Wednesday, November 11, 2015

IRS Drives Home Rules Regarding Transactions With Foreign Entities

In recently released PLR 201539032, the IRS addressed the consequences of a U.S. nonprofit maintaining a poorly run foreign grant program.

Facts Presented
An organization was formed to provide financial support for a separate foreign organization as well as provide support for needy individuals, provide student stipends, support Jewish education and outreaches and provide room and board for students attending Jewish institutions.  During the process of applying for exempt status, the IRS initially determined that due to the specific support of a foreign organization, the organization could qualify as a tax exempt organization, but donations to it would not be deductible.  However, after agreeing to change its operations to not specifically support the foreign entity, the IRS agreed to allow the organization to receive tax deductible gifts.

Unfortunately the organization did provide support to a specific foreign organization and stated on its Form 990 its purpose was raising funds for the foreign organization.  Based on the information provided on Form 990, the IRS initiated inquiries as to the organization's foreign grant procedures.

Inquiries revealed the following:

  • The organization did not screen grant recipients through the Office of Foreign Asset Control Specially Designated Global Terrorist list to determine if the recipient was included on the watch list;
  • No application or other documentation was requested from the grantee;
  • Scholarships made directly to students were based on teacher recommendations;
  • No detailed description of any specific projects were required;
  • All of the grants were to persons connected with one particular organization;
  • All grants were intended for educational purposes, but no follow up was conducted to determine if those goals were being met;
  •  Students provided direct scholarships were not required to provide any proof of educational expenses;
  • The grants were approved by the board of directors, but always in the amount requested; 
  • The foreign organization did not provide any financial reports or accounting to the U.S. organization for any of its operations; 
  • There were no agreements that reflected the organization's discretion to withdraw funds in the event the charitable purposes were not met and no follow up evaluation was conducted; and
  • The organization's review of the effectiveness of the grants was limited to its on-site visits.

Legal Issues to Consider

Few U.S. organizations, including churches, realize the restrictions on supporting foreign organizations.  There are two primary issues that must be addressed in working with foreign individuals and foreign organizations;

  1. Tax Deductible Gifts;  U.S. tax law does not allow a U.S. taxpayer to deduct contributions to foreign organizations outside of limited exceptions with neighboring countries.   In the same manner, a U.S. organization that is merely a conduit or a fundraising organization for the foreign organization may operate as a tax exempt entity in the U.S., but its donors are not allowed to make tax deductible gifts to the U.S. organization.  In order for the U.S. organization to not operate as a conduit for the foreign organization, it must maintain control over its operations and its funds.  The IRS detailed examples of the application of these principles in Revenue Rulings 63-252 and 66-79.
  2. Private Benefit vs. Charitable Purposes:  A tax exempt entity must operate for its specific exempt purposes and not for private purposes.   Any activity that is not clearly documented to be an exempt activity is considered to be a private benefit activity or a nonexempt activity.  The existence of a single nonexempt purpose can destroy an organization's exemption. Better Business Bureau v. U.S. 34 AFTR 5 & American Campaign Academy v. Comm., 92 TC 1053
Expenditure Responsibility
If a U.S. organization is going to actively support a foreign organization and avoid being considered a conduit, then it must control over all funds provided to the foreign organization.   If a U.S. organization is going to provide support to a foreign organization or to an individual, it must be able to prove that assisting the recipient is an exempt purposes.   Both of these goals are addressed and met through a concept known as expenditure responsibility. (This private letter ruling describes the classic case of failing to meet both of these requirements.  The result was revocation of the organization's exempt status.  The IRS also noted that in the event the exempt status was retained, the organization would be considered a conduit and would not be able to receive tax deductible contributions.)

Expenditure responsibility isn't one set item or circumstance, but it is combination of several items indicating the U.S. organization is in control of the funds and is assured its funds are used for its charitable purposes.  If the funds are not being used for charitable purposes, then the presumption is they are being used for private purposes.  Items or actions that create expenditure responsibility may include, but are not limited to:

  • Predetermined grant requirements
  • Grant applications
  • Project budgets
  • Proof of actual expenditures
  • For scholarships, proof of fulfillment of educational requirements
  • Proof of financial need
  • Overall financial information of the organization
  • On-site visits by U.S. representatives
  • Direct accounting of expenditures
  • Compliance with anti-terrorism procedures
  • Personal involvement in project planning or fulfillment
  • Periodic reporting of a project's progress

Take A Ways from PLR 201539032
This ruling provides an excellent analysis of what the IRS expects from an organization to be able to address the two issues described above.  An organization actively operating in foreign countries should us this guidance to review its own policies and procedures to avoid any threat to its own exempt status.  Different organizations may have different specific ways to achieve expenditure responsibility, but the goal of an organization's grant making program should be to:

  • Know who is receiving the funds - Through applications, interviews and hands on knowledge, this information should be well documented.
  • Know the purposes for the funds - Require budget proposals or other financial information in the decision making process to allow for an educated decision as to the amount of funds to be made available.
  • Make clear the expectations - Grant recipients need to know what is expected out of them and the consequences of failing those expectations.
  • Know the end result of the funds - Don't assume the funds are used correctly, follow up to determine if the end result has been accomplished.
  • Avoid designated funds - Don't become a conduit for a well intended donor.  Refuse contributions earmarked for a foreign entity that is not participating in the organization's established foreign grant program.  Donations to foreign organizations and individuals are clearly not deductible if not controlled by the U.S. organization. 
Organizations filing Form 990 are required to disclose a synopsis of foreign grant making procedures on Schedule F.  A poor disclosure may lead to an IRS inquiry as it did in this ruling.  A church is still subject to all of these rules, but avoids the natural oversight that comes through the Form 990.  Therefore, it is important that churches realize the rules involved in foreign grant activity and build programs that will comply and protect the church's exempt status. If an organization's foreign grant program closely resembles the one described in PLR 201539032, then it is time to dust off those policies and procedures and take a fresh look at it.  Instituting changes may be difficult, but it is necessary to protect the organization's exempt status and the donors' tax deductible donations. 


Monday, August 18, 2014

Tax Court Sends Reminder of Documentation Rules

In a recently released decision, the Tax Court has reminded us of the importance of adequately documenting business expenses for mileage, travel and meals.  In Marcus O. Crawford, TC Memo 2014-156, the Court upheld the disallowance of Mr. Crawford’s business expenses for mileage, travel and meals due to inadequate documentation of the business purpose.  While the ruling deals with deductions claimed on Mr. Crawford's tax return, its theory applies to all documentation for these common expenses incurred by any church or nonprofit.  

Mr. Crawford operated a side business in addition to being a full time employee for another company.  The disallowed deductions related to his side business and were claimed on his Schedule C.  To support his deductions for mileage, meals and other travel expenses, Mr. Crawford provided his calendar with various notations as to places, names, activities or miles.  For his meals and entertainment expenses, he presented a spreadsheet indicating the place, the date, the amount and the business purpose.  (Sounds pretty good so far, right?) However, the IRS was not satisfied with the documentation and disallowed the expenses.  The Court and the IRS agreed on the following deficiencies:
  •  Documentation inaccurate:  Mr. Crawford's calendar proved to be inaccurate.  Entries on the calendar were in conflict with other independent documentation.  Since some of the entries were determined to be inaccurate, it was determined that none of the entries were reliable. 
  • Documentation vague or ambiguous:  Even if the calendar notations had been deemed reliable, the notations were determined to be too vague or ambiguous to support the business purposes.  The mileage entries did not clearly indicate the business purpose.  The Court refused to assume that the mileage notations were automatically associated with the business activities.  Other notations just listed someone's name with no other information to support the business activities. 
  • What was paid:  Invoices and confirmation print outs were presented to document travel expenses.  However, the Court could not determine if Mr. Crawford had paid for the expenses or if his employer had paid for the expenses or what were final expense amounts.  Once again challenging Mr. Crawford’s credibility, the IRS determined that some of the invoices had been paid for with a credit card that was reimbursed by Mr. Crawford’s employer. 
  • Lack of notated business purpose:  For receipts that were deemed credible, there was no business purpose noted on the receipt to clearly indicate the business purpose of the trip.
  • Business purpose too generic:  The spreadsheet presented to support the meal and entertainment expenses contained most of the required elements.  However, the business purpose was consistently listed as “interview/team training”.  Since some of the meals were only for Mr. Crawford, the documentation was suspect.  For those involving other people, the spreadsheet did not contain adequate documentation as to who was involved and the business relationship. 

In reviewing the Crawford case, I felt a certain déjà vu.  As a part of our IRS Compliance Reviews, we review expense reports as well as the documentation of a church/nonprofit organization’s credit card expenses.  We consistently find weaknesses in the documentation of these types of expenses.  Some of the weaknesses align with the Crawford case.  Consider the following:
  • Documentation vague, ambiguous or generic:   Use of the word “ministry” as the business purpose is not a sufficient business purpose and is as insufficient as Mr. Crawford’s “interview/team training”.   Another common one for churches is “hospitals” without any detail as to where the staff member actually traveled. 
  • Question as to what was paid:  Reservation confirmations are not always proof of an expenses.  Additionally, clarification of who has paid for an expense is vital to the reimbursement process.  Care needs to be taken to determine the actual payer of an expense prior to reimbursement by the church/organization and to reimburse for the final expense amount.   While normally not intentional, I have seen instances of expenses reimbursed that were originally charged on a corporate credit card. It is always a good practice to request original receipts be turned in for any reimbursement or for any credit card charge. 
  • Lack of any business purpose:  In regards to meals, just listing who was at the meal does not fulfill the documentation requirements.  The business connection of the person must be clearly established as well as the business purpose for the meal. 
  • Conflicting or unclear documentation:   It was determined that Mr. Crawford was reimbursed by his employer for some of the expenses that he claimed on his Schedule C. If a minister or other staff member is involved with a business or ministry outside the church, it is important to be able to determine the correct business associated with an expense. While the church or organization may gain an intangible benefit from a person's outside activities, it does not create a justification for the payment of the expenses of the outside business.  

Over time it is easy to fall into sloppy documentation habits.  Leaders of nonprofit organizations have many competing demands for their time and spending time documenting business expenses is tedious.  However, proper documentation of expenses is not only required by the tax law, it is critical to avoiding other undesirable consequences.  This is especially true of these three common expense areas.  In a separate blog post, we will review the consequences of poor expense documentation habits to both an organization and to the individuals involved.  In the meantime, it is time to review your organization's accountable expense reimbursement plan not only as it is written, but also as it is executed.  

Wednesday, March 5, 2014

Designating Housing Allowances - A "Must Do" Step for the Church

Ministers performing qualifying ministerial services may have a portion of their compensation designated as a housing allowance pursuant to Section 107(2) of the Internal Revenue Code.  (Terminology varies interchanging such words as housing, parsonage, rental or manse depending on the culture of the church.  The Internal Revenue Code and Regulations refer to it as "rental allowance".)  Within certain limitations, this portion of a minister's compensation is not subject to federal income tax. 

Internal Revenue Regulation 1.107(b) requires that in order to be "rental allowance", the amount must be designated as such pursuant to an official action taken in advance of the payment of the allowance by the employing church or other qualifying organization. Two cases decided in 2013 remind us of the critical need to properly designate housing or rental allowances.

In Ricky Williams v. Comm., pro se TC Summary Opinion 2013-60, the minister entered into an employment contract with his church.  The initial contract provided for a housing allowance for a period of six months.  Any provision extending beyond the six months would have to be formally decided at a later date.  The church never revisited this issue, so none of Reverend Williams' future compensation was designated as housing.  During an examination of his 2007 Form 1040, Rev. Williams asserted that over $33,000 of his compensation should be considered as housing allowance.  The IRS disagreed, so off to court they went.  The court ruled that Rev. Williams could not claim the housing allowance, since the church had never formally designated an amount as housing allowance after the initial six month provision.  Therefore, for 2007, no housing allowance existed.  Rev. Williams produced a new employment agreement dated in 2012 that included the housing allowance provision, but the court reiterated the requirement of having the designation prior to receiving the funds. The 2012 employment agreement was too little, too late.

In Donald L. Rogers, V. Comm., TC Memo 2013-177, Rev. Rogers' church paid his mortgage payments and utilities directly rather than pay him an allowance for the expenses.  Despite making the payments directly, the church failed to formally designate the payments as payments made pursuant to IRC Section 107.  Lacking the formal designation, the court agreed with the IRS that the payments represented taxable compensation to Reverend Rogers. 

Many churches are lax in their housing allowance designations.  I recommend that housing allowance designations be approved every year and be approved by either the appropriate committee, the board of directors or by a high ranking employee that has specifically been granted the authority to make the designations on behalf of the church or other qualified organization.  Remember the designation has to be done prior to the payment of the allowance, so beware of late designations or of designations that attempt to reclassify prior payments.  In this area, it pays to do it well and do it early in order to provide the maximum benefit to the minister.

Cautionary Note:  In Freedom From Religion Foundation, Inc. v. Lew, 112 AFTR 2d 2013-7107, the court ruled that IRC Section 107(2) is unconstitutional.  This ruling makes the housing allowance, but not the provision of a parsonage, unconstitutional.  The judge delayed the mandate for the IRS to enforce the ruling until the conclusion of the appeals process.  The government has appealed the decision to the 7th Circuit Court of Appeals.  Therefore, the future fate of this tax provision is in the hands of the U.S. Department of Justice and the 7th Circuit Court of Appeals.

Wednesday, January 22, 2014

Connect With Me At The 2014 Texas Ministry Conference

People often ask me about my speaking schedule, so in 2014 I am resolving to write posts to update you on where I will be and when.  I am honored to speak at many great conferences during the year and I am always excited to have the opportunity to catch up with people that have joined me on my blog. 

February 20th I will be at speaking at the Texas Ministry Conference in Houston, Texas.  The conference is held at Champion Forest Baptist Church and is hosted by Church Supplies and Services, Inc.  This year I am co-presenting with my husband, Frank Sommerville, on issues involving facilities usage, the legalities to consider with foreign activities as well as our general tax and legal update.  However, we are just a small part of this conference.  Consistently year after year the conference provides a great slate of speakers and topics and offers something for everyone in church administration.  In fact, there are so many great topics, that I encourage my churches to take several people in order to take advantage of all the information available. 

You can register at or call toll free 888-350-3264.  First time attendees will be entered in special drawings to be held during lunch.  I hope to see some of you in Houston in February!

Wednesday, January 15, 2014

New IRS Form 8822-B Requires Action By Virtually All Organizations

In an effort to update its records, the IRS is requiring any organization or entity that obtains an employer identification number (EIN) to report to the IRS a change in the "responsible party" within 60 days of that change.  This change is reported using Form 8822-B, Change of Address or Responsible Party - Business.  This is a good thing as it helps to provide assurance that critical communications from the IRS will not be directed to a person who is no longer associated with an entity.  However, in its efforts to update contact information, the IRS is requiring virtually every entity to provide current information.

Who is a "Responsible Party"
Currently the application for an EIN requests the name and identifying number of the "responsible party".  This is defined to be as the person who has a level of control over, or entitlement to, the funds or assets in the entity and the disposition of its funds and assets.  This is a fairly general definition and may actually apply to multiple people within an entity.  However, when applying for the EIN, an entity is only required to list one responsible party.  In essence, this is listed as the primary contact for the entity and provides assurance that mail sent from the IRS will be directed to someone with enough authority to deal with the issue at hand. 

Why does this affect so many entities?
The complication enters the picture with the direction from the IRS that if the "responsible party" has changed prior to 2014, then the entity must file the Form 8822-B no later than March 1, 2014.  Prior to January 2010, the term "responsible party" did not exist.  Therefore, it can be presumed that if an entity obtained its EIN prior to January 2010, it should file the Form 8822-B by March 1, 2014 to declare its "responsible party".    If an entity gained its EIN after January 2010, then it should check its application to see who was listed as the "responsible party" to determine if the filing is required.  For the future, entities should understand that the "responsible party" must be updated in the event the listed party leaves the entity. 

Form 8822-B
The form is used for both updating the "responsible party" for an entity as well as updating the address for an entity.  It may be obtained at for download.  Contact your CPA or attorney, if your entity needs assistance in determining its reporting requirements.

Thursday, May 9, 2013

May 15th Filing Deadline Draws Close

As May 15th draws near next week, I want to remind our nonprofit organizations of two important deadlines. 

Forms 990, 990-EZ & 990-N
For calendar year returns, Forms 990 and 990-T need to be filed by the 15th or properly extended.  If an organization is extending Form 990-T, then it should deposit via EFTPS any tax that is due with the return to avoid late payment penalties and related interest. If the organization has less than $50,000 of gross income and less than $200,000 in fixed assets, it should file its Form 990-N by May 15th.

Form 5578
Another deadline often overlooked is the deadline for private schools that do not file Form 990 or Form 990-EZ to file Form 5578.  Form 5578, Annual Certification of Racial Nondiscrimination for a Private School Exempt from Federal Income Tax is also due by May 15th for schools with a calendar year end.  This return is generally required to be filed by churches that operate schools as a direct part of their activities or by church affiliated schools that do not have a Form 990 filing requirement. 

The Form 5578 certifies that the school (church) has satisfied the applicable nondiscrimination requirements as detailed in Revenue Procedure 75-50.  In general these requirements are:

  1. The governing documents contain the proper prohibition against discriminating as to admission or employment on any of the protected grounds other than based on religious discrimination;
  2. The school's handbook and other documents should also contain similar language;
  3. The school maintains records that indicate the racial make up of the student body, teaching faculty and administrative faculty; and
  4. The school/church has publicized its nondiscrimination policy using either the appropriate radio or televsion medium.  (Internet does not qualify to meet this requirement.)  There are some exceptions to this rule, but they are very narrow and do not apply to many church operated schools. 
Form 5578 may be downloaded from the IRS website at Failure to file can result in an IRS inquiry and failure to comply with Revenue Procedure 75-50 can result in revocation of the school's tax exempt status. 

Monday, March 18, 2013

Want To Buy A Raffle Ticket?

When the Form 990 was redesigned in 2008, the form was rewritten to gain additional information regarding an organization's gaming activities.  Gaming activities have to be separately reported in Part VIII of the form and in some instances, greater detail is required through Schedule G associated with the return. 

With this additional information required, we are finding that many organizations are conducting some sort of gaming activity that previously was buried as a part of a fundraiser, such as a gala, dinner or golf tournament.  What most organizations do not realize is that state laws always govern any type of gaming activity.  While most people understand that state laws may regulate professional gaming activities, they fail to realize that state laws also regulate gaming activity that is carried out as a part of a fun filled event conducted by a nonprofit organization or a church. 

At this point, I will apologize to all of my followers that are not from Texas.  I have been asked to specifically blog the Texas rules for raffles.  Realizing that some of my readers are from other states, I encourage everyone to do a little digging and determine how your state may be regulating raffles and determine if your organization is in compliance with the applicable state statutes.

In 1999, Texas passed The Charitable Raffle Enabling Act that allows for charitable raffles to be conducted by qualifying organizations.  However, there are strict rules to be followed, if an organization desires its raffle to be covered by the act.

What Is A Raffle
In general, a raffle occurs any time someone pays for the chance to win a prize. Qualifying organizations are allowed to conduct two raffles each year that comply with the state law. 

Who Can Conduct a Raffle In Texas
An organization has to be a qualified organization:
  • An association organized primarily for religious purposes that has been in existence for 10 years;
  • A voluntary EMS that does not pay its members;
  • A volunteer fire department that does not pay its members; and
  • A nonprofit organization that:
    • is at least three years old;
    • elects its governing body;
    • has 501(c) tax exemption;
    • has members;
    • does not distribute its income to its members; and
    • does not participate in political campaigns.
Any other organization is prohibited from conducting a raffle in Texas.

What Must the Organzation Do
The qualifying organization must follow a few rules:
  1. They must have possession of the prizes that are offered.
  2. Prizes may not be cash or items converted to cash.  (It is thought that this does not prohibit gift cards as long as they cannot be readily converted to cash.)
  3. If the organization purchases the prize, its value cannot exceed $50,000.
  4. It must print tickets that include the name & address of the organization, the price of the ticket, the date the prize will be awarded and a general description of each prize that is valued at more than $10.
  5. Tickets may only be sold by members or authorized representatives.  They may not be sold by compensated staff.  You also cannot pay someone to plan and conduct the raffle.
  6. The raffle cannot be advertised statewide or through paid advertisements.  This means that it cannot be advertised on the organization's website as this would be considered as "state wide."
Penalties & Enforcement
Conducting an illegal raffle is issue for the organization's local district attorney.  It is a Class A misdemeanor for conducting an illegal raffle and a Class C misdemeanor for participating in one.  This means that the people actually conducting the raffle are at risk and should take seriously the above rules.

In essence, an organization cannot have an unplanned raffle or a spur of the moment raffle.  Complying with the above rules take care and consideration.  Therefore, organizations and churches should prepare policies and procedures to guide any type of activity that can be construed as a "raffle".