Top 10 tax issues faced by nonprofits

FROM GRANTTHORTON.COM

Nonprofit organizations, while exempt, still have many tax issues to deal with. The following is a list of the top 10 tax issues facing not-for-profits and higher education organizations as we transition into 2014.

1. Unrelated business income

It is expected that the IRS will conduct examinations with renewed focus on unrelated business income within all exempt organizations. This follows the Colleges and Universities Compliance Project Final Report, released in April 2013, that resulted from the IRS’s questioning and review of numerous higher education institutions. The IRS has pointed out these issues:

• Organizations are not reporting income from activities that don’t further their exempt purpose or are excluded by the Internal Revenue Code.
• Organizations are not properly supporting allocations of expenses that offset reported income.
• Organizations are using activities that generate continual losses as a way to reduce other profitable activities.

The current IRS enforcement efforts will likely cause many organizations to start showing profits on unrelated activities, and to reduce or eliminate loss carry-forwards. All of this will result in taxes being paid. Organizations need to review their activities to see how they measure up. Unrelated business income should not be looked at as “bad” since it may be a good way for organizations to supplement funding cuts and decreased earnings on investments and/or charitable contributions.

2. Compensation and benefits

Another area of concern for the IRS surrounds the subject of intermediate sanctions. The IRS continues to review high levels of compensation, and the provision of benefits and perquisites that may not be reported or appropriately treated as taxable wages. The major finding they identified was the failure of organizations to properly support the peer group they use to gather reasonable compensation information. The documentation of the compensation process, which includes reasonable comparisons and proper disclosure on Form 990, has important components the IRS reviews in support of paid compensation. Organizations also need to be able to support their conclusions and decisions involved in the process. Learn more to help in your compensation and benefits planning:

3. Governance and transparency

The IRS believes the absence of appropriate policies and procedures can lead to excess benefit transactions, private inurement, operations for nonexempt purposes or other activities inconsistent with tax-exempt status. Examination agents have an IRS checklist for capturing data about organizations’ governance practices and related internal controls. While agents can’t penalize an organization that lacks IRS-deemed best practices, they have been instructed to “dig deeper” on those that do lack the practices. In addition to IRS requirements, other governance matters are important considerations to the public, the media, ratings agencies and charity watchdog groups. It is prudent for all exempt organizations to take great care in adopting strong policies and procedures that will protect them, and in disclosing information to the public.

4. Health care reform

The Patient Protection and Affordable Care Act (ACA) will require most organizations with employees to make certain business decisions regarding the provision of health insurance benefits. Specifically, effective Jan. 1, 2015, employers with at least 50 full-time employees or full-time equivalent employees that fail to offer medical coverage to at least 95% of those employees will be subject to a $2,000 annualized penalty for each full-time employee (including those actually offered coverage). In addition, if an employer is sufficient in offering coverage, but the coverage is deemed unaffordable or does not provide certain value, the employer may be subject to a $3,000 annualized penalty for each affected employee. Besides these penalties, there are a number of other requirements imposed by the ACA; these include providing notices, ensuring compliance with health benefits, and paying other new taxes and fees. Learn more about health care reform challenges and solutions: 

5. Employment tax

The IRS Exempt Organizations Division will continue to focus on employment tax as part of a national research examination project. Randomly selected exempt organizations will be subject to approximately 500 audits over the next three years. Agents will focus on the following areas relevant to nonprofit organizations: employee versus independent contractor classifications, fringe benefits, officer compensation, employee expense reimbursement and certain deferred compensation matters.

6. International issues

The 2013 Exempt Organization Work Plan indicates the IRS is interested in ensuring that assets and income of domestic charities are not diverted to noncharitable purposes when the funds are sent abroad. Specifically, the IRS is focused on whether U.S. charities comply with regulations on recordkeeping and reporting when they operate, invest or donate funds overseas. Penalties for failure to file various forms (Forms 926, 5471 and 8865) are extensive, and the IRS will not be lenient.

7. State and local issues

As states continue to grapple with large budget deficits, organizations are encountering aggressive state and local tax audits, exemption challenges and Nexus inquiries. Organizations face many issues with state taxing authorities, such as Nexus, and with taxes: sales and use, income and franchise, employment, and property. Organizations should continue to monitor their activities and state taxing authority regulations.

8. Form 990 and tax compliance

Form 990 was expanded in 2008 to require responses on governance and policy issues. It is vital that organizations incorporate procedures to maximize their profile on these public documents and properly support their case with workpapers in case of examination. In addition, state charitable and other filings are highlighted in this return, making it vital that organizations review their operations to make sure they are filing the appropriate forms in the required states/jurisdictions.

9. Hospitals — 501(r)

The ACA has resulted in significant changes for tax-exempt hospitals. In addition to complying with the requirements of Section 501(c)(3) and the traditional community benefit standards, tax-exempt hospitals must satisfy the requirements of the new Section 501(r). Each hospital organization is required to meet four general requirements on a facility-by-facility basis:

• Establish written financial assistance and emergency medical care policies
• Limit amounts charged for emergency or other medically necessary care to individuals eligible for assistance under the hospital’s financial assistance policy
• Make reasonable efforts to determine whether an individual is eligible for assistance under the hospital’s financial assistance policy before engaging in extraordinary collection actions against the individual
• Conduct a community health needs assessment (CHNA) and adopt an implementation strategy at least once every three years

These CHNA requirements are effective for tax years beginning after March 23, 2012.
Additionally, Form 990 Schedule H, Part V has been expanded to include sections in which the taxpayer:

• must list all hospital facilities operated during the tax year;
• must separately report on activities, policies and practices of each of hospital facility; and
• must list all nonhospital health care facilities operated during the tax year.

Also, new Schedule H questions relating to CHNAs were also added, effective for tax years beginning after March 23, 2012.

10. Bond financing

The required completion of Schedule K of Form 990 for organizations with tax-exempt bonds requires organizations to be diligent in their efforts to determine private use, calculate arbitrage and meet the requirements to ensure their bonds maintain exempt status. In recent years, the IRS has increased its scrutiny of the tax-exempt bond market by increasing the responsibilities for bond issuers. Post-issuance compliance requires issuers of tax-exempt bonds to actively monitor compliance throughout the entire period their bonds remain outstanding, not just at the time of issuance. Issuers are also urged to adopt written procedures relating to continuing disclosure. These should comprise important municipal bond information that arises after the initial issuance of the bonds. The Municipal Securities Rulemaking Board’s Electronic Municipal Market Access, or Emma, is a website that publicly displays continuing disclosures provided either as required disclosures, per SEC Rule 15c2-12, or as voluntary disclosures, without a contractual obligation to do so.