Consequences of Participant Designated Accounts

One subject that continually makes its way into practically every speech I deliver has to do with the tax consequences of maintaining participant designated accounts for fundraising activities. I have been speaking about this particular subject for approximately 4 years as the IRS has continued to get more and more serious about the ramifications of maintaining these types of accounts.

Possible Scenario:

Youth group needs money to help pay for camp fees for the students. A local advertiser tells the church that they will pay the church a set amount, if the students will go to a local stadium and place flyers in all the stadium seats prior to the big game on Sunday. The youth minister tells the kids that the funds paid to the church will be designated to the students' camp fees according to how long they assist in putting out the flyers.

Potential Consequences:

Payroll - The students have now been paid for their help in putting out the flyers. Therefore, they have been paid for their personal services. This has been done under the direction of the church staff. Therefore, all the students who have money credited to their camp fees have been compensated for their services and have been turned into employees of the church. Now the church is required to have all of the employment forms completed on the students and pay all the related payroll taxes. This was the result a few years ago with two booster clubs in Kentucky. See the story at http://www.kentucky.com/211/story/485490.html.

Tax Exemption - The IRS has ruled that this type of activity is private benefit to the students. Substantial private benefit to individuals can jeopardize an organizations exempt status. This was the conclusion in PLR 201035034 issued by the IRS last year. In the letter ruling, the IRS revoked the tax exempt status of a booster club due to the fact that practically all of their activities were performed to generate funds directed into participant accounts.

Income Tax - While not automatic, many fundraising activities do not generate unrelated business income due to the exception provided for activities conducted by volunteers. If all the volunteers have been turned into paid employees, this exception is no longer available. Therefore, it is possible that the activity will generate unrelated business income and subject the organization to filing Form 990-T.

Just How Serious????

Responses to this topic have varied from incredulous to skeptical to dismay. With the issuance of the above private letter ruling, it was obvious the IRS was beginning to take this issue to a more public level. Earlier this year I was informed that exempt organization agents were being trained in this specific issue.

On June 27, 2011, the Director of Exempt Organizations, Lois Lerner, issued a directive to the Director of Examinations and the Director of Rulings & Agreements. The directive clearly states that such programs are considered to be private benefit and could result in an organization losing its exempt status and the amounts credited to a participant's account could result in employment taxes. With this directive, the issue will be considered one for review for organizations that are undergoing examinations and/or that are requesting rulings as to their tax exempt status.

Conclusion

While these types of fundraising programs still can provide additional funds for a church, school or other type of organization, the distribution of the funds cannot be connected with the work performed by the person. The funds must be used for the general purposes of the organization or to provide for a reduced cost of an activity for all involved, working or not.