Tax Planning and Compliance for Tax-Exempt Organizations

JODY BLAZEK is a leading authority on accounting practices and planning and compliance for tax-exempt organizations. She is a partner in Blazek & Vetterling, a CPA firm focusing on exempt organizations. She is the author of six books in the Wiley Nonprofit Series, including Financial Planning for Nonprofit Organizations Made Easy and The Tax Law of Private Foundations, Fifth Edition, as well as The Legal Answer Book for Private Foundations, coauthored with Bruce R. Hopkins. She is a frequent speaker at nonprofit symposia.

List of Exhibits xiii

Preface xvii

About the Author xxiii

Acknowledgments xxv

Part I Qualifications of Tax-Exempt Organizations 1

Chapter 1 Distinguishing Characteristics of Tax-Exempt Organizations 3

1.1 Differences between Exempt and Nonexempt Organizations 10

1.2 Nomenclature 13

1.3 Ownership and Control 13

1.4 Role of the Internal Revenue Service 14

1.5 Suitability as an Exempt Organization 15

1.6 Start-Up Tax and Financial Considerations 18

1.7 Choosing the Best Form of Organization 22

Chapter 2 Qualifying Under IRC §501(c)(3) 27

2.1 Organizational Test 29

2.2 Operational Test 36

Chapter 3 Religious Organizations 59

3.1 Types of Religious Organizations 60

3.2 Churches 65

3.3 Religious Orders 72

3.4 Religious and Apostolic Associations 73

Chapter 4 Charitable Organizations 75

4.1 Relief of the Poor 77

4.2 Promotion of Social Welfare 79

4.3 Lessening the Burdens of Government 88

4.4 Advancement of Religion 91

4.5 Advancement of Education and Science 91

4.6 Promotion of Health 92

4.7 Cooperative Hospital Service Organizations 116

Chapter 5 Educational, Scientific, and Literary Purposes and Prevention of Cruelty to Children and Animals 118

5.1 Educational Purposes 119

5.2 Literary Purposes 134

5.3 Scientific Purposes 134

5.4 Testing for Public Safety 139

5.5 Fostering National or International Amateur Sports Competition (But Only If No Part of Its Activities Involves the Provision of Athletic Facilities or Equipment) 140

5.6 Prevention of Cruelty to Children or Animals 141

Chapter 6 Civic Leagues and Local Associations of Employees: §501(c)(4) 143

6.1 Comparison of (c)(3) and (c)(4) Organizations 145

6.2 Qualifying and Nonqualifying Civic Organizations 151

6.3 Local Associations of Employees 155

6.4 Neighborhood and Homeowner’s Associations 157

6.5 Disclosures of Nondeductibility 160

Chapter 7 Labor, Agricultural, and Horticultural Organizations: §501(c)(5) 169

7.1 Labor Unions 170

7.2 Agricultural Groups 175

7.3 Horticultural Groups 178

7.4 Disclosures of Nondeductibility 179

Chapter 8 Business Leagues: §501(c)(6) 180

8.1 Basic Characteristics 181

8.2 Meaning of “Common Business Interest” 181

8.3 Line of Business 183

8.4 Rendering Services for Members 186

8.5 Sources of Revenue 192

8.6 Membership Categories 193

8.7 Member Inurement 194

8.8 Chambers of Commerce and Boards of Trade 195

8.9 Comparison to §501(c)(5) 195

8.10 Recognition of Exempt Status 196

8.11 Formation of a Related Charitable Organization 197

8.12 Disclosures for Lobbying and Nondeductibility 199

Chapter 9 Social Clubs: §501(c)(7) 200

9.1 Organizational Requirements and Characteristics 202

9.2 Member Inurement Prohibited 205

9.3 Membership Requirements 207

9.4 Revenue Tests 208

9.5 Unrelated Business Income Tax 211

9.6 Filing and Disclosure Requirements 217

Chapter 10 Instrumentalities of Government and Title-Holding Corporations 218

10.1 §501(c)(1) Instrumentalities of the United States 218

10.2 Governmental Units 219

10.3 Qualifying for §501(c)(3) Status 223

10.4 §501(c)(2) Title-Holding Corporations 235

10.5 §501(c)(25) Title-Holding Corporations 239

Chapter 11 Public Charities 241

11.1 Distinctions between Public and Private Charities 242

11.2 “Inherently Public Activity” and Broad Public Support: §509(a)(1) 245

11.3 Community Foundations 259

11.4 Service-Providing Organizations: §509(a)(2) 268

11.5 Difference Between §509(a)(1) and §509(a)(2) 270

11.6 Supporting Organizations: §509(a)(3) 282

11.7 Testing for Public Safety: §509(a)(4) 296

Part II Standards For Private Foundations 297

Chapter 12 Private Foundations—General Concepts 299

12.1 Why Private Foundations Are Special 299

12.2 Special Rules Pertaining to Private Foundations 302

12.3 Application of Taxes to Certain Nonexempt Trusts 310

12.4 Termination of Private Foundation Status 311

Appendix 12-1: Brief Description of Tax Sanctions Applicable to Private Foundations 335

Excise Tax on Investment Income—§4940 Tax 335

Chapter 13 Excise Tax Based on Investment Income: IRC §4940 339

13.1 Formula for Taxable Income 341

13.2 Capital Gains 348

13.3 Ponzi Scheme Losses 354

13.4 Deductions from Gross Investment Income 356

13.5 Tax-Planning Ideas 361

13.6 Foreign Foundations 365

13.7 Timely Payment of Excise Tax 367

13.8 Tax on Private Colleges and Universities 368

13.9 Exempt Operating Foundations 369

Chapter 14 Self-Dealing: IRC §4941 370

14.1 Definition of Self-Dealing 371

14.2 Sale, Exchange, or Lease of Property 374

14.3 Loans 384

14.4 Compensation 387

14.5 Transactions that Benefit Disqualified Persons 399

14.6 Payments to Government Officials 406

14.7 Sharing Space, People, and Expenses 407

14.8 Indirect Deals 410

14.9 Property Held by Fiduciaries 412

14.10 Issues Once Self-Dealing Occurs 415

Chapter 15 Minimum Distribution Requirements: IRC §4942 420

15.1 Assets Used to Calculate Minimum Investment Return 422

15.2 Measuring Fair Market Value 428

15.3 Distributable Amount 435

15.4 Qualifying Distributions 438

15.5 Private Operating Foundations 455

15.6 Satisfying the Distribution Test 464

Chapter 16 Excess Business Holdings and Jeopardizing Investments: IRC §§4943 and 4944 471

16.1 Excess Business Holdings 471

16.2 Jeopardizing Investments 480

16.3 Program-Related Investments 487

16.4 Penalty Taxes 492

Chapter 17 Taxable Expenditures: IRC §4945 498

17.1 Lobbying 500

17.2 Voter Registration Drives 506

17.3 Grants to Individuals 506

17.4 Grants to Public Charities 519

17.5 Grants to Foreign Organizations 530

17.6 Expenditure Responsibility Grants 532

17.7 Noncharitable Expenditures 546

17.8 Excise Taxes Payable 547

Appendix 17–1: Examples of Emergency, Hardship Grant Application, Church and Foreign Equivalency Grants 549

Part III Obtaining and Maintaining Tax-Exempt Status 583

Chapter 18 IRS Filings, Procedures, and Policies 585

18.1 IRS Determination Process 586

18.2 Annual Filing of Forms 990 595

18.3 Reporting Organizational Changes to the IRS 607

18.4 Weathering an IRS Examination 613

18.5 When an Organization Loses Its Tax-Exempt Status 618

Chapter 19 Maintaining Exempt Status 620

19.1 Checklists 620

Chapter 20 Private Inurement and Intermediate Sanctions 643

20.1 Defining Inurement 646

20.2 Salaries and Other Compensation 648

20.3 Setting Salary 650

20.4 Housing and Meals 652

20.5 Purchase, Lease, or Sale of Property or Services 653

20.6 Loans and Guarantees 654

20.7 For-Profit to Nonprofit and Vice Versa 655

20.8 Services Rendered for Individuals 656

20.9 Joint Ventures 658

20.10 Intermediate Sanctions 659

Chapter 21 Unrelated Business Income 671

21.1 IRS Scrutiny of Unrelated Business Income 673

21.2 History of the Unrelated Business Income Tax 674

21.3 Consequences of Receiving UBI 675

21.4 Definition of Trade or Business 677

21.5 What is Unrelated Business Income? 680

21.6 “Regularly Carried On” 681

21.7 “Substantially Related” 683

21.8 Unrelated Activities 688

21.9 The Exceptions 710

21.10 Income Modifications 717

21.11 Calculating and Minimizing Taxable Income 727

21.12 Debt-Financed Property 736

21.13 Museums 743

21.14 Travel Tours 745

21.15 Publishing 746

Chapter 22 Relationships with Other Organizations and Businesses 750

22.1 Creation of (c)(3) by (c)(4), (5), or (6) 751

22.2 Alliances with Investors 755

22.3 Creation of a For-Profit Corporate Subsidiary 759

22.4 Active Business Relationships 762

Chapter 23 Electioneering and Lobbying 765

23.1 Election Campaign Involvement 766

23.2 Voter Education versus Candidate Promotion 772

23.3 Tax on Political Expenditures 777

23.4 Lobbying Activity of §501(c)(3) Organizations 786

23.5 Permissible Amounts of Lobbying 793

23.6 Lobbying Limits for §501(c)(4), (5), (6), and Other Exempt Organizations 796

23.7 Advocacy and Nonpartisan Analysis 797

Chapter 24 Deductibility and Disclosures 799

24.1 Overview of Deductibility 800

24.2 The Substantiation and Quid Pro Quo Rules 812

24.3 Valuing Donor Benefits 820

24.4 Unrelated Business Income Aspects of Fund-Raising 824

24.5 State and Local Regulations 825

Chapter 25 Employment Taxes 826

25.1 Distinctions Between Employees and Independent Contractors 828

25.2 Ministers 835

25.3 Reporting Requirements 839

Chapter 26 Mergers, Bankruptcies, and Terminations 844

26.1 Mergers and Other Combinations 844

26.2 Bankruptcy 849

26.3 Terminations 852

Table of Cases 855

Table of IRS Revenue Rulings 867

Table of IRS Procedures 873

Index 875