You-are-Here irs 501 c 3

Editor’s note: This interview with Virginia Gross, member of the Exempt Organizations (EO) subcommittee of the IRS Advisory Committee on Tax Exempt and Government Entities (ACT), delves into the current state of the regulation of exempt organizations by the IRS. Gross describes a major shift at the IRS that combines a greater use of technology to review returns with a more siloed approach to its various roles. All of this adds up to a sense that there will be less discretion by the Exempt Organizations division right at the point when the floodgates have been opened with the Form 1023-EZ.

As a shareholder with Polsinelli PC, Gross focuses on providing advice and counsel to nonprofit and tax-exempt organizations on all aspects of tax-exempt organizations law—such as their formation, qualification, activities, and business ventures—and advises nonprofit clients on issues regarding their operations, fundraising practices, grantmaking, unrelated business income planning, joint venturing and partnering, and the use of supporting organizations and for-profit subsidiaries. Her publications include Nonprofit Governance: Law, Practices & Trends (2009) and The New Form 990: Law, Policy, and Preparation (2008), published by Wiley & Sons. She is also a contributing author to The Jossey-Bass Handbook of Nonprofit Leadership and Management (2011) and Nonprofit Management 101: A Complete and Practical Guide for Leaders and Professionals (2010).

This article is from the summer 2016 edition of the Nonprofit Quarterly magazine, “The New Nonprofit Regulatory Environment: What You Should Know.”

Ruth McCambridge: The assumption on the part of nonprofits has always been that the IRS had a primary role in its monitoring and regulation—and sometimes, though relatively rarely, in enforcement. Can you talk a little bit about how that may have changed over the past decade or so?

Virginia Gross: The IRS has always had a role in determining whether an organization fits into a particular tax-exempt organization category—and it still does. It has produced guidance in the form of revenue rulings, information letters, and lots of private letter rulings, allowing taxpayers to ask specific questions about whether their activities qualified, whether certain things they do could jeopardize their status, and what would be the tax treatment of those activities. And then, certainly in the past, we saw a lot of compliance checks. Many of these compliance checks have been industry-specific, like the big hospital compliance check many years ago—and, of course, the college and university study several years ago was a huge one.

But a lot has changed internally that, in the end, will have external effects. It is a reorganization that more strictly assigns certain kinds of tasks to specific departments. First, we’ve had the big shift of employees from the Exempt Organizations division to the Chief Counsel division, and now that division is doing everything with private letter rulings, technical advice memoranda, and formal guidance. The EO division is now more about the determinations function (which concentrates on reviewing applications for tax-exempt status) and the exam function (which involves auditing exempt organizations).

This likely has owed from the 501(c)(4) brouhaha, which caused Congress to take a look at the EO division and work at eliminating discretionary or subjective power over nonprofits. I don’t think that ten years ago we would have seen things like the spending bill associated with PATH, the Protecting Americans from Tax Hikes Act of 2015, where you had Congress saying to the IRS that it couldn’t issue the 501(c)(4) regulations—that they were going to restrict the IRS from doing that.

RM: So, it’s the imposition of limitations on the IRS’s discretion?

VG: Exactly. And the IRS itself is moving to be more objective in other areas, too. That lessening of discretion is also seen in a more automated exam function—one that is being implemented more broadly and organized around a system of approximately 190 Form 990 queries, designed to surface potential compliance risks. What the IRS is saying is that this is going to lead to more objective examination and review of exempt organizations, because basically they’ll take all the 990s, they’ll run them through the queries, and then, based on those queries, they’ll identify the organizations that are more at risk for noncompliance.

So, rather than having to pick an industry and say, “We’re going to study colleges and universities,” “We’re going to study hospitals,” or, “We’re going to study social clubs,” the new process will instead study all exempt organizations that file 990s, and decide who’s going to be examined based on those queries.

RM: Can you talk a little bit about the queries?

VG: Well, they’re keeping those very close to their chest. But I can imagine they might touch on such matters as loans with officers or directors, the existence or not of a conflict-of-interest policy, and how you’re answering certain questions on Schedule L—and seeing if all that matches up. Certainly, they might look for information that could give rise to intermediate sanctions, or items that might give rise to questions concerning unrelated business income. I think that those more major categories and topics would be what the queries are focused on, but we really don’t know. This is purely speculation on my part.

RM: When would the queries be made?

VG: I think after the returns are led, it would be part of the review process of the returns. Right now, I believe that less than 1 percent of exempt organizations are examined, because it takes a lot of manpower to pull a 990, review it, and decide if there are things on it that should be questioned or looked at further.

RM: What are we headed for now?

VG: The new process will vastly increase the number of returns the IRS can look at, and there may be a greater likelihood of a more qualitative exam if the query process raises warning flags.