity for public comment and

discussion.

31

Barker, How Nonprofits Spend Millions on Elections and Call it Public Welfare, ProPublica, April 18, 2012.

http://www.propublica.org/article/how-nonprofits-spend-millions-on-elections-and-call-it-public-welfare

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Part II – WASHINGTON UPDATE

A. Senate Developments

1. S. 2750, CHARITY Act (Charities Helping Americans Regularly Throughout the Year)

Provides that it is the sense of the Senate that encouraging charitable giving should be a

goal of tax reform, and Congress should ensure that the value and scope of the deduction

for charitable contributions is not diminished during a comprehensive rewrite of the tax

code. Expands the IRA rollover to include distributions to donor-advised funds. Requires

all tax-exempt organizations to file Form 990 electronically. Authorizes the Treasury

Department to align the standard mileage rate for the charitable contributions deduction

(for using a personal vehicle for volunteer charitable services)with the medical/moving

expenses deduction. Provides an exception from the excess business holding tax on private

foundations for certain philanthropic business enterprises. Excess business tax exception

applies if the philanthropic business enterprise satisfies the following:

-- Exclusive ownership requirement: all ownership interests in the business enterprise are

held by the foundation at all times during the taxable year, and all of foundation’s

ownership interests in the enterprise were acquired by will or trust

-- “All profits to charity” requirement: business enterprise must distribute to the

foundation an amount equal to its net operating income for the taxable year within 120

days of the close of the year

-- Independent operation requirement: prohibits certain interrelatedness between the

foundation and business enterprise

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2. S. 2648, CREATE Act of 2016

Prescribes a special rule to allow a creator of a qualified artistic charitable

contribution (i.e., any literary, musical, artistic, or scholarly composition, or similar

property, or the copyright thereon, or both, contributed to a tax-exempt charitable

organization) to deduct the fair market value of the contribution from gross income.

B. House of Representatives Developments

1. H.R. 4907, Grow Philanthropy Act

Legislation would amend Section 408(d)(8)(B)(i) to permit tax-free distributions from

individual retirement plans to donor-advised funds. Legislation would apply to

distributions made in taxable years beginning after December 31, 2016.

2. H.R. 4706, Interest for Others Act of 2016

Facilitates charitable donations of small amounts of dividends and interest income.

New Code section 139F would exclude from gross income up to $50 of interest and

money market fund dividend income payments donated to charity. Modifies the

requirements relating to the reporting of such payments so that banks are not required to

issue Form 1099- INT reporting on small amounts.

3. H.R. 4311, Protecting Charitable Contributions Act of 2015

Provides that the definitions and regulations in effect on January 1, 2015, relating to the

substantiation of deductible charitable contributions in excess of $250, shall apply on and

after the bill’s enactment date. Provides that the IRS shall not issue, revise, or finalize any

regulation, revenue ruling, or other guidance relating to such definitions and regulations

4. H.R. 4281, Charitable Giving Privacy Protection Act

Amends the Internal Revenue Code to prohibit the IRS from requiring or accepting the

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Social Security numbers of donors of charitable donations from donee organizations when

such organizations are providing substantiation of such donations.

C. President’s FY 2017 Budget Proposals

• Increase funding for the IRS by about $1 billion (9%), targeted to improve taxpayer

services and enforcement activities.

• Implement new requirements for filing returns

-- Require electronic filing for all Forms 8872 and Form 990 series tax and information

returns

-- Assess a $5,000 penalty for failure to comply with e-filing requirements

-- Accelerate the due date for filing Form 1099 and other information returns with the IRS

to January 31 and eliminate extended due date for electronically filed returns

• Impose a single excise tax rate of 1.35% on private foundations

• Consolidate contribution limitations for charitable deductions

-- Retain the 50% limitation for contributions of cash to public charities

-- Apply a 30% deduction limitation for all other contributions

• Extend the carryforward period for excess charitable contribution deduction amounts

from 5 years to 15 years

• Limit itemized deductions to 28% for high-income taxpayers

• Implement a new minimum tax, the “Fair Share Tax” (FST), on high-income taxpayers

-- FST = 30% of adjusted gross income, less a charitable credit of up to 28% of itemized

charitable contributions

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• Disallow the deduction for charitable contributions that are a prerequisite for purchasing

tickets to college sporting events

• Modify the standard mileage rate for automobile use by volunteers

-- Increase from statutory limit of 14 cents/mile to the rate set by the IRS for the medical

and moving expenses deduction, adjusted annually

• Modify the conservation easement deduction and pilot a conservation credit

-- Strengthen minimum requirements for organizations to qualify to receive deductible

contributions of conservation easements

-- Modify definition of eligible “conservation purpose”

-- Require a donor to provide a detailed description of the conservation purpose(s)

furthered by a contribution

-- Modify section 6033 to require electronic reporting and public disclosure of easement

contributions by donee organizations

-- Pilot a non-refundable credit for conservation easement contributions as an alternative

to a deduction

C. IRS and Treasury

1. 2015-2016 IRS Priority Guidance Plan (Second-Quarter Update)

13 projects were outlined for Exempt Organizations in 2015–2016 Plan

The item on proposed regulations under §501(c) (relating to political campaign

intervention) has been annotated to note they are suspended in accordance with

Consolidated Appropriations Act of 2016.

Exempt Organizations items published:

Final regulations on §509(a)(3) supporting organizations – published 12/23/15

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Proposed regulations on requirements for Type I and Type III supporting organizations

published 2/19/16.

Notice on §529A interim guidance regarding certain provisions of proposed

regulations relating to qualified ABLE programs – published 12/07/15

Final regulations under §§4942 and 4945 on reliance standards for making good faith

determinations – published 09/25/15

Notice on investments made for charitable purposes (mission-related) – published

09/28/15

Final regulations under §4944 on program-related investments – published 04/25/15

Notice on §506 notification requirement for new and certain existing section 501(c)(4)

organizations – published 2/08/16

Notice on transition relief for certain §529 Qualified Tuition Programs required to File

Form 1099-Q – published 2/16/19

2. New Regulations for Type I and Type III Supporting Organizations

On February 19, 2016, the IRS published a Notice of Proposed Rulemaking

promulgating proposed amendments to existing regulations for supporting

organizations. Notice and Comment period ends May 19, 2016 .

The regulations cover the following topics:

Type I and Type III organizations – meaning of contribution from “controlling donor”

Type III organizations

Notification requirement

Responsiveness test

Integral part test for functionally-integrated and non-functionally integrated Type III’s

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Type I & Type III organizations – meaning of “control”

A Type I or III supporting organization may not accept contributions from any person

who directly or indirectly controls the governing body of its supported organization, or

from anyone who is related to such a person.

Definition of “control” under NPRM:

The power, either alone or in concert with other related persons, to require governing

body to perform any act that significantly affects its operations, or to prevent the board

from performing such an act

Type III organizations – notification requirement

Supporting organizations must provide certain information to their supported

organizations each year, including the type and amount of support provided.

The NPRM clarifies that the deadline to deliver such information is the last day of the

fifth month of the taxable year after the taxable year in which it provided the support.

Type III organizations – responsiveness test

Supporting organizations must be responsive to the needs or demands of their

supported organizations (must meet relationship test and significant voice test)

NPRM clarifies that a supporting organization must satisfy the responsiveness test

with respect to each of its supported organizations.

New Example 3:

Demonstrates a “cost-effective” means to satisfy the test

E.g., acceptable for a supporting organization to conduct teleconferences jointly

with the officers of all of its supported organizations, where other favorable

factors are present

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Integral part test (functionally-integrated Type III) – parent relationship

Amended definition of “parent”:

A supporting organization and its supported organizations must be part of an

“integrated system,” such as a hospital system.

The supporting organization must engage in activities typical of a parent of an

integrated system in relation to its supported organizations, including, but not limited

to, the following:

---- Coordinating activities

---- Engaging in overall planning

---- Policy development

---- Budgeting

---- Resource allocation

A majority of the officers, directors, or trustees of the supported organization must be

appointed or elected by the governing body, members of the governing body, or

officers (acting in their official capacities) of the supporting organization

Integral part test (functionally-integrated Type III) – governmental supported

organizations

“Governmental supported organization” now defined in reference to existing definitions

in § 170(c)(1) & (2) and (b)(1)(A)

A functionally integrated supporting organization may support more than one

governmental organization, as long as all of the governmental organizations either:

---- Operate within the same geographic region; or

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---- Work in close coordination or collaboration with one another to conduct a

service or program supported by the supporting organization.

---- A “substantial part” of the supporting organization’s total activities must

directly further the exempt purposes of its governmental supported organizations.

Substantial part does not mean “substantially all.”

-- Type III organization in existence on or before February 19, 2016, is treated as

functionally integrated if, subject to certain requirements, it supports one or more

governmental organizations but no more than one non-governmental organization

-- Transition relief under Notice 2014-4 extended

Integral part test (NFI Type III) – distribution requirement

-- An organization may no longer reduce its distributable amount by the amount

of its unrelated business income tax (UBIT) paid in the preceding taxable year.

-- Current list of five items that count towards meeting the distribution

requirement is revised and is made to be exclusive

---- Fundraising expenses generally do not count as distributions.

---- But reasonable and necessary expenses incurred to solicit contributions

received directly by supported organizations do count (as long as the expenses do

not exceed the actual amount of contributions received and the amounts are

substantiated in writing).

Program-related investments (PRIs) do not count.

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3. Trends in the Donor-Advised Fund Sector

IRS Statistics on Income reports growth from tax years 2006 to 2012:

-- Number of organizations sponsoring donor-advised fund (DAF) accounts

increased by 19% (from 1,779 to 2,121)

-- Total number of individual DAFs increased by 56%

-- Total value of all DAFs increased by 55% from 2010 to 2012 (up to approx.

$53 billion)

For 2012, the seven largest sponsoring organizations reported more than $24

billion value in DAFs from over 100,000 individual funds

Median payout rate of sponsoring organizations for 2012: 10% of total value of

funds

4. Industry Issue Resolution Program - Rev. Proc. 2016-19

The IIR Program aims to identify and resolve frequently disputed or burdensome

tax issues that are common to a significant number of entities. The IIR Program

was initially introduced as a pilot program for large and midsized business

taxpayers, and has expanded. Effective April 25, 2016, the IIR Program has been

expanded to entities under the jurisdiction of TE/GE.

• Requesters should generally be an organization or a group of entities that

represents a significant number and cross-section of the entities with a particular

tax issue.

• At least annually, the IRS will make public all IIR Program requests and those

selected.

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• Selected requests may result in published guidance or new administrative

procedures.

• Issues appropriate for consideration under the IIR Program have two or more of

the following characteristics:

1. The proper tax treatment of a common factual situation is uncertain;

2. The uncertainty results in frequent, and often repetitive, examinations of

the same issue;

3. Frequent, and often repetitive, examinations require significant

resources from both the IRS and impacted entities;

4. The issue is significant and impacts a large number of entities;

5. The issue requires extensive factual development; and

6. Collaboration would facilitate proper resolution of the tax issues by

promoting an understanding of entities’ views and business practices.

• IIR Program requests and information submitted will be subject to FOIA.

• IIR Program requests should include an issue statement, a description of why the

issue is appropriate for the IIR Program, an explanation of the need for

guidance, an estimate of the number of entities affected by the issue, a

description of how the requester relates to those entities, and a contact person

for additional information. The submission may also include a recommendation

as to how the issue may be resolved.

• IIR Program requests and information submitted will be subject to FOIA.

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Part III

ESTATE PLANNING

A STUDY IN UNANTICIPATED CONSEQUENCES

I. Section 501(c)(3), Private Foundations and the Gift Tax

The Tax Reform Act of 1969 and the enactment of section 4943 effectively ended the ability of

entrepreneurs to use private foundations as an estate planning tool, at least where the goals of

avoiding the dismantling of the business enterprises, ensuring family, or at least close control, for

the future, and sheltering the assets and resulting income from estate tax or gift tax, and income

tax are concerned. Entrepreneurs were left with gifts to public charities, which often meant a

loss of donor/family control, or the sequential divestiture of control over the fruits of the

entrepreneur’s labor. The presence of the gift tax, section 2501 of the Code, made gratuitous

distributions of interests in the enterprise to family members and friends a significant taxable

event as well. Further complicating the use of private foundations were the array of private

foundation excise taxes in Chapter 42 of the Code, including the mandatory payout requirement

in section 4942, which was problematic for those assets where the value was in the build-up of

the value of the enterprise, rather than in the cash flow.

II. The “Gift Tax Five”

In early 2011, the existence of IRS audits of five donors to one or more section 501(c)(4) for gift

tax liability came to light.

Gifts were made in the wake of the Supreme Court’s decision Citizens United v. FEC.

Influential Republican members of Congress publicly complained to the IRS.

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IRS Deputy Commissioner terminated the audits and suspended any further gift tax audits

of gifts to section 501(c)(4) groups.

Gift tax issue went dormant.

III. PATH Act to the Rescue

Section 408 of the Protecting Americans From Tax Hikes Act of 2015 (the “PATH Act”)

modified section 2501(a) to exempt gifts to organizations exempt under section 501(c)(4),

section 501(c)(5) and section 501(c)(6) from the gift tax.

IV. Why Section 408 is Important for Tax/Estate Planning

Section 501(c)(4) organizations have the following characteristics:

The income of a (c)(4) is exempt from federal income tax

The private foundation excise taxes (Chapter 42 of the Code) do not apply to (c)(4)s

In particular, the limitation on the amount of ownership interests in business

enterprises (section 4943) does not apply

While the excess benefit excise tax in section 4958 does apply to limit related party

transactions, including salaries, the limit is set at fair market value, in contrast to the

prohibition on related party (disqualified person) transactions in section 4941 (self-

dealing).

There is no particular statutorily mandated payout requirement, only a requirement

that the organization actually conduct activities that advance social welfare.\

The charitable contribution deduction is not available.

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V. Bottom Line

For those taxpayers who have amassed wealth that resides in closely-held business

structures, and who are concerned about preserving the integrity of their enterprises and

permitting family members to continue to control/manage the enterprises after the donor retires

or passes away, and for whom charitable deduction is of less importance than preserving that

control, the formation of a section 501(c)(4) organization may be a realistic option. The option

may be particularly useful in situations where a second class of stock or LLC membership

interest that carries an income component, but does not include voting/control rights, can be

donated to a public charity, thus permitting a charitable contribution of some amount.

PART IV – CONCLUSION/QUESTIONS

The IRS, and federal tax administration in general, are undergoing an extraordinary transition.

The impact on tax administration as it affects tax-exemption organizations, in particular, is

undergoing dramatic change, with a trend towards registration as a means of establishing

exemption and significant reductions in enforcement capacity. Various observers, including the

Taxpayer Advocate, have warned that the changes could result in significant tax challenges for

oversight in the future. It behooves tax practitioners to follow events closely, both to understand

the changes and the legitimate tax planning options they provide, and to understand the potential

for a future reaction, or over-reaction, if and when the fisc is adversely impacted.