5 Highlights from the ABA Exempt Organizations Committee Meeting 1/29/16

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Here are 5 highlights from the American Bar Association Exempt Organizations Committee Meeting held in Los Angeles on January 29, 2016:

1. Form 1023-EZ

The IRS Tax Exempt & Governmental Entities Division (TE/GE) disagreed with the critical conclusions made by the National Taxpayer Advocate regarding the level of noncompliance by organizations filing the Form 1023-EZ Streamlined Application for Recognition of Exemption Under Section 501(c)(3). But TE/GE Commissioner Sunita B. Lough stated that the Form 1023-EZ was still in “test-and-learn” mode and more would be determined after the planned post-determination correspondent audits which are scheduled to start this month.

2. New Notice Requirement for 501(c)(4) Organizations

Social welfare organizations will soon be required to notify the IRS within 60 days after the organization is established of its intent operate, as established by section 405 of the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act), which includes new Section 506 of the Internal Revenue Code. The IRS issued Notice 2016-09 on January 19, 2016 stating that the Treasury Department and the IRS intend to issue temporary regulations prescribing the manner in which social welfare organization will provide the notification (which the IRS hopes but has not promised will be electronic). Even organizations that seek IRS recognition of tax-exempt status using Form 1024 will need to provide this new notification.

3. Equivalency Determination

Equivalency determination is considered an alternative to expenditure responsibility for allowing private foundations to make grants to foreign organizations that meet the qualifying distribution requirements and do not violate the taxable expenditure rules. The general rule is that a favorable equivalency determination requires a foundation manager to make a good faith determination that a foreign organization is the equivalent of a U.S. public charity described by Section 509(a)(1), (2), or (3) of the Internal Revenue Code. Such determination may be based in part on an affidavit supplied by the foreign organization setting forth sufficient supporting facts. The special rule provides that a determination based on the written advice of a qualified tax practitioner (QTP) ordinarily will be considered as made “in good faith.” A grantee affidavit (in place of the written advice of a QTP) will not afford a private foundation with the benefit of the special rule.

Under the special rule, the written advice of the QTP must be current. Background to the final regulations promulgated in 2015 provide:

Written advice will be considered current if, as of the date of the distribution, the relevant law on which the advice was based has not changed since the date of the written advice and the factual information on which the advice was based is from the organization’s current or prior year. However, consistent with rules for determinations of public support over a five-year test period for U.S. public charities, written advice that an organization satisfied the public support requirements under section 170(b)(1)(A)(vi) or section 509(a)(2) based on support over a test period of five years will be treated as current for the two years of the grantee immediately following the end of the five-year test period.

4. Commerciality Doctrine

Under applicable case law, the IRS may deny or revoke the 501(c)(3) status of an organization that is operated in a “commercial manner” and therefore not primarily in furtherance of an exempt purpose. See our previous post on Unrelated Business Income and the Commerciality Doctrine. Interestingly, the Advisory Committee on Tax Exempt And Government Entities, in its 2014 public report, recommended a rejection of application of the commerciality doctrine.

Because commerciality is not consistently defined, and it’s unclear how much commercial activity is permitted before it will jeopardize an organization’s exemption, organizations must be careful. Parsing the regulations, attorney Matt Clausen summarized the following points applicable to a 501(c)(3) organization:

  • An unrelated business can be a substantial part of the activities if it is “in furtherance of” an exempt purpose [however, query what type of business is in furtherance of, but not related to, an exempt purpose];
  • An unrelated business cannot be a primary purpose; and
  • A related business can be a primary purpose .

Some questions remain:

  1. Does the commerciality doctrine add something to the regime that already governs commercial activities?
  2. Does it make sense to apply the doctrine ex ante?
  3. Does the doctrine discourage nonprofits from entering into traditional for-profit business areas?

5. Mission Related Investments

For private foundations, new guidance from the IRS recognizing mission-related investments (MRIs) was published in 2015. While an MRI is not currently defined by the Internal Revenue Code or Treasury Regulations, it is generally considered to be an investment for both a financial return and a social impact return (more specifically, one that advances the particular mission of the investor).

IRS Notice 2015-62 “confirms that under section 4944 of the Internal Revenue Code, private foundation managers may consider the relationship between a particular investment and the foundation’s charitable purpose when exercising ordinary business care and prudence in deciding whether to make the investment.” This conforms the investment standard under federal tax laws with the state prudent investment laws under the Uniform Prudent Management of Institutional Funds Act (UPMIFA), “which generally provide for the consideration of the charitable purposes of an organization or certain factors, including an asset’s special relationship or special value, if any, to the charitable purposes of the organization, in properly managing and investing the organization’s investment assets.”

Accordingly, whether you can take mission into account in investing is becoming more clear. How you take mission into account is still open to some speculation. And how much of a diversified portfolio of assets can be MRIs must also be considered on a case-by-case basis.

Moderator David Levitt asked the panelists how much of a trade-off you could make of profits for mission. Jeffrey Hom of Omidyar Network noted two recent studies from Cambridge Associates and Wharton Social Impact Initiative which provided early indications that at least some investments can generate market-rate returns with social and/or environmental impact. He noted, however, that there is no bright line definition of an acceptable financial return when making a tradeoff for mission.

Prompted by a question from the audience, Levitt also questioned when something was an MRI versus a programmatic expenditure requiring expenditure responsibility. See Levitt’s article Investing In The Future: Mission-Related And Program-Related Investments For Private Foundations.