Intermediate Sanctions

In 1996, Congress passed a bill generally referred to as the “Intermediate Sanctions” legislation. This law gives the IRS power to assess penalties against exempt organizations and their managers, short of revocation of exempt status, for various violations of the Internal Revenue Code. Previously, the only effective sanction available to the IRS was revocation of exempt status, which the Service was understandably reluctant to impose except in cases of very serious violations. Lesser violations often went unpunished for lack of an appropriate level of punishment.

The provisions of the law apply to organizations exempt under Sections 501(c)(3) (not including private foundations) and 501(c)(4) and include penalties that may be assessed against both the management of the organization and the individual responsible for an improper transaction. Types of transactions covered by the law are generally those in which some kind or amount of benefit is given to a person not properly entitled to it.

Another provision of the law requires organizations to provide a copy of their Form 990 to persons requesting it. A reasonable charge may be made for copying. Penalties are incurred for failure to file a Form 990 or to make it available on request.

In 1997, Congress passed many changes in the tax law, generally referred to as the Taxpayer Relief Act of 1997. There are many, but mostly minor, matters affecting not-for-profit organizations in the new law. Most of the changes have to do with split-interest gifts, unrelated business income, estate and gift taxes, and deductions for charitable contributions.

On August 17, 2006, the Pension Protection Act of 2006 became law. This new law has several provisions that affect tax reporting and compliance by not-for-profit organizations, some of which are as follows:

• Controlling organizations must report income from and loans to controlled organizations, as well as transfers between controlled and controlling organizations on their Form 990 information returns due after the date of the enactment of the new law.
• Section 501(c)(3) organizations must now disclose unrelated business income tax returns (Form 990-T) and make them available for public inspection. This provision is effective for returns filed after the date of the enactment.
• Private foundation and excess benefit penalty excise taxes are doubled.
• Donor advised funds, supporting organizations, and credit counseling organizations are subject to new requirements.
• Charitable contribution deductions for food, book, and certain conversation property are increased.
• Charitable contribution deductions for nonmonetary donations, certain easements, taxidermy property, clothing and household goods, and certain other items are limited.
• Exempt organizations (other than private foundations) with gross receipts under $50,000 must file an annual notice called an “e-Postcard” (Form 990-N).

Not-for-profit organizations should review the new requirements to assess their impact on each organization's tax compliance and reporting matters.

Private Inurement

One of the essential requirements for many organizations seeking exemption is that they must be organized and operated in such a way that no part of their net earnings inures to the benefit of any private shareholder or individual. The phrase “no part” means the level of inurement is not material; any inurement at all, no matter how small, could endanger an organization's tax-exempt status.

Private inurement is prohibited for many organizations. The term encompasses transactions that confer preferential treatment upon private shareholders or individuals. The concept requires investigation of the transactions between the organization and its insiders (i.e., those who can control the use of the organization's assets). Section 501(c)(3) allows exemption for an organization only if no part of the net earnings of the organization inures to the benefit of any private shareholder or individual. A private shareholder or individual is a person or persons having a personal and private interest in the activities of the organization.

Organizations can lose their exempt status due to private inurement from unreasonable compensation or fringe benefits, personal use of an organization's assets, forgiveness of indebtedness owed by insiders, personal expenses being paid by the organization, low-interest or unsecured loans to insiders, unreasonable housing allowances, and other than arm's-length purchases or sales between the organization and insiders.

To avoid the private inurement issue, organizations should avoid transactions with insiders that even remotely appear to unreasonably benefit the insider. This does not prohibit an organization from transacting business with members of its board of directors or paying competitive salaries. It does mean that certain guidelines need to be applied, and all transactions should be properly documented before relationships with insiders are formed.

Excise Tax on Investment Income

The Tax Reform Act of 1969 established an excise tax on net investment income:⁶ Net investment income includes dividends, interest, rents, royalties, and net capital gains.⁷ For purposes of calculating gain on investments acquired prior to December 31, 1969, the tax basis of the property is the higher of the fair market value at December 31, 1969, or the cost. In calculating net investment income, reasonable expenses directly related to the production of investment income can be deducted. Also, income that is subject to unrelated business income tax is not included in the calculation of net investment income. This would include items of income such as interest or dividends from debt-financed stocks and bonds and capital gains from the sale of debt-financed assets. An example of the excise tax applied to a private foundation that had stocks and bonds that were acquired both before and after December 31, 1969, follows:⁸

It is important to keep accurate accounting records of the cost basis for all investments as well as an accurate segregation of any expenses applicable to investment income. With respect to investments acquired prior to December 31, 1969, it is also important to keep a record of the fair market value as of December 31, 1969.

Foundations are required to pay estimated excise taxes on a quarterly basis.

Tax Consequences of Gifts of Securities

On investments received by gift subsequent to December 31, 1969, the contributor's tax basis is the basis that the foundation must use when calculating taxable gain. For investments received prior to December 31, 1969, the basis is the higher of fair market value at December 31, 1969, or contributor's tax basis. In most instances, the fair market value is higher. Thus, a private foundation must obtain from the donor, at the time a gift of securities is received, a statement of tax basis. This is very important and great care should be taken to obtain this information promptly upon receipt of the gift. At a later date the donor may be difficult to locate or may have lost the necessary tax records. Since donated securities are recorded for accounting purposes at fair market value at date of receipt, the foundation must keep supplementary memo records of the donor's tax basis.

Here is an illustration of how two gifts of the same marketable security can have different tax consequences to the private foundation. Both gifts made in 1980 involve 100 shares of stock A.

Gift 1—Very low basis:

Mr. Jones acquired his 100 shares of stock A in 1933 when the company was founded. His cost was only 10 cents a share, and therefore his basis for these 100 shares was only $10. Market value on the date of gift was $90 a share, or a total of $9,000. The tax basis to Mr. Jones of $10 carries over to the private foundation. If the foundation later sells the stock for $10,000, it will pay a 2% tax on $9,990 ($10,000 sales proceeds less $10 tax basis), or a tax of $199.80.

Gift 2—Very high basis:

Mr. Smith acquired his 100 shares of stock A in 1970 at a cost of $110 a share or a total of $11,000. The market value on the date of his gift was also $90 a share, or a total of $9,000. If the private foundation later sells this stock for $10,000, it will have neither a taxable gain nor loss. In this instance, the donor's basis of $110 a share carries over to the foundation for purposes of calculating taxable gain, but for purposes of calculating loss, the fair market value at date of gift ($90 a share) becomes the tax basis. Since the sales price ($100) is more than the fair market value at the date of gift ($90), but less than the donor's cost ($110), there is no gain or loss recognized.

As can be seen from this example, in one instance the private foundation had to pay a tax of $199.80 and in the other instance had no tax. Rather than sell appreciated stock and pay excise tax on the gain, a foundation might consider distributing the stock to a publicly supported organization and letting the distributee organization sell it. The distributee organization would not incur tax on the gain since capital gains are exempt from unrelated business taxable income and publicly supported organizations are not subject to the excise tax on net investment income. To the extent a private foundation has capital losses, they can be offset against capital gains in the same year. If there are no capital gains to offset such losses, the losses cannot be offset against investment income. Capital losses cannot be carried over to another year.

Distribution of Income

A private foundation is required to make qualifying distributions of at least the distributable amount by the end of the year following the current taxable year. Qualifying distributions are those amounts paid to accomplish the exempt purposes of the foundation. If the foundation fails to distribute the required amount, it may be subject to taxes that ultimately have the effect of taxing 100% of any amount not distributed.

Starting in 1982, the “distributable amount” is defined as the minimum investment return, less the excise tax and, where applicable, less the unrelated business income tax.

The minimum investment return is 5% of the fair market value of all the foundation's assets that are not used in directly carrying out the organization's exempt purpose. Cash equal to 1.5% of the total foundation's assets is deemed to be used in carrying out the exempt purpose and is deducted for this calculation. This means that if a foundation has marketable securities and cash with a market value of $1,000,000, it must make minimum qualifying distributions of 5% of $985,000 ($1,000,000 less 1.5% of $1,000,000) or $49,250, regardless of its actual income. If, for example, actual investment income were only $30,000, the foundation would still have to make qualifying distributions of $49,250.

Note that contributions and gifts received are included in the calculation of the distributable amount only to the extent that they increase the fair market value of the foundation's assets.

This means that the private foundation will not have to make qualifying distributions out of principal, provided its investment income plus contributions and gifts equal the distributable amount. In the preceding example, if contributions to the foundation were $50,000, the distributable amount would still be $49,250. These requirements will have little effect on private foundations that receive continuing contribution support.

Here is an illustration showing how these calculations work. Using the condensed financial statements of the A. C. Williams Foundation, the distributable amount is calculated as follows:⁹

Thus, the distributable amount is $48,250. Qualifying distributions were $70,000, which exceeds the distributable amount by $21,750, and the requirement has thus been met. This excess can be carried over for five years to meet the requirements of a year in which there is a deficiency. Where there is such a carryover, the order of application of the amounts distributed would be current year, carryover from earliest year, carryover from next earliest year, and so forth.

Excess Business Holdings

A private foundation is not allowed to own a stock interest in a corporation if the stock it owns together with the stock owned by disqualified persons¹⁰ would exceed 20% of the voting stock. The provision also applies to holdings in partnerships, joint ventures, and beneficial interests in trusts.

Prohibited Transactions

There are several categories of transactions in which private foundations may not engage. They cannot engage in “self-dealing,” make investments that jeopardize their exempt function, or make expenditures for certain prohibited purposes (so-called taxable expenditures). There is an excise tax both on the foundation and on the foundation manager who engages in these prohibited transactions. For example, the tax on taxable expenditures is initially 10% and 2.5% on the foundation and foundation manager, respectively, but is increased to 100% and 50%, respectively, if corrective action is not taken within a specified period of time.

Annual Information Return

The annual information return (Form 990-PF) filed with the Internal Revenue Service is considerably longer and more complex than Form 990 filed by most other not-for-profit organizations. A discussion of the annual return and an illustration of the completed form are included later in this chapter.

A private foundation must also furnish a copy of the annual return to anyone desiring to see it.

Qualifying Tests

In addition to expending substantially all (85%) of its income directly for the active conduct of its exempt function, a private foundation, to be a private “operating” foundation, must meet one or more of the following tests:

1. It devotes 65% or more of the fair market value of its assets to direct use in its exempt function.
2. Two-thirds of its minimum investment return is devoted to its exempt function and used chiefly by the foundation to accomplish that function.
3. It derives 85% or more of its support, other than investment income, from the general public and from five or more exempt organizations, none of which provides more than 25%. In addition, not more than 50% of its total support is from investment income.

Advantages

There are several advantages to being a private operating foundation. The minimum distribution rules imposed on private foundations do not apply to private operating foundations and donors are allowed to deduct a contribution to a private operating foundation up to 50% of the donors' adjusted gross income versus the 30% of donors' adjusted gross income limitation on contributions to private foundations.

Contribution Disclosures

Contributions other than cash are subject to special reporting by both donors and recipient charities. Contributors must attach Form 8283 to their tax returns to support noncash charitable contributions of $500 or more to the same donee. The form requires an appraisal by a competent, independent appraiser and, in some cases, the recipient organization is required to sign the form also. If the recipient organization is required to sign the form, and disposes of the property within two years of the date of the gift, then the organization must file Form 8282 with the Internal Revenue Service within 125 days of the disposition. The organization must also supply the donor with a copy of Form 8282. By requiring this reporting, the Internal Revenue Service is better able to monitor sizable charitable deductions on individual returns.

Contribution Acknowledgments

For single charitable contributions of property and/or cash of $250 or more, donors will need an acknowledgment from the charity to substantiate a charitable tax deduction. A canceled check is not sufficient in this case. Charities should be prepared to acknowledge gifts to assist their individual and corporate donors with substantiation of these deductions. A recent change in tax law now requires donors to obtain written evidence substantiating all charitable contributions for which a tax deduction is taken. A canceled check is sufficient for gifts under $250.

Solicitation Disclosures

When an organization gives a donor something in return for a contribution, for example, a dinner or a raffle ticket, the amount given may not constitute a charitable contribution. A portion, or all, of the payment may be payment for receipt of a benefit, and not a gift to the organization. Revenue Ruling 67-246 and Revenue Procedure 90-12 provide guidance to organizations that provide a benefit to donors in conjunction with solicitation of funds.

Organizations must inform their donors, in clearly stated language, how much, if any, of the payment is deductible as a charitable contribution if the total received is greater than $75. An example of this is an organization that sponsors a fundraising dinner. A comparable dinner in a restaurant would cost a donor $50. In order to attend the dinner, donors pay $200. In this case, the organization must inform donors that $150 of their $200 payment is deductible as a charitable contribution. Charities should print this information on the donors' tickets or receipts, thereby providing donors with documentation for the charitable deductions they claim on their tax returns.

There are exceptions for low-cost items that are distributed as part of a fundraising effort. Charitable organizations should consult the Revenue Ruling and Revenue Procedure and ensure that their solicitation materials comply. The Internal Revenue Service is empowered to impose penalties in cases of failure to comply with the notification requirements.

Excise Tax Considerations

There are several excise taxes imposed on organizations under certain circumstances. The following provides a short summary of each tax:

• Excess Expenditures to Influence Legislation—Sec. 4911 imposes a 25% excise tax on the excess lobbying expenditures (including grassroots lobbying expenditures) of an organization that has elected to be covered under Sec. 501(h). The election under Sec. 501(h) provides qualifying organizations with a safe harbor for their lobbying and grass- roots expenditures. In any year in which the organization's lobbying expenses exceed the safe harbor amounts, the organization must pay the excise tax under Sec. 4911.
• Tax on Disqualifying Lobbying Expenditures of Certain Organizations—If an organization loses its status under Sec. 501(c)(3) because of making more than an insubstantial amount of lobbying expenditures, Sec. 4912 imposes excise taxes on an organization and its management. The tax on the organization is 5% of the lobbying expenditures in the taxable year in which Sec. 501(c)(3) status is revoked. A separate 5% excise tax is imposed on the management of the organization, if the management agreed to the expenditures while knowing the organization might lose its exemption. This excise tax does not apply to private foundations or organizations that elect the safe harbor of Sec. 501(h). (Note that organizations that lose their Sec. 501(c)(3) status when more than an insubstantial portion of their activities is lobbying may not become exempt under Sec. 501[c][4].)
• Political Expenditures of Sec. 501(c)(3) Organizations—Sec. 501(c)(3) organizations are forbidden from participating or intervening in any political campaign on behalf of or in opposition to any candidate for public office. Sec. 4955 imposes a two-level excise tax on the organization and its management that participate in prohibited activities. The first level of tax is imposed on the organization at the rate of 10% of the amount of the expenditures, and on the management at the rate of 2.5% of the expenditures if the management agreed willfully to the expenditures. If the organization does not correct the political expenditure by obtaining a refund of the amounts spent, a second level tax of 100% and 50% of the expenditure is imposed on the organization and management, respectively. (Note that if a private foundation makes political expenditures and pays the tax imposed by this section, then the expenditures will not also be taxed under Sec. 4945 as taxable expenditures.)

Summary of Individual Tax Deductions

Charitable organizations depend, to a very large extent, on individual contributions for support. To the extent that a contributor receives a tax deduction for a contribution, there is more inclination to be generous in the contribution. Accordingly, the tax deductibility of a contribution is of real importance. Exhibit 1 summarizes the general rules applicable to common types of contributions.

As Exhibit 1 indicates, the amount of deduction allowed in any year is limited to a percentage of the donor's adjusted gross income. Contributions limited in this manner may be carried forward for five years until fully used. The adjusted gross income limitation depends on the type of donee organization, the type of property donated, and whether the organization will use the property in pursuit of its exempt purpose (related) or will use the property in a way unrelated to its exempt purpose (such as selling the property).

Gifts of appreciated property may have additional tax implications to the donor. Because the charitable contribution rules are somewhat complex, donors should consult with their tax advisors before making a large contribution to any organization. Exhibit 1 is intended to be a general guide only.

Key  AGI—adjusted gross income

1. FMV—fair market value

2. Public—50% type charities including private operating foundations

   Private—30% type charities including private nonoperating foundations

^a Taxpayer may elect to decrease the amount of deduction to fair market value less long-term gain potential and to increase the AGI limitation to 50%.

^b In the case of a contribution of qualified appreciated stock to a private nonoperating foundation, the full FMV is deductible.

Social and Recreation Clubs

Another type of organization that is granted exemption from tax is the club “organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.” Social and recreation clubs are exempt as long as substantially all their activities are for members. Income derived from nonmember activities, such as investment income and nonmember use of the club, can have significant implications for the social club.

Trade Associations

Another example of an exempt noncharitable organization is a trade association exempt under Sec. 501(c)(6). Trade associations are membership organizations that function for the common business purpose of their members. The activities of a trade association must be directed toward the improvement of business conditions as opposed to performing particular services for individual persons or members.

Contributions or dues paid to a trade association are not deductible as charitable contributions. Most members, however, are entitled to deduct dues and other fees paid as a business deduction.

Title-Holding Companies

Sec. 501(c)(2) provides an exemption for corporations that hold title to property, collect the income therefrom, and remit the net income to another exempt organization annually. These organizations most frequently hold title to real property but may also hold investment portfolios. The organizations are allowed exempt status because of their relationship to the parent exempt organization. Possible abuse situations are avoided by requiring the Sec. 501(c)(2) organization to remit net income from the property to the exempt parent and forbidding a Sec. 501(c)(2) organization from participating in any activity except holding title.

Definition

There is always difficulty in knowing exactly what is unrelated business income. Here is the way the law reads:

The term “unrelated trade or business” means … any trade or business the conduct of which is not substantially related … to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption … [Sec. 513(a) of the Internal Revenue Code] … the term “unrelated business income” means the gross income derived by any organization from any unrelated trade or business … regularly carried on by it, less the deductions … which are directly connected … [Sec. 512(a)(1) of the Internal Revenue Code].

There are three key phrases in these definitions. The first is “unrelated,” the second is “trade or business,” and the third is “regularly carried on.” All three criteria must be present for an activity to be categorized as an unrelated trade or business activity. It is not difficult to determine whether the business in question is “regularly carried on,” but it is difficult to know what is truly unrelated, and it is sometimes difficult to ascertain what is a trade or business. The burden is on the exempt organization to justify exclusion of any income from this tax.

According to Regulation Sec. 1.513-1(d), unrelated business income results within the meaning of Sec. 513(a) if the conduct of the trade or business that produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted. The presence of this requirement requires organizations to distinguish between the business activities that generate the particular income in question (the activities, that is, of producing or distributing the goods or performing the services involved) and the accomplishment of the organization's exempt purposes. In determining whether activities contribute importantly to the accomplishment of an exempt purpose, the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt function, which they purport to serve.

The terms “trade” or “business” have the same meaning as in §162, and generally include any activity carried on for the production of income from the sale of goods or performance of services. In general, any activity of an otherwise exempt organization carried on in a commercial fashion that is similar to a trade or business and which, in addition, is not substantially related to the performance of the organization's exempt function is sufficiently close to the concept of a trade or business to be taxable.

The term does not include any trade or business:

1. In which substantially all the work is performed for the organization without compensation;
2. Which is carried on by the organization primarily for the convenience of its members, students, patients, etc.;
3. Which is the selling of merchandise, substantially all of which has been donated as gifts or contributions to the organization.

According to the regulations under §1.513-1(b), the primary objective of adopting the unrelated business income tax rules was to eliminate a source of unfair competition by placing an unrelated business activity on the same basis with its for-profit counterparts. On the other hand, where an activity does not possess the characteristics of a trade or business within the meaning of §162, such as when an organization sends out low-cost articles incidental to the solicitation of charitable contributions, the unrelated business income tax does not apply because the organization is not in competition with taxable organizations.

According to Regulation §1.513-1(c), the regularly carried-on requirement must be applied in light of the purpose of the unrelated business income tax to place exempt organization business activities upon the same tax basis as the nonexempt business endeavors with which they compete. Hence, for example, specific business activities of an exempt organization will ordinarily be deemed to be regularly carried on if they manifest a frequency and continuity, and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations. Keep in mind that this requirement has to be applied in light of the purpose of the unrelated business income tax to place a trade or business on the same tax basis as the business endeavors with which it competes.

Many not-for-profit organizations have begun to invest in alternative investments, which is a term generally meant to include hedge funds, private equity funds, etc. For tax purposes, the not-for-profit organization may receive Form K-1s from these investments, on which their share of income is reported. As the K-1s often report types of income that would be subject to the unrelated business income tax, for example, ordinary income, the tax consequences (as well as foreign tax and foreign bank account reporting requirements) must be carefully evaluated and monitored. In some cases, a “blocker corporation” may hold these investments for the not-for-profit organization and effectively convert ordinary taxable income into investment income, which would be exempt. The point is that the tax aspects of these types of investments may be substantial and should be evaluated from a financial statement perspective to ensure any required tax provision is recorded.

Tax Rates on Unrelated Business Income

Unrelated business income is taxed at the same rates as net income for corporations. All exempt organizations having gross income from unrelated business activities of $1,000 or more are required to file Form 990-T within four and a half months of the end of the fiscal year (May 15 for calendar-year organizations). Extensions can be obtained if applied for before the due date of the return. Organizations are required to pay estimated taxes on a quarterly basis.

Need for Competent Tax Advice

From the above discussion, it should be obvious that taxes on unrelated business income may be substantial and can apply to most organizations. It must be emphasized that every organization contemplating an income-producing activity should consult with a competent tax advisor to determine the potential tax implications of that activity.

Uncertainty in Income Tax Provisions

GAAP has certain accounting and disclosure requirements related to uncertain tax positions, which can be found in the FASB ASC at 740-1. While primarily aimed at for-profit organizations that prepare tax accruals within their financial statements, these requirements are applicable to not-for-profit organizations, including those reporting tax provisions on unrelated business income.

The underlying concept of these requirements is that some tax positions taken by an organization may ultimately not prove acceptable to the taxing authority, resulting in a liability to that authority. FASB ASC 740-01 provides guidance in determining whether a risk threshold has been exceeded, and if it has, how to measure the resulting liability from the uncertainty.

A tax position is defined as “a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim and annual periods.” This definition includes, but is not limited to, the following:

• A decision not to file a tax return;
• An allocation or shift of income between two jurisdictions;
• The characterization of income or a decision to exclude reporting taxable income in a tax return;
• A decision to classify a transaction, entity, or other position in a tax return as tax exempt.

Note that exempt status itself is considered a tax position, and even though an organization may have a letter from the IRS attesting to that status, this letter was issued sometime in the past, and organizations must be able to show that they have not done anything since then to jeopardize that exempt status.

An organization should recognize the financial statement effects of a tax position when it is more likely than not, based on its technical merits, that the position will be sustained upon examination. More likely than not means a likelihood of more than 50%, considering the facts, circumstances, and information available at the reporting date.

Once a tax position meets the more likely than not recognition threshold, it is initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information.

Not-for-profit organizations should consider the effects of applying the guidance of FASB ASC 740-01 to events or circumstances that could endanger their tax-exempt status and the potential impact on their financial statements, as well as considering its effect on tax provisions on unrelated business income and, for private foundations, the excise tax on net investment income. Chapter 23 describes specific considerations that not-for-profit organizations should make in evaluating their tax positions.

Initial Registration

All charitable (Sec. 501[c][3]) organizations, except churches and certain charitable organizations having annual gross receipts of less than $5,000, must comply with Internal Revenue Service notification requirements before they may be considered exempt from income tax. Charitable organizations comply with these notification requirements by submitting Form 1023 to the Internal Revenue Service District Director within fifteen months of the start of their operations. If the application is approved, the Internal Revenue Service will send the organization a determination letter that recognizes the organization's exempt status and publicly supported (or private foundation) status under one of the law's provisions.

Organizations must file the application within fifteen months of the start of business in order to have exempt status apply to the organization's entire period of existence. Organizations that apply after the fifteen-month period expires will have exempt status recognized only from the date of the application.

Organizations that anticipate they will meet one of the public support tests are given an advance determination letter. This letter allows the organization up to sixty months to meet the public support test without being classified as a private foundation. If, at the end of the sixty months, or advance determination period, the organization fails to meet the support test, it will be characterized as a private foundation retroactive to the date operations began.

Exempt organizations other than Sec. 501(c)(3) charities may apply for recognition of exempt status by submitting Form 1024. Some noncharitable organizations are required to apply for recognition of exempt status (e.g., Voluntary Employee Benefit Associations) (Sec. 501[c][9]).

Annual Information Returns

Almost all exempt organizations are required to file annual information returns. The principal exceptions to this reporting requirement are churches and their integrated auxiliaries, and certain organizations normally having gross receipts of $50,000 or less. Most organizations must file Form 990, Return of Organization Exempt from Tax. For 2011, organizations with gross receipts of less than $200,000 for the taxable year and total assets at year-end of less than $500,000 may file Form 990-EZ. For Forms 990 and 990-EZ, a separate schedule (Schedule B) must be filed to provide information about contributors. Schedule B is generally not subject to public inspection. A sample of Schedule B is included in Exhibit 4. All private foundations must file Form 990-PF without exception.

These information returns must be filed by the fifteenth day of the fifth month after the end of the fiscal year (May 15 for calendar-year organizations). There is a penalty for failure to file the return on time. Extensions of time for filing can usually be obtained if there is good reason why the return cannot be filed on a timely basis, but application for extension must be made before the filing deadline. These returns do not require certification by an outside auditor.

In addition, all exempt organizations having gross unrelated business income of $1,000 or more must file a separate tax return and pay taxes at regular corporate rates on all taxable income over $1,000.

Return Inspection

All organizations exempt from tax under Sec. 501(a) or (d) must make their Form 990 (or 990-PF), and Form 990-T, if applicable, available for public inspection. Except for the list of contributors that are reported on the return on Schedule B, the return and all statements filed therewith must be made available for inspection upon request. Generally, a copy of the return must also be provided upon request. The Internal Revenue Service makes the annual return, except for lists of contributors, available to the general public. The Internal Revenue Service also makes an organization's Application for Recognition of Exempt Status (Form 1023 or 1024) available for public inspection. The regulations under Sec. 6104 provide procedures for requesting these forms from the Internal Revenue Service.

Form 990: Return of Organization Exempt from Income Tax

Form 990-EZ: Short Form

The concepts inherent in completing Form 990-EZ are the same as for Form 990, except that the reporting is simplified. Schedules A and B must also be completed by organizations using Form 990-EZ. See Exhibit 5 for Form 990-EZ.

Form 990-N: e-Postcard

Form 990-N is used by smaller not-for-profit organizations (those with gross receipts normally $50,000 or less) to electronically provide the IRS with some very basic information about the not-for-profit organization each year.

Form 990-PF: Return of Private Foundation

All private foundations must file Form 990-PF by the fifteenth day of the fifth month after the end of the fiscal year (May 15th for calendar-year private foundations) and there is a penalty for failure to file, unless it can be shown that there was a reasonable cause for not doing so.

This return consists of twelve pages and to the uninitiated appears to be a difficult form to complete. Most private foundations would be well advised to have a competent professional prepare this form for them.

Form 990-T: Exempt Organization Business Income Tax Return

Form 990-T must be filed if an exempt organization has unrelated business income and the gross (not net) income was $1,000 or more. All exempt organizations are subject to this tax whether or not a Form 990 is required to be filed. Form 990-T is due the fifteenth day of the fifth month after the end of the fiscal year (May 15th for calendar-year organizations).

The complete Form 990-T is four pages long, and is complicated. Similar to Form 990-PF, competent tax assistance should usually be obtained when this form is required to be completed.

Registration for Organizations Soliciting Funds

A number of states have laws requiring not-for-profit organizations to register with a regulatory agency (or obtain operating licenses or permits) prior to soliciting any funds within the state. Most states make no distinction between resident and nonresident organizations and, in most instances, an organization soliciting funds by mail or through advertisements would have to register, even though it has no office or employees in that state.

This registration often requires yearly renewals, as well as a requirement that an annual financial report be filed. Since 1982, most states accept a copy of IRS Form 990 as the basic financial statement. The financial statements included in this report must sometimes include an opinion of an independent public accountant and, in some instances, the state will even specify the accounting principles to be followed. Where an organization must provide this type of information, particularly where the organization is not a resident in that state, considerable planning is required. These annual reports are usually due between three and six months after the end of the organization's fiscal year.

Most states exempt certain classifications of not-for-profit organizations from their registration and reporting requirements. These exemptions are usually limited to one or more of the following organizations:

Organizations in Categories 2 and 3 usually are required to file a copy of the fiscal report filed with other state agencies such as the Department of Education or Health.

There are other types of exemptions as well, and their applicability depends upon a number of factors, including dollar limitations on contributions and/or total income, use of professional fundraisers, etc. Most states require that organizations register if they use professional fundraisers, no matter how small the contributions received.

Registration for Organizations Having Assets within the State

In addition to the registration of organizations soliciting funds, some states also have laws requiring all not-for-profit organizations or charitable trusts to register with a state agency if they have assets or are residents within the state, even if they do not solicit funds. Each organization must be careful to comply with these requirements. Sometimes a different agency of the state is involved, and the reporting requirements may be different from the requirements under the solicitation law.

As with the requirements for organizations soliciting funds, an organization may be required both to register initially and to file an annual report. The principal interest of the state is the proper administration and disposition of assets held by the organization.

Moreover, the Internal Revenue Code and regulations provide that every private foundation is required to submit a copy of its Form 990-PF to the attorney general of each state in which it conducts activities. The intent of this requirement is to encourage state officials to oversee the activities of this type of exempt organization.