November December 2006 (free edition)

Nonprofit and Church Legal Trends - Free Edition - November December 2006 (free edition)

Dear Friends and Subscribers,

Here’s the latest news from the legal and tax front on church and nonprofit organization related issues. This complementary version of the Nonprofit and Church Legal Trends memo is provided free of charge to all who are interested. For more information and detailed analysis on each of the topics discussed below, please see the subscriber version of the memo at www.nonprofitchurchlaw.com.

This issue has one focus – the new laws, regulations, and inflation adjustments which have recently taken effect or will on January 1, 2007. The biggest new law is of course the Pension Protection Act of 2006. In this issue we highlight the major provisions. The IRS has already provided some guidance on a couple of these and they are featured in sidebars.

On January 1, 2007, many items will be increased for inflation, including the standard mileage rate. This issue lists a few of the ones most relevant to charities.

And finally we’ll review the Exempt Organizations Implementing Guidelines for 2007. This is the IRS game plan for next year. What are they concerned about and what should you be aware of that might affect your organization?

One housekeeping note – we are in the process of substantially revamping our website. In the next month or two we’ll be moving everything to a new address and adding some exciting new benefits to our members-only section. We’ll let you know as soon as we make the switch.

The new Pension Protection Act (PPA) of 2006 contains numerous provisions applicable to charitable organizations. Here are the major provisions:

1. Tax-free distributions from IRA’s for charitable purposes. The new law allows an exclusion from income for IRA distributions in the case of what is known as a “qualified charitable distribution.” In part that means only donors who are 70 1/2 can do this and they can’t give more than $100,000 per taxpayer per year.
2. Modifying tax treatments of certain payments to controlling exempt organizations. Now, for example, the payment of rent by a controlled sub to its tax-exempt parent is included in unrelated business income only to the extent that the rent exceeds fair market value.
3. Encourage contributions of real property made for conservation purposes. The new law allows individuals to deduct the fair market value of any qualified conservation contribution up to the 50% contribution base. And if you exceed the 50% level, you may carry over the excess for 15 years. This could prove to be a significant incentive for conservation related contributions.
4. Excise tax exemptions for blood collector organizations. Qualified blood collector organizations are now exempt from certain retail and manufacturers’ excise taxes to the extent that the items are for the exclusive use of the organization for the distribution or collection of blood.
5. Amounts received under a life insurance contract. Under the new law, charities with certain interests in insurance contracts will now be required to file an information return.
6. Increase the amount of tax imposed on excess benefit transactions, self-dealing, failure to distribute income, excess business holdings, jeopardizing investments, and taxable expenditures. All the penalties related to each of these areas are essentially being doubled.
7. Changing the rules for contributions of easements in historic districts. For any contribution, taxpayers must include a qualified appraisal of the property interest, regardless of the claimed value. The appraisal must be attached to the taxpayer’s return. The donor and the donee must enter into a written agreement containing IRS prescribed certifications. And if a taxpayer is claiming a deduction greater than $10,000, he will have to pay the IRS a $500 fee. Imagine that – paying the IRS for a deduction!
8. Restricting the contributions of taxidermy. The new law provides that the amount allowed as a deduction for contributions of taxidermy property that is contributed by the one who prepared it or who paid for the cost of preparing it, is the lesser of the basis in the property or the fair market value of the property.
9. Recapture of the tax benefit on property not used for an exempt use. The new law changes some things. First, the two year time frame is now expanded to three years. Charities will have to keep track of certain contributed property longer. Second, if the charity disposes of the property within 3 years, the donor is subject to an adjustment of his deduction. The donor must include as ordinary income on his tax return the excess of the amount of the deduction that he previously claimed as a charitable contribution over his basis in the property at the time of the contribution.
10. Limits on the charitable deduction for contributions of clothing and household items. The IRS can now deny a deduction for items of minimal value like socks and underwear.
11. Recordkeeping and substantiation requirements. The new law puts more stringent requirements on contributions of less than $250. Now the donor must maintain a bank record or a written communication from the donee showing the name of the organization, the date of the contribution, and the amount of the contribution.
12. Contributions of fractional interests in property such as artworks. For purposes of determining the deductible amount of each additional contribution of an interest in the same item of art, the fair market value of the item is the lesser of the value used at the initial contribution or the fair market value of the art at the time of the subsequent contribution.
13. Increased penalties on taxpayers for overstated appraisals and on appraisers. Currently, accuracy related penalties do not apply if a taxpayer shows there was reasonable cause for an underpayment and the taxpayer acted in good faith. But under the new law reasonable cause does not apply if there was a gross misstatement. Thus, no gross misstatement can arise from a reasonable cause. And the law changes the definition of a “qualified appraiser.”
14. 14. Established additional standards for credit counseling organizations. Due to what Congress sees as continuing abuses by credit counseling organizations of their exempt status, the new law establishes additional standards that these organizations must meet in order to be exempt. In addition to the requirements of current law, ten new and significant requirements are put on the organizations.
15. Expands the definition of convention or association of churches. The new law clarifies that an organization can be considered a convention or association of churches even if the membership includes individuals as well as churches and even if individuals have voting rights in the organization.
16. Filing requirement for small organizations implemented. Under current law, if an organization has less than $25,000 in revenue during a year, it does not have to file a Form 990. The new law now requires those organizations to file an electronic form with the IRS containing the following information: name, address, Internet address, taxpayer identification number, name and address of a principal officer, and evidence of its continuing basis for its exemption from filing a Form 990.
17. Disclosure to state officials. The IRS may now disclose to certain state officials some information about 501(c)(3) organizations. This includes information on revocation of exempt status.
18. Require public disclose of Form 990-T. Under current law an organization is required to make public its Form 990 but not its Form 990-T. The 990-T is the annual return for unrelated business income tax. Under the new law, the public inspection and disclosure requirements, and related penalties, are now made applicable to the Form 990-T.
19. Treasury study of donor advised funds and supporting organizations. The Treasury is directed to undertake a study of donor advised funds and supporting organizations.
20. Improving accountability of donor advised funds. The bill creates two new sections of the Tax Code to deal with donor advised funds (new sections 4966 and 4967). It enacts the first legislative definition of a donor advised fund and establishes a three-prong test of what a DAF actually is: a fund or account that is (1) separately identified by reference to contributions of a donor or donors; (2) owned or controlled by a sponsoring organization; and (3) with respect to which a donor (or any person appointed or designated by such donor (a “donor advisor”) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the fund by reason of the donor’s status as a donor.
21. Automatic excess benefit transactions from Donor Advised Funds. A donor, donor advisor, or certain persons related to them are considered disqualified persons with respect to the fund (similar to the present definition of disqualified person for excess benefit transaction rules) and any grant, loan, compensation, or “other similar payment,” such as reimbursement of expenses, from a donor advised fund to such disqualified person is automatically treated as an excess benefit to the entire amount of the transaction.
22. Taxable distributions from DAF’s. A distribution from a donor advised fund to any natural person, for any noncharitable purpose, or to any organization that is not a public charity (other than a disqualified supporting organization), is a taxable expenditure (like a private foundation), and the sponsoring organization is subject to an excise tax equal to 20% of the amount of the distribution. An organization manager who knowingly approves the distribution can also be taxed up to $10,000 for each transaction.
23. Reporting and disclosure of DAF’s. Each sponsoring organization must disclose on its Form 990 tax return the total number of DAFs it owns, the aggregate value of those funds and the aggregated contributions to and grants made from those funds during the year.
24. Improve accountability of supporting organizations. There are new provisions applicable to all supporting organizations.As with the new rules for donor advised funds (above), it will be deemed to be an automatic excess benefit if a SO makes a grant, loan, payment of compensation or other similar payment to a substantial contributor to the SO (or certain related persons). All supporting organizations, without regard to the amount of gross receipts, will be required to file an annual Form 990 tax information return. And the bill creates a new class of Type III supporting organizations that are “functionally integrated” with the activities of the supported organizations.
25. Other provisions related to SO’s. If a Type I or Type III supporting organization accepts any gift or contribution from a person (other than a public charity, not including another SO) who directly or indirectly controls a supported organization, the SO will be treated as a private foundation until it can satisfy the IRS that it qualifies as a public charity other than as a supporting organization.

The IRS publishes its game plan for 2007. Under the 2007 Exempt Organization Implementing Guidelines the IRS let’s us know what it will focus on in 2007. They’ve got a busy agenda. A lot of time will be spent implementing the new legislative changes from the PPA of 2006. But new projects include a closer look at organizations involved in gaming, identifying organizations who are not complying with the employment tax withholding laws, and conducting a compliance project of community foundations. Critical initiatives include a continuation of their investigations of organizations involved in political activity and reporting on executive compensation abuses such as loans to officers and excess benefit transactions. The IRS will also engage in more scrutiny of credit counseling organizations, tax-exempt hospitals (should they really be exempt?) down-payment assistance organizations, and donor advised funds. Other projects for the IRS include enforcing the electronic filing requirement for major organizations, speeding up the 1023 approval process, redesigning Form 990, and implementing a web-based tool for completing 1023’s. Finally, the IRS promises to continue upgrading its publications and forms, keep offering tax forums and phone forums, and debut a new web-based training program.

In this issue we also highlight some of the new inflation adjusted items for 2007. For example, contributions to HSA’s are increased to $2850 for individuals and $5650 for families, the low-cost article threshold is going to be $8.90, and the insubstantial benefit item thresholds will be $8.90, $44.50, and $89.00. The foreign earned income exclusion will be $85,700. And the new standard mileage rate beginning on January 1, 2007 will be 48.5 cents per mile. Finally, if you’re wondering why your 1023, Application for Recognition of Exemption, is taking so long to process, you can find out where it is in the queue by going to this website: http://www.irs.gov/charities/article/0,,id=156733,00.html.

Oh yes, and don’t forget that in our subscribers memo we have another edition of Legally Funny.