Trends and the future of tax oversight

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So You Think You're Tax Exempt:Trends and the future of tax oversight

Original Broadcast Date: September 2013

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Today'sPresenters

Daniel RomanoPartner-in-chargeNot-for-Profit and Higher Education Tax PracticeNew York, NY

Frank GiardiniPrincipalNot-for-Profit and Higher Education Tax PracticePhiladelphia, PA

Joe DeTranePartnerNot-for-Profit and Higher Education Tax PracticeSan Francisco, CA


• Explain trends in the industry in response to oversight and regulation

• State predictions for the future in regard to tax and regulatory oversight

• Identify best practices that exist in the not-for-profit industry as it relates to tax matters

So You Think You're Tax Exempt: Trends and the future of tax oversight

Learning objectives



Agenda

• Compensation• Unrelated business income• Tax-exempt bonds• International activity• Hospital issues• Governance and transparency• Worker classification• Related organizations and controlled

entity issues• Group exemptions• Charitable donations, fundraising

and gaming


What is the 990 all about, anyway?



Agenda



and gaming

6


What is reasonable compensation?

“Amount that would ordinarily be paid for

like services

by

like enterprises

(whether taxable or tax-exempt)

under

like circumstances”

7


What are intermediate sanctions?

• Personal excise tax on unreasonable compensation– Section 501(c)(3) and 501(c)(4) organizations

• Disqualified persons– 25% of excess benefit– 200% if excess benefit not returned to organization

• Organization managers– 10% of excess benefit– $20,000 maximum for each excess benefit transaction

8


Rebuttable presumption that compensation is reasonable

• Don't pay compensation until approved by authorized body of the organization composed entirely of individuals with no conflict of interest

• Rely on external third-party comparable market data• Prepare records concurrently to document the authorized

body's decisions– Authorized body must review and approve the records

9


Opinion letter

• Written by an appropriate professional– Accounting firm, legal counsel, compensation consultant

• Must be a "reasoned" opinion• Protects organization manager from intermediate sanctions,

even if IRS disagrees with opinion

10


Caution: Automatic excess benefits

• Benefit that is not documented as payment for services– Causes the benefit to be automatically treated as an excess

benefit subject to intermediate sanctions taxes• Use any of the following to satisfy the documentation requirement:

– Report the benefit as compensation on Form W-2 (employees) or Form 1099-MISC (nonemployees)

– The disqualified person reports the benefit as income on his or her income tax return

– Benefit is provided for in a written employment contract executed and approved before the benefit is provided

– Documentation is prepared indicating that authorized body approved the benefit before it was paid

11


Form 990 considerations

• Part IV, line 25a– Specifically asks whether organization engaged in an

“excess benefit transaction” (i.e., paid unreasonable compensation) with respect to a disqualified person during the year

• Part VI, line 15– Asks questions to indicate whether organization

established a rebuttable presumption with respect to the compensation of its “CEO, executive director or top management official” and its “other officers or key employees”

12


IRS college and university compliance projectRebuttable presumption findings in examinations

• Compensation of 94% of officers, directors, trustees, key employees set using procedure intended to satisfy rebuttable presumption

• Compensation for most positions set in the range of the 75th percentile

• 20% of institutions included institutions in comparability data set that were not similarly situated

13


Comparability factors taken into account by IRS in examinations

• Type of institution– Private or public– Liberal arts, research university, etc.

• Size of undergraduate enrollment• Faculty size• Location

– Urban, rural, suburban– Region of the U.S.

• Endowment size• Tuition and cost to attend• Selectivity

– SAT ranges, etc.• Age of institution

– Year founded

14


Compensation survey problems found in examinations

• No documentation as to selection criteria for schools in the survey

• No explanation as to why schools were deemed comparable• Survey not limited to schools that were sufficiently similar

– No adjustment to survey results to remove schools not sufficiently comparable

• No specification in survey as to whether amounts were salary only or total compensation

15


Schedule J, Part 1, Question 1a

• First-class or charter travel • Travel for companions• Tax indemnification and gross-up payments• Discretionary spending account• Housing allowance or residence for personal use• Payments for business use of personal residence• Health or social club dues or initiation fees• Personal services (e.g., maid, chauffeur, chef)

16


Schedule J compensation questions

• Did the organization provide incentive compensation:– based on the revenues or net earnings of the

organization and any related organization?• Did the organization provide any other type of nonfixed

compensation?

17



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Background and basics of UBI

UBI is income from a trade or business that is regularly carried on and is not substantially related to the organization’s exempt purpose.

3-pronged test:

• A trade or business

• Regularly carried on

• Not substantially related

19


Exclusions from unrelated trade or business under Sec. 513

• Activities in which substantially all work is performed by volunteers

• Activities operated for the convenience of members, students, patients or employees

• Sales of merchandise that is substantially all donated to the organization

20


Exclusions from unrelated trade or business under Sec. 513

Statutory exclusions from unrelated trade or business under Sec. 513:

• Qualified public entertainment

• Shared services provided to small tax-exempt hospitals

– 100 beds or less

• Bingo games (watch out for state laws!)

• Rentals of membership lists

• Distribution of low-cost articles

21


Excluded from taxable income under Sec. 512

• Dividends

• Payments for securities loans

• Interest

• Annuities

• Royalties

• Rental income from real property

• Capital gains

22


Exceptions to exclusions

• Dividends exempt, but:

- at corporate level, payor taxed on income and on built-in gain on distributed property;

- potential add back for debt-financed property.

• Interest exempt, but:

- potential add back for controlled affiliates and

- debt-financed property.

• Rents from real property exempt, but:

- incidental and percentage rents for personal

- property,


- debt-financed property.

• Royalties exempt, but:


- debt-financed property,

• separating fee for services from royalty for use of IP.

23



Rental of real estate is generally not taxable

The following may be taxable:

• Rental based on income or profits of lessee is taxable

• Services other than customary rental may taint rental

• Portion for personal property rental is generally taxable

• Parking rental is generally taxable

• Hotel income is generally taxable

• Rental income from controlled organizations is taxable

• Debt-financed rental is generally taxable

24



Rental of personal property is generally taxable

• Ignored as incidental if value is 10% or less

• Separated, if between 10% and 49%

• If 50% or more — then it's all taxable

Services provided with the rental

• Other than customary landlord/tenant maintenance

• For benefit of the tenant

• May render entire rental as taxable

25



Common facility rentals:

• Sports facilities

• Halls

• Auditoriums

• Banquet facilities

• Conference space

26



• Income from controlled subsidiary:

– Rents

– Interest

– Annuities

– Royalties

• Are the transactions at fair market value?

These rules are complex!

27



• Control = more than 50%• Interest, royalties, rents added back• Except to extent affiliate’s use = substantially

related if carried on by controlling organization

• FMV exception for certain payments – Binding contract 08-17-06– Received after 2005 and before 2012

> 50%

28



Debt-financed investment income rules

• Investment income on margin

• Real estate rental with acquisition debt

– calculated on monthly average acquisition debt

– unless used ≥ 85% in exempt purpose

– exception for educational institutions and pension plans

• Sale of debt-financed property

– calculated on highest amount of debt during past year

29



• Does it make a difference if assets are bought with cash or debt?

- It just might

- e.g., if buy stock with “acquisition indebtedness,” the “leveraged” portion of dividends or gain on sale potentially subject to UBIT

• Substantially related use and UBTI

– 85% related = 100% excluded from UBIT

– Less than 85% = proportional exclusion from UBTI

• UBIT “taint” not permanent

- Decreases as leverage decreases

- Disappears after leverage gone

30


Potential UBI-generating activities

• Advertising

• Corporate sponsorships

• Trade shows

• Contract research

• Management or other services

• Sales of merchandise and publications

• Royalty/affinity income

• Mailing lists

• Investments in joint ventures

31


Advertising

• Any language which is an inducement to purchase a product or service

• Qualitative or comparative language

• Price information

• Indication of savings

• Endorsements

• Call to action

32


Examples of activities that may generate advertising income

• Sports programs

• Scoreboards

• Sponsorship of a departmental newsletter

• Periodical advertising

• Website advertising

• TV and radio broadcasting rights

33


Corporate sponsorship

Treatment of corporate sponsorship income

• If deemed to be a qualified sponsorship payment, the contributions are not considered UBI.

• A qualified sponsorship payment is one in which the sponsor does not receive any arrangement or expectation of a substantial benefit.

• An organization can acknowledge the sponsor's payment as long as it is not considered "advertising" income, which would be considered UBI.

34


Royal/affinity income

Will agreements pass the Sec. 512(b)(2) test? • Are they licensing rights to intangible property?• Are payments based on gross revenue?• Are they providing any taxable services?• Are payments for services priced separately? • Are payments allocated between royalty and service?

Be careful; it’s also taxable as UBI if received from a controlled organization under Section 512(b)(13)

35


Investment income:K-1s from partnerships, S corporations and LLCs

Included in UBTI:• Partnership, S corporation, LLC income

- Look for footnote or Code V• Passive income generated through use of borrowed funds

(specifically debt-financed)• Understand what is generating the partnership or S corporation

income to determine if it is UBI • Alternative investments — a new source of UBIT• Misconception: You do not need to be a general partner

or controlling member for UBI to be generated.

36


Investment income:K-1s from partnerships, S corporations and LLCs

Other considerations• State tax filings

• Some states have no UBI threshold for filing• International filings

• $10,000 penalties for not filing• Forms to look for — 926, 8858 and Reportable

Transaction Filings 8886

37


Contract research may constitute unrelated business income

Related to exempt purposes — How to tell• Is the project scientific? — Must be yes• Is the project research? — Must be yes• Is the project in the public interest? — Must be yes

Excluded from unrelated business income• Conducted for federal or state governments — Sec. 512(b)(7)• Conducted for colleges and hospitals — Sec. 512(b)(8)• Fundamental research available to the public — Sec. 512(b)(9)

The regulations are complex and require a contract-by-contract analysis

39


Unrelated business income

• Application of hobby loss rules• “Profit motive” being questioned• Expense allocations being questioned• Is revenue properly captured?• New 990 question about “new” activities• Consider reviewing activities and reassessing now

40



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and gaming41


Tax-exempt bonds

42


Tax-exempt bonds

43



Agenda



and gaming44


Globalization of the not-for-profit industry

• Current landscape– Transformation over the past decade– IRS focus

• End of FY 2012 exam results• End of FY 2013 workplan

• Organizational strategy– Global footprint– Additional considerations– Grant-making — Best practices

• Reporting requirements– U.S. reporting requirements related to foreign activities – Foreign reporting requirements related to foreign activities

45


Organizational strategy

• Global footprint– Investment strategy– Offshore presence

• Legal formation — Incorporation needed?• Nonprofit status

• Additional considerations– Advising employees on tax treaty benefits, tax withholding and

reporting requirements, and personal benefit restrictions– Monitoring and reporting of offshore activities– Reporting of alternative investments– Repatriation– Transfer pricing– Fundraising

46


Organizational strategy

• Grant-making — Best practices

– Upfront due diligence

• Qualifying nongovernmental organization or purposes

• Ability of grantee to handle grant

• Vetting of grantee

– Site visits

– Adoption of expenditure responsibility procedures

– Granting in tranches

47


Reporting requirements

• Assessment of activities– Who is conducting the activities?– Where are the activities conducted?– What type of activities are conducted?– What are the characteristics of the activities?

• U.S. reporting related to foreign activity• Foreign reporting related to foreign activity

48


Reporting requirements

49


U.S. reporting related to foreign activity

• Form 926 — Who must file– Generally required for transfers of property to foreign corporations if

organization holds (directly or indirectly) at least 10% of the voting power or total value of the foreign corporation or if cash transferred during 12-month period (ending on the date of the transfer) exceeds $100,000.

– If the transferor is a partnership (domestic or foreign), each domestic partner is treated as a transferor of its proportionate share of the property and required to file Form 926, if required.

• Form 926 — Failure to file– If a transfer of property to a foreign corporation is not properly reported on

Form 926, the U.S. transferor is subject to a penalty equal to 10% of the fair market value of the transferred property at the time of the exchange, but not to exceed $100,000 unless the failure with respect to such transfer was due to intentional disregard.

50



• Form 5471 — Who must file– Generally, Form 5471 is required when:

• U.S. person is an officer or director of a foreign corporation in which a U.S. person has acquired a 10% stock ownership,

• U.S. person acquires or disposes of a 10% stock ownership in a foreign corporation,

• U.S. person had control (greater than 50% vote or value of all classes of stock) of a foreign corporation for an uninterrupted period of at least 30 days, or

• U.S. person owns stock in a foreign corporation that is classified as a controlled foreign corporation.

• The penalties for failure to file Form 5471, or failure to file it correctly, depend upon the category of filer, and can include monetary penalties ($10,000 penalty is imposed for each annual accounting period of each foreign corporation), extension of the statute of limitations and loss of foreign tax credits.

51

Dickinson, Charles

added ornot and, right?



• Form 8621 — Overview and who must file– A U.S. person who owns a direct or indirect interest in a Passive Foreign

Investment Corporation (PFIC) is generally required to file Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, for each tax year in which that U.S. person:

• recognizes gain from a direct or indirect disposition of PFIC stock,• receives direct or indirect distributions from the PFIC, or• makes one of the elections on the form.

– If a shareholder of a PFIC is a tax-exempt organization, the rules of Section 1291 will apply only if a dividend from the PFIC would be taxable to the shareholder under Subchapter F.

– Form 8621 is attached to the U.S. person's return.

52



• Form 8865 — Who must file

– A U.S. person qualifying under one or more of the Categories of Filers (see instructions) must complete and file Form 8865.

– Generally, Categories of Filers include a U.S. person who:

• controlled the foreign partnership at any time during the partnership's tax year; or

• owned a 10% or greater interest in the partnership, at any time during the tax year of the foreign partnership, while the partnership was controlled by U.S. persons each owning at least 10% interests.

• Contributed property during that person's tax year to a foreign partnership in exchange for an interest in the partnership (a Section 721 transfer), if that person either:

– owned directly or constructively at least a 10% interest in the foreign partnership immediately after the contribution; or

– the value of the property contributed (when added to the value of any other property contributed to the partnership by such person, or any related person, during the 12-month period ending on the date of transfer) exceeds $100,000.

53



• Form 8865 — Who must file (continued)

• Had a reportable event under Section 6046A during that person's tax year.

– There are three categories of reportable events under Section 6046A: acquisitions, dispositions and changes in proportional interests.

• Form 8865 — Failure to file

– There are three potential sanctions for failure to comply:

• a monetary penalty (dependent on the Category of Filer, but may include a $10,000 penalty imposed for each tax year of each foreign partnership for failure to furnish the required information and/or 10% of the fair market value of the property at the time of the contribution);

• a loss of foreign tax credits; and

• an extension of the statute of limitations.

54



• Form TD F 90-22.1 — Who must file

– Under nontax law (the Bank Secrecy Act), U.S. persons holding a financial interest in, or signature or other authority over, foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.

55


Foreign reporting related to foreign activity

• Ongoing/regularly occurring– Preparation and filing of monthly financial statements– Maintaining books and records in local currency in accordance

with local accounting principles– Preparation, filing and coordinating payment of relevant statutory

taxes– Preparation, filing and coordinating payment of Value Added

Tax/Goods and Services Tax (commonly known as VAT/GST) returns

– Employee payroll filings for local nationals and foreign employees (expatriates and third-country nationals)

– Computation of statutory employees' and employer's social insurance contributions

56


Foreign reporting related to foreign activity

• Annual– Completion of a statutory financial statement audit.– Completion and filing of annual corporate tax returns,

payroll forms, and coordination of required payments; and renewal of business registration and licenses with government authorities.

• Bilateral income tax treaties

57



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IRC section 501(r)Overview

Section 501(r) imposes additional requirements for charitable hospital organizations to retain tax-exempt status:

• Community health needs assessment (CHNA)

• Financial assistance policy

• Limitation on charges

• Billing and collection requirements

59


Community health needs assessmentOverview

IRC Section 501(r)(3) Community health needs assessments

501(r)(3)(A) In general, an organization meets the requirements of this paragraph with respect to any taxable year only if the organization:

• 501(r)(3)(A)(i) has conducted a community health needs assessment which meets the requirements of subparagraph (B) in such taxable year or in either of the two taxable years immediately preceding such taxable year, and

• 501(r)(3)(A)(ii) has adopted an implementation strategy to meet the community health needs identified through such assessment.

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IRC Section 501(r)(3) Community health needs assessment, continued

501(r)(3)(B) Community health needs assessment — A community health needs assessment meets the requirements of this paragraph if such community health needs assessment:

• 501(r)(3)(B)(i) takes into account input from persons who represent the broad interests of the community served by the hospital facility, including those with special knowledge of or expertise in public health, and

• 501(r)(3)(B)(ii) is made widely available to the public.

61



• Proposed regulations issued on April 5, 2013, and apply to taxable years beginning on or after the date the regulations are published as final.

• In general, the proposed regulations are consistent with the anticipated rules described in Notice 2011-52, with certain modifications intended to be responsive to the more than 80 comments received on Notice 2011-52.

• IRS Notice 2011-52 provides guidance which can be relied on for CHNA conducted and implementation strategies adopted up to six months after April 5, 2013.

62


Community health needs assessmentProposed treasury regulations - general

•A hospital organization is required to conduct a CHNA once every three taxable years.

•A CHNA is conducted in the taxable year that the written report is adopted for the hospital facility by an authorized body and its findings are made widely available to the public.

•A hospital organization can conduct a CHNA in collaboration with other organizations, including other related organizations, other hospital organizations, for-profit and governmental hospitals, and state and local agencies.

•CHNA requirements are effective for tax years beginning after March 23, 2012.

63


Community health needs assessmentProposed treasury regulations – written report

Hospital organizations will be required to document, in a written report, the following in a CHNA for each hospital facility:

• Community served and how it was determined

• Process, methods and sources of data utilized

• How and when input from persons who represent the broad interests of the community served was taken into account and the input provided by such persons

• Prioritized description of significant community health needs identified, including process and criteria used to prioritize, and

• Existing health care facilities and other resources within the community available to meet the needs identified in the CHNA.

64


Community health needs assessmentProposed treasury regulations – community served

Community served by a hospital facility:

• Defined by geographic location

• May also take into account target populations serviced (i.e., children, women, elderly, etc.)

• Hospital facility's focus on a particular specialty area, targeted disease or other principal function

65


Community health needs assessmentProposed treasury regulations – broad interests

Persons who represent the broad interests of the community served by the hospital facility include:

• state, local, tribal, or regional governmental public health department (or equivalent department or agency) with knowledge, information, or expertise relevant to the health needs of the community;

• members of medically underserved, low-income, and minority populations in the community, or individuals or organizations serving or representing the interests of such populations;

• written comments received on the hospital facility's most recently conducted CHNA and most recently adopted implementation strategy.

66


Community health needs assessmentProposed treasury regulations – prioritization

A hospital facility may determine whether a health need is significant based upon all the facts and circumstances present in the community it serves.

Examples of prioritization criteria:

• Burden, scope, severity or urgency of the health need

• The estimated feasibility and effectiveness of possible interventions

• The health disparities associated with the need

• And/or the importance the community places on addressing the need

67


Community health needs assessmentProposed treasury regulations – joint CHNA reports

A hospital facility may collaborate with other hospital facilities in conducting its CHNA if:

• an authorized body of the hospital facility adopts a joint CHNA report produced for all of the collaborating hospital facilities,

• all of the collaborating hospital facilities define their community to be the same and conduct a joint CHNA process, and

• the joint CHNA report is clearly identified as applying to the hospital facility.

68


Community health needs assessmentProposed treasury regulations – widely available

A hospital facility's CHNA report will be considered to be widely available to the public if:

• a complete version of the CHNA report is posted and can be easily found on a website;

• CHNA report must remain on the website until at least two subsequent CHNA reports have been posted;

• an individual is not required to create an account or otherwise be required to provide personally identifiable information in order to access the CHNA report on a website; and

• a paper copy of the CHNA report must be available for public inspection without charge at the hospital facility at least until the date the hospital facility has made available for public inspection, without charge, a paper copy of its two subsequent CHNAs.

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Community health needs assessmentProposed treasury regulations – implementation strategy

Address significant health needs identified through a CHNA for a particular hospital facility:

• Describe how the hospital facility plans to meet the health need; or

• Identify the health need as one the hospital facility does not intend to meet and why.

Must be adopted by the governing body, or authorized committee, by the end of the same taxable year in which the CHNA is conducted.

Attached to and filed with Form 990

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Excise tax

IRC Section 4959 imposes a $50,000 excise tax on a hospital organization that fails to meet the CHNA requirements for any taxable year.

Temporary and proposed regulations issued on August 14, 2013, provide the following guidance:

• File Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code, by the 15th day of the fifth month after the end of the taxable year when the organization’s excise tax liability under Affordable Care Act Section 4959 was incurred.

• The tax must be paid when the form is filed.

• Relief can be granted if failing CHNA requirements was unintentional.

• Hospital could face other penalties for failing to meet CHNA requirements.

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Financial assistance policyOverview

IRC Section 501(r)(4) Financial assistance policy — An organization meets the requirements of this paragraph if the organization establishes the following policies:

501(r)(4)(A) Financial assistance policy. A written financial assistance policy which includes:

• 501(r)(4)(A)(i) eligibility criteria for financial assistance, and whether such assistance includes free or discounted care;

• 501(r)(4)(A)(ii) the basis for calculating amounts charged to patients;

• 501(r)(4)(A)(iii) the method for applying for financial assistance.

72


Financial assistance policyOverview

501(r)(4)(B) Policy relating to emergency medical care — A written policy requiring the organization to provide, without discrimination, care for emergency medical conditions (within the meaning of Section 1867 of the Social Security Act (42 U.S.C. 1395dd)) to individuals regardless of their eligibility under the financial assistance policy described in subparagraph (A).

Proposed regulations issued June 26, 2012, apply to taxable years beginning on or after the date the regulations are published as final.

Financial assistance policy is sometimes referred to as a charity care policy.

73


Limitation on chargesOverview

501(r)(5) Limitation on charges — An organization meets the requirements of this paragraph if the organization:

• 501(r)(5)(A) limits amounts charged for emergency or other medically necessary care provided to individuals eligible for assistance under the financial assistance policy described in paragraph (4)(A) to not more than the amounts generally billed to individuals who have insurance covering such care, and

• 501(r)(5)(B) prohibits the use of gross charges.

Proposed regulations issued June 26, 2012, apply to taxable years beginning on or after the date the regulations are published as final.

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Additional requirementsForm 990

IRC Section 6033(b)(15)(A) requires a hospital organization to report on its Form 990 a description of how the organization is addressing the needs identified in each CHNA and a description of any needs that are not being addressed together with the reasons why the needs are not being addressed.

IRC Section 6033(b)(15)(B) requires a hospital organization to file with its Form 990 a copy of its audited financial statements (or, in the case of an organization the financial statements of which are included in consolidated financial statements with other organizations, its consolidated financial statements).

75


Tax considerations for ancillary joint ventures

• The environment: Health care systems have to provide more services for more people with fewer resources.

• The restrictions: No shareholders to ask for additional funding; national and state health care regulations.

• One option: Ancillary joint ventures

– Source of alternative capital

– Mitigate business risk

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• Smaller in size and scope than whole system joint ventures — they also usually have a medical focus

• Types of ancillary JVs (included but not limited to):

– cardiac

– pulmonary

– diagnostic imaging services

– physical therapy

– ambulatory surgery

– durable medical equipment

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• Who participates in an ancillary JV?

– the health system or systems

– physicians (as individuals or as a group)

– other business partners

• The law (Treas. Reg. § 1.501(c)(3)-1(c)(1): A tax-exempt health care system can participate in a partnership JV if:

– (1) participation in the partnership furthers its tax-exempt purpose, and

– (2) no more than an insubstantial amount of the partnership’s activities are not in furtherance of the health system’s tax-exempt purposes.

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• Test 1: "Control" is key:

– Does the tax-exempt partner have voting control? (Answer: Sometimes, but not always!)

– In the absence of voting control, what other mechanisms are in place to give the tax-exempt partner "control"?

• Redlands (9th Cir. 2001): 50/50 board = no "control"

• St. David's (5th Cir. 2003): 50/50 board + partnership agreement required the JV promote tax-exempt charitable purposes of hospital, even to the detriment of the partnership = "control" by tax-exempt entity

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• "Redlands" was hurt because:

1) there was no obligation in the partnership document to fulfill a charitable purpose;

2) there was a lack of formal control;

3) arbitration was required in the event of a deadlock between the equally split board;

4) a long-term management contract existed by which the tax-exempt partner abdicated some authority;

5) significant decisions were delegated to a medical advisory group which was also split 50/50 with the for-profit partner; and

6) there was a lack of informal control.

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• Why does it matter how the IRS views the joint venture?

– If there is no control, then the activity could be UBTI.

– If the UBTI is too large, it endangers the tax-exempt status of the health care system.

• Strategies to protect the tax-exempt entity partner:

– Provide the services to "patients" of the hospital.

– Establish that the joint venture furthers the tax-exempt purposes of the health care system.

– Make the documentation strong — Use it as a way to establish control by the tax-exempt parent over the joint venture.

81


Joint venture strategies

Tax/other considerations

• Corporate structure

• Partnership / LLC structure

• Management agreements

• Intermediate sanctions

• Compensation

• Fair market value

• Other

Exempt partner considerations

• Who "controls" the JV?• Ownership (>50%)• Voting rights • Governance • Charitable mission • Rights over key decisions• Unrelated business income

• Risk to exempt status• Political/lobbying activity• Misuse of charitable funds • Mismanagement• Conflicts of interest

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• Partnership / LLC structure



• Compensation


• Other

• RVU models recommended.• Incentive models recommended;

100% fixed compensation NOT recommended.

• Consider FMV of entire package.• Bonuses OK as long as total = FMV.• Noncompete agreements. • Deferred compensation (limited,

depending on corporate structure).• Fringe benefits and retirement plans.

• Keep compensation models as simple as possible and as clear as possible; the less subjectivity the better.

83





• Partnership/LLC structure



• Compensation


• Other

• Applies to transactions between tax-exempt organizations and “disqualified persons,” those who have the ability to significantly influence the organization.

• Physicians can be disqualified persons

• "Rebuttable presumption of reasonableness”

• Transaction must be at fair market value

• Approved by governing board or committee

• Approval documented in board minutes

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Governance and transparency

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Governance and transparency

87


IRS' increased focus on governance of nonprofit organizations

• Board members (and the policies they have in place) are in the spotlight more than ever before.

• The focus on governance clearly indicates the kind of policies, practices and procedures that the IRS believes responsible persons and organizations should have in place to exercise their fiduciary duty to the public.

• The IRS believes that the absence of appropriate policies and procedures can lead to opportunities for excess benefit transactions, private inurement, operation for nonexempt purposes or other activities inconsistent with nonexempt status.

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• Conflict of interest policy

• Whistleblower policy

• Document retention and destruction policy

• Form 990 board review policy

• Compensation policy

• Joint venture policy

• Gift acceptance policy

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• Organizations are required as part of the new Form 990 to describe the process the board engages in to review the return.

• Because of this required disclosure, organizations are investing significantly more time preparing, reviewing and filing complete and accurate 990s.

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High-performing boards are more consistent with certain benchmarks of good governance than lower-performing boards regarding community benefits• A substantial proportion of high-performing boards:

– collaborate regularly with other local organizations in community needs assessment,

– regularly engage in formal discussions about their organization's community benefit responsibilities and programs,

– have a system-level policy and a formal system-level plan with measurable objectives for community benefit programs,

– regularly receive reports on the performance toward established community benefit objectives, and

– are actively engaged in disclosure and decision-making processes, are willing to express their views and constructively challenge each other and the management team.

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Transparency gained via Form 990?

Stated goals of the IRS:

• Enhance:

– disclosure about use of resources

• Promote:plince

– compliance with all tax laws by asking questions

• Minimize:

– burden, but still accomplish other two goals

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Temporary and part-time employment vs. independent contractor

Who has the right to control how the work is accomplished?

It is the right to control, not whether that right is exercised, that governs whether there is an employer/ employee relationship.

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These are ALL considered employees

• Temporary workers

• Part-time or short-term workers

• Seasonal workers

• Household workers (nannies, housekeepers)

• Former employees hired back as "consultants"

• Anyone subject to your direction and/or control (regardless of contract or duration of relationship)

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Nonemployee characteristics

• Clauses in contract

• Worker has own business cards, letterhead, invoices

• Worker can incur monetary loss

- Unreimbursed expenses

- Nonpayment for services if job is terminated

- Significant financial investment by worker

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Nonemployee characteristics

• Worker can hire assistants (without preapproval)

• Worker determines tools or equipment, order to follow, where to purchase supplies, etc.

• Worker has other sources of income

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20-factor test and "categories of evidence"

• IRS Revenue Ruling 87-41 provides guidance with respect to 20 main factors that define the employment relationship.

• In the mid-1990s, a new "categories of evidence" test was established to determine employment relationship.

– Behavioral control– Financial control– Relationship of the parties

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20 factors from Revenue Ruling 87-41

• Instruction• Training• Integration• Services rendered

personally• Hiring, supervising and

paying assistants• Oral or written report• Payment by hour, week or

month

• Significant investment• Realization of profit/loss• Work for more than one firm at

a time• Services available to general

public• Right to discharge• Right to terminate• Payment of business/travel

expenses• Furnishing of tools/equipment

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"Categories of evidence"Behavioral control

Deals with the “right of direction and control” — that is, how the worker performs the tasks assigned.

• Where should the work be done? (Factor 9)

• What tools or equipment should be used? (Factor 14)

• What routines should be used?

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"Categories of evidence"Financial control

Addresses the “business aspects” of the worker’s activities:

• Is there a significant investment made by the worker? (Factor 15)

• Does the worker have unreimbursed expenses? (Factor 13)

• Are services made available to the general public? (Factor 18)

• How is the worker paid? (Factor 12)

• Can the worker realize a profit or loss? (Factor 16)

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"Categories of evidence"Relationship of the parties

Addresses how the parties perceive their relationship:

• Is the relationship short term, long term or indefinite? (Factor 6)

• Are there limits on the company’s right to terminate the worker? (Factor 20)

• Are there limits on the individual’s right to quit? (Factor 20)

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"Categories of evidence"Relationship of the parties

Addresses how the parties perceive their relationship:

• What benefits (if any) are provided to the worker by the company?

• Can/does the individual work for more than one company? (Factor 17)

• Are services made available to the general public? (Factor 18)

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Evaluating the evidence

• Revenue Rule 87-41 cautions against applying the 20-factor test in a mechanical fashion: – “the degree of importance of each factor varies

depending on the occupation and the factual context in which the services are performed.”

• As this weighs numerous subjective factors, the analysis is often confusing, and the conclusion is frequently uncertain.

• Experienced practitioners apply “smell test”; you know one when you see one. IRS agents are often result-oriented.

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What triggers an audit?

• Unemployment/disability/workers' compensation claim• Large and small case audit• Wage and hour complaint• Worker filing Form SS-8 or 8919 with the IRS

• Form 1099 and W-2 issued to same individual in the same year

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Ways to strengthen independence relationships

• Clauses in contract• Worker has own business cards, letterhead, invoices, Yellow

Pages listing• Worker can incur monetary loss

– Unreimbursed expenses– Nonpayment for services if job is terminated– Significant financial investment by worker

• Worker can hire assistants (without preapproval)

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Ways to strengthen independence relationships

• Worker determines tools or equipment, order to follow, where to purchase supplies, etc.

• Worker has other clients or sources of income• Worker can refuse assignment(s)/project(s)• Legal entity vs. individual (with some exceptions)• Worker files Schedule C with federal Form 1040

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Possible corporate relationships

• Parent — Corporation (nonprofit or stock) that controls another corporation.

– Examples:

• Not-for-profit corporation (NFP) — control usually gained via "sole membership" of NFP subsidiary or through "overlapping" board control

• For-profit corporation (F/P) — control determined by percent of common stock ownership

• Subsidiary — Corporation (either NFP or F/P) controlled by the parent organization.

– More than 50% of stock ownership or overlapping board constitutes control

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• Brother/sister — Organizations controlled by person or corporate parent organization

• Supporting organization — An organization that is at any time of the tax year a supporting organization (pursuant to IRC Section 509 (a)(3) of a supported organization pursuant to IRC Section 509 (a)(1) or 509 (a)(2))

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• For Form 990 Schedule R purposes:

– IRS defines a "related organization" to include:

• parent of filing organization,

• subsidiary of filing organization,

• brother/sister of the filing organization, or

• supporting organization of the filing organization.

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Determining "control"

• Nonprofit corporation — "Control" determined by:

– sole membership of percentage of membership,

– board/officers overlap with another NFP organization as required by organizational by-laws, or

– percentage of NFP stock ownership.

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Determining "control"

• Stock corporation — "Control" determined by:

– percentage of common stock ownership

• Partnership — "Control" determined by:

– percentage of partnership ownership (units)

• Trust — "Control" determined by:

– percentage of beneficial interest held

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Schedule R

• Organizes all information about related organizations into one schedule

– Schedule is divided into seven sections:

• Part I — Disregarded entities

• Part II — Related tax-exempt organizations

• Part III — Related organizations taxable as a partnership

• Part IV — Related organizations taxable as a corporation

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Schedule R

• Part V — Transactions with related organizations and noncharitable exempt organizations

– Gifts, grants or capital contributions

– Sale, purchase or exchange of assets

– Loans or loan guarantees

– Lease of facilities, equipment, etc.

– Performance of services

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Schedule R

• Part VI — Unrelated organizations taxable as a partnership

– Required if the organization conducted more than 5% of its activities in the partnership as measured by total assets or gross revenue

• Part VII — Supplemental deficient

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Best practices to follow

• Central organization should set clear guidelines for subordinates to follow.

• Annual reports should be obtained from subordinates:– Description of current activities and accomplishments– Information on receipts and expenditures– Assertion of no politics or excess lobbying– Details about current officers and directors– Verification of Form 990 compliance

• Periodic reviews could be conducted.

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Group exemption basics

• Approximately 500,000 organizations exempt under group ruling letters.

• Central organization acts as the IRS in ensuring exempt status of subordinates.

• IRS feels group rulings (or at least group 990 filings) are no longer prudent.

• IRS hesitant to issue new group exemptions.• Questionnaire recently sent.• Clearer definition of "supervision and control" needed.

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Non-cash contributions

• Valuation of assets• Filing of Forms 8283 and 8282• Boats, cars and intellectual property• Donated services• Timing of gifts/transfers

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Gaming

• State and local gaming licenses/rules• Issuance of Form W-2G• Withholding of taxes

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Other fundraising issues

• "Anonymous" donors• Auctions• Donor substantiation rules• Use of professional consultants• Special events

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Comments?Questions?


ContactInformation

Daniel RomanoT 212.542.9609E [email protected]

Frank GiardiniT 215.656.3060E [email protected]

Joe DeTraneT 415.318.2238E [email protected]

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Disclaimer

This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered.

For additional information on matters covered in this presentation, contact your Grant Thornton LLP adviser.

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