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.

The List Is Out

Background
In 2006 Congress passed the law that automatically revoked the tax exempt status of any organization that failed to fulfill its Form 990 filing requirement for 3 years in a row. 2010 brought the first year this would be possible since the passing of the law with those who failed to file anything for the years 2007, 2008 & 2009. While the revocation date was effective for calendar year returns on May 17, 2010, the IRS continued to show some grace by allowing organizations to file through a special program conducted through October 15, 2010.

Results
With that program at its end and the final time passing to file most of the returns for the 2009 year, the IRS has finally issued the dreaded list of revocations. The list contains the names of approximately 275,000 organizations and can be found at www.irs.gov/autorevocationlist. It is organized by state. (Strangely enough the revocations for Texas is so large that it takes two files to cover it.)

What To Do
The law is clear - there is no disputing the revocation with the IRS or challenging it through the courts. IRS Notice 2011-44 details the process for reinstatement of tax exempt status. Organizations on the list are required to file new exemption applications, either Form 1023 or Form 1024, to request the exempt status be reinstated. Both the exemption application and the envelope should clearly indicate "Automatically Revoked" in order for the application to be directed to correct processing area.

Reinstatement will be effective the filing date of the exemption application unless the organization can provide reasonable cause for the failure to file Forms 990 all those years and provides the Forms 990 for 2007, 2008, 2009 and 2010. If the organization would have been eligible to file Form 990-N during all of the three missed year, then special procedures have been described to allow for a lower user fee to be paid with the application and they will gain retroactive exempt status. Procedures describing these special provisions can be found in IRS Notice 2011-43.

There will be many questions as organizations scramble to try to regain tax exempt status. The IRS has addressed many of those in its frequently asked questions found at http://www.irs.gov/charities/article/0,,id=221600,00.html. If an organization has received its notice of revocation or it is listed on the published list, it should seek the counsel of a CPA experienced in preparation of Forms 990 as well as experienced in the preparation of Forms 1023/1024.

Housing Allowance for Vacation Homes

In a remarkable decision by the full Tax Court, the Court has ruled that Phil Driscoll should be allowed to utilize the housing allowance provisions under IRC Sec. 107 for both his primary residence and his lake home. Utilizing a technical provision in the law, the Court has agreed that the term "a home" should not be interpreted as purely singular in nature, but should also apply in the plural. The result is that the housing allowance utilized to provide the Driscoll's lake home is excluded from their income. Writing the dissenting opinion, Judge Gustafson noted that there was insufficient evidence to state that Congress intended multiple homes to be covered under this provision. Additionally, he points out that the court's job is to narrowly construe the exclusions from income and not to throw open the door to excluding expenses for two, three, or four homes. These are valid points and will more than likely be the basis for an appeal by the IRS. What does this mean for ministers today? A Tax Court decision is binding on the IRS. Therefore, at this moment, it is the law in regards to this provision. However, it is more than likely that the IRS will appeal this ruling. It is not one that they can easily agree to. In the event that the appeal rules in favor of the IRS, then it will be as if this current case was never law. However, in the event the IRS does not appeal or loses the appeal, this case stands as binding on the IRS. It seems that "caution" would be the best watch word for the day. However, there are some actions that ministers should take today to capture this tax benefit in the event the case is allowed to stand. Ministers should consider the following actions: For 2011: Preparing for the Future

• Housing allowance cannot be changed at the end of the year, so ministers with current second homes should consider increasing their housing allowance for 2011 to cover the expenses of the second home. If the decision of the Tax Court is not reversed by an appellant court, it would be too late to fully benefit from this change in the law at the end of a tax year.

For 2010: To Claim or Not To Claim

Ministers with excess housing allowance for 2010 should consider if they are ready to follow this ruling and claim expenses on a second home for 2010. This is a serious decision that should be fully explored with a tax professional. There are two viable options to be considered:

• Use the expenses associated with the second home to determine the amount of housing allowance to be excluded from income and do not report any excess housing allowance on the 2010 Form 1040. This is an acceptable provision under current law. However, in the event the case is overturned on appeal, the IRS will have the ability to adjust the Form 1040 and assess all related taxes, penalties, and interest associated with the tax savings from this particular provision. Depending on the amount of the tax involved, ministers taking this route may wish to invest the additional taxes saved in order to preserve the funds in the event of a reversal.


• Do not use the expenses associated with the second residence to determine the amount excluded from income and file as would be normal. As a second step, the minister may file a protective refund claim stating that they are due a refund based on this particular case. If the Driscoll case is on appeal, the IRS will more than likely hold the refund claim until a decision has been issued by the appellant court. This will take an estimated 2 to 3 years.

As previously stated, these are very serious decisions to consider and require an understanding of the ramifications of each decision. However, with the assistance of a tax professional, a minister should be able to make a decision that aligns both with the law and with his/her risk tolerance level.

Driscoll v. Commissioner of Internal Revenue, 135 T.C. No. 27.

Long Awaited Cell Phone Relief

The Small Business Jobs Act of 2010 has passed through Congress and is on its way to the President's desk for signature. While the majority of the bill is directed at for profit businesses, there is a provision that will bring great relief to nonprofits as well as for profit businesses. The bill contains the long awaited relief for the onerous rules regarding employer provided cell phones. Under the old law, cell phones were treated as "listed property". This classification required the extensive documentation of who, when, and why of each call in order to substantiate the business purpose of the call and the related business use of the phone. This classification was created at the time when cell phones were rather large and sat in our cars and not in our pockets. The phones and the calling plans were very expensive. The recent advances in technology have created a totally different animal. Between cheap phones, flat rate plans and data services, the substantiation requirements of "listed property" became a burden too great to bear. In recent years, employers have either gone to not paying for the phones at all or including the entire expense for the phone in an employee's taxable income. In response to requests from the Treasury Department, Congress has "delisted" cell phones. This places them under the general rules for proving up business expenses. This doesn't mean that cell phones can become a free for all benefit. There are still other issues that have to be addressed by employers. The employers have to carefully consider providing cell phones to employees due to the inherent personal use of the phones. Working Condition Fringe Benefit: Employers can provide the cell phones as "working condition fringe benefits". However, in order to meet this test, the phone has to still be used in a business fashion that would allow the employee to deduct the expense, if the employee paid it personally. Therefore, the phone has to have a significant business purpose. Only the business portion can be excluded from the employee's income. However, now that the phone is not "listed property", it may be easier to determine a reasonable amount that can be considered as business use without the requirement of documenting every single phone call. De Minimis Fringe Benefit: Employers may determine that the amount of personal use of the phone is so small that accounting for it is unreasonable or administratively impracticle. In this case, the employer will make the case that the personal use is a "de minimis fringe benefit" that does not have to be valued for inclusion in the employee's personal income. The result is that employers have to take an honest look at their cell phone policies and determine if the personal use is so small that it can be considered as de minimis or that the personal portion is such that the employer will decide to consider a portion of the phone as personal and either have the employee pay for that portion or include that portion of the cell phone bills as a taxable fringe benefit on the employee's Form W-2. In any case, we no longer have to demand who, when, and why of every call in order to make the decision. Warning: Do not consider this change the liberty to provide employees with cell phones on a tax free basis without any thought or consideration to the business use of the phone. Employers should clearly document why they believe the cell phone is a business related expense and be prepared to support any challenge from the IRS as to the provision of a cell phone as a tax free fringe benefit.

Relief For Small Organizations Facing Revocation

The Pension Protection Act in 2006 enacted laws that require the IRS to revoke the tax exempt status of any organization that is required to file Form 990, but fails to do so for three consecutive years. (This is only effective for organizations that have a Form 990 filing requirement. It does not effect churches.) The first set of revocations was to be effective on May 17, 2010. However, the IRS became concerned that too many organizations did not fully understand the ramifications of not filing, and it created a leniency program.

If an organization has received a determination letter indicating it has a Form 990 filing requirement, then it must file either Form 990, Form 990-EZ or Form 990-N for each year of its existence. The IRS has granted an extension until October 15, 2010 for organizations to file one of these forms for each of the past three years or at least for 2009 for those eligible to file Form 990-N. This action will avoid revocation of the organization's exempt status.

If an organization does not qualify to file Form 990-N, and it should have filed Forms 990/990-EZ for each of the last three years, the IRS has created a voluntary compliance program. The organization must file returns for all three outstanding years and pay a compliance fee. The maximum compliance fee is $500 and the program relieves an organization from the assessment of penalties for late filing of the returns. This represents a savings of thousands of dollars since the late filing penalty is $20 per day for small organizations and $100 per day for larger organizations.

It is advisable that all organizations determine if they are in compliance with their filing requirements. The IRS has published a listing of organizations with planned revocation on its website. The lists are separated by state. If you have question regarding an organization, the lists may be reviewed to determine if the organization is scheduled for revocation.

With all of the extra effort expended by the IRS, it is anticipated the the revocations will be issued later this year. Additionally, if an organization has a return that has not been filed, it should pursue the voluntary compliance program as a remedy. If only one return is late, it should be filed through this program. After the end of this program, the IRS will probably be fairly unforgiving to late filers.

Form 1099-Misc Reporting Nightmare

Perhaps you have heard the ugly rumors of the increased mandatory reporting for payments to vendors. Unfortunately, it isn't all rumor, but it is truth. In an effort to make the health care bill "deficit neutral", the legislation included a provision that would require Forms 1099-Misc to be filed for virtually all vendor payments, including those to corporations, that exceed $600 for the year. It seems that this provision alone is anticipated to raise $17 billion of the nearly $1 trillion needed for the health care legislation. While this looked good on paper, no one attempted to consider the logistics or the cost to comply with such legislation. For example, what would be the cost to businesses to comply or better yet, could the IRS handle all of those Forms 1099-Misc. It is estimated that the provision will increase the filings by five fold. The provision is set to become effective in 2012. However, help may be on the horizon. It seems that both Democrats and Republicans are realizing this is not the best idea and something may have to be done. Rep. Dave Camp of Michigan has introduced H.R. 5893 to repeal this provision citing information that the compliance with the provision will cost American businesses more than the amount of revenue generated for the government. The cost is anticipated to be extremely burdensome to small business and small organizations. This translates into money diverted to regulatory compliance that a nonprofit should be able to use to fund its programs. At this point, we are watching Congress to see what will happen. We don't have to begin gearing up for the reporting just at this time, and have some time for Congress to save the day. Stay tuned to the final outcome on this issue and more guidance on when, or if, you will need to send a Form W-9 to Office Depot to gain their address and employer identification number.

Payroll Tax Responsibilities - A Gentle Reminder

A recent Tax Court memo decision serves as a good reminder that an organization is ultimately responsible for payroll tax deposits and filings even if the duties are delegated to an outside provider. In McNair Eye Center, Inc. v. Commissioner, TC Memo 2010-81, the owner of the eye center was held to be ultimately responsible for the timely deposit of payroll taxes despite the fact he hired an outside CPA to take on those responsibilities. The CPA filed the 2005 Forms 941 in February of 2006 and failed to pay the 2005 payroll taxes. The IRS determined, and the Court agreed, that the ultimate responsibility for the payment of the payroll taxes was the owner of the eye center. Therefore, there was not a reasonable cause to abate the penalties related to the late payment of the payroll taxes and the late filing of Forms 941.

While this case involves a for profit entity, the rules are the same for nonprofit organizations. Organizations should take seriously all responsibilities surrounding payroll. The ultimate responsibility for the payment of the payroll taxes is often attributed to the board of directors of the nonprofit or the officers of the nonprofit. This is true even if the organization has hired someone to handle all of the payroll functions of the organization and even if the organization uses an outside payroll service to process its payroll.

Not only are the related penalties a concern for an organization, but anyone deemed to be a "responsible person" can be held personally liable for unpaid payroll taxes. Therefore, it is in everyone's best interest to institute procedures to confirm the organization's compliance in regards to its payroll tax deposits and its payroll tax filings.