Tax reform, IRS Work Plan and expedited exemptions

NONPROFIT NEWS

In late September, we saw the issuance of the proposed framework for tax reform from the White House administration and Republican congressional leaders. While the framework retained the charitable contribution deduction, its other proposals seem likely to reduce the number of taxpayers eligible to benefit from the deduction, which could potentially decrease overall charitable contributions. We also saw the release of the IRS Tax Exempt and Government Entities FY 2018 Work Plan, which, of particular interest, provides some insight into how the division plans to focus its enforcement efforts in the coming year. Finally, September unfortunately brought yet more natural and man-made tragedies to the country. As individuals strive to respond to those effected by these events, I've included a brief summary of the procedures for requesting expedited review of an application for recognition of exemption under Section 501(c)(3).

Tax Reform

On Sept. 27, the White House administration and Republican congressional leaders issued the Unified Framework for Fixing Our Broken Tax Code, starting the long-promised tax reform process. The framework was the product of what is being referred to as the "Big Six": House Speaker Paul Ryan (R-Wisc.), Senate Majority Leader Mitch McConnell (R-Ky.), House Ways and Means Chairman Kevin Brady (R-Texas), Senate Finance Committee Chairman Orrin Hatch (R-Utah), Treasury Secretary Steven Mnuchin, and White House economic policy advisor Gary Cohn. It states that it "serves as a template for the tax-writing committees that will develop legislation through a transparent and inclusive committee process."

The high-level framework generally calls for fewer tax brackets (down to three from the current seven), a roughly doubled standard deduction, repeal of the state and local taxes deduction, an increase in the child tax credit, and repeal of the federal estate tax and alternative minimum tax. While tax reform is likely of course have diverse and widespread impact, there are a few potential implications of the framework of direct relevance for the nonprofit sector.

The framework claims a goal of maintaining the deductibility of charitable contributions to eligible 501(c)(3)s and states it "retains tax incentives for home mortgage interest and charitable contributions," which "help accomplish important goals that strengthen civil society, as opposed to dependence on government." However, experts have determined that, by increasing the standard deduction and lowering the top tax rate, the framework proposal would in fact reduce the overall value of the charitable deduction. It is estimated that the proposed changes to the tax code would reduce the number of taxpayers eligible to take advantage of the tax benefits of the deduction from more than 30 percent to only five percent, leaving tax incentives for charitable giving for only a small number of wealthy taxpayers.

Of course, the deductibility of charitable contributions is not the only, or even the main, reason why individuals donate to nonprofits. However, it of course has a significant impact on charitable giving. According to an article in The NonProfit Times on the day the framework was released, "[r]emoving the charitable deduction for most Americans could reduce giving by as much as $13 billion while expanding the deduction to all American could increase giving by almost $5 billion annually, according to a study by the Indiana University Lilly Family School of Philanthropy released in May."

While certain nonprofit sector leaders are expressing relief and approval of the framework's proposed maintenance of the charitable deduction, many are emphasizing the potential collective impact of the framework's other proposals on the sector and the importance of continuing to push for an expansion of the charitable deduction to all Americans.

2018 TE/GE Work Plan Released

On Sept. 28, the IRS released the Tax Exempt and Government Entities FY 2018 Work Plan. In a statement at the outset of the plan, the TE/GE Commissioners acknowledge that "[t]o a degree, this is a creative response to the IRS's and TE/GE's declining workforce."

The plan indicates the division intends to focus on compliance by examining organizations that fall within a few specific categories: those that file a Form 990-N and claim public charity status on the basis of being supporting organizations; those that operated as for-profit entities prior to converting to 501(c)(3) exempt entities; and those that show (unspecified) indicators of potential private benefit or private inurement to individuals or private entities. It also indicates that the division will continue focusing on data-driven approaches, including its compliance models for reviewing Forms 990, 990-EZ, and 990-PF data and identifying anomalies and risk factors in such returns.

According to the plan, in early 2018, revisions will be made to the Form 1023-EZ to require applicants to provide a description of their activities and to answer additional questions regarding gross receipts, asset thresholds, and foundation classification. As I've previously written, there have reports of significant misuse (whether intentional or not) of the Form 1023-EZ by entities not in fact qualified for exemption under Section 501(c)(3) or ineligible to use the streamlined application. Perhaps these changes to the Form will lead to some reduction in such misuse. Of course, the plan states that, as a result of these changes, it is expected that the average processing time for 1023-EZ applications will increase.

In FY 2018, TE/GE plans to launch a Compliance Strategy Tool and an Internal Submission Portal to collect input regarding areas of non-compliance from issue experts, which, together with continued increased reliance on data analysis, will inform the division's future compliance strategies. Of course, without sufficient funding or staffing, the division's enforcement activities will necessarily continue to become increasingly focused and its ability to act on any feedback that is received will likely be hindered.

The plan also announced some structural changes within the division, including combining Indian Tribal Governments and Tax Exempt Bonds into a single functional unit (ITG/TEB) and moving Federal, State and Local Governments into Exempt Organizations, which will now be referred to as Federal, State, Local/Employment Tax (FSL/ET). It seems that these combinations of distinct specialty areas were likely part of the "creative response" to the declining workforce and reduced funding mentioned by the Commissioners at the outset of the plan.

Expedited Review of Exemption Applications

Unfortunately, the stream of recent natural and human-created disasters has continued this month, including the complete devastation Hurricane Maria brought to Puerto Rico (and the pathetic lack of quick and sufficient federal aid in response to the disaster), the senseless killing of concertgoers by a single individual with a cache of 23 weapons (including 12 rifles outfitted with a bump-fire stock enabling rapid firing) in Las Vegas, and the deadly wildfires raging in Northern California right now. In response to such disasters, in addition to seeing increased charitable contributions to existing nonprofits, we often also see increased interest in forming new nonprofits to directly respond to the needs of those affected.

The process of submitting an application for exemption to the IRS and receiving a determination letter back can take months, particularly if the longer Form 1023 is used, which can hinder the ability of new organizations to respond quickly to disasters. However, there is a process for requesting expedited review of a Form 1023 exemption application under certain circumstances, as set forth in Revenue Procedure 2017-5.

The Rev. Proc. indicates that, while exemption applications are typically processed in order of receipt, "expedited processing of a request for a determination letter may be approved where a request for expedited processing is made in writing and contains a compelling reason for processing the request for a determination letter ahead of others." The request for expedited processing must be made in writing and the IRS prefers that it be set forth in a separate letter submitted with or soon after the exemption application is filed. If the request is not made in a separate letter, the letter in which the request for a determination letter is made should state at the top of the first page "Expedited Handling is Requested. See page __ of this letter."

The Rev. Proc. further clarifies that the granting of an expedite request is within the IRS's discretion, but that circumstances that generally warrant expedited processing include (a) a pending grant to the applicant where the failure to secure the grant may have an adverse impact on the organization's ability to continue operating; (b) a newly created organization formed to provide disaster relief to victims of emergencies; and (c) undue delays in issuing a determination letter caused by an IRS error. Note also that applications made using the streamlined Form 1023-EZ are not eligible for expedited processing.