Our friends at California Association of Nonprofits have some creative tips for how nonprofits can make their voices heard on Election Day, and some resources to help. Check it out!
A charitable remainder annuity trust (“CRAT”) is a trust that pays a fixed amount to a beneficiary (typically the donor) for his/her life or a term of years, and then pays the remainder to one or more charities. The fixed amount is generally defined as a percentage of the initial value of the asset(s) contributed to the trust, and cannot be less than 5%. The donor receives a charitable contribution deduction upon formation of the CRAT, based on the present value of the expected distribution to charity. To qualify as a CRAT, the trust has to pass two tests, measured at the date of creation, related to the expected charitable interest: (1) the 10% minimum remainder requirement (which requires that the present value of the future charitable interest be at least 10% of the amount contributed to the trust), and (2) the 5% probability test (which requires that the probability that the trust will run out of funds before it terminates in favor of the charity be less than 5%). The former can be satisfied with even a relatively young beneficiary, but the latter test is very hard to satisfy with today’s low interest rates. Consequently, many trusts pass the 10% remainder test but fail the 5% probability test – for example (using an AFR of 1.8%), a CRAT paying 5% of its initial asset value will satisfy the 10% test with a beneficiary as young as 52, but won’t pass the 5% probability test unless the beneficiary is at least 73 (at which point the remainder interest is a whopping 47%, almost five times the required minimum!).
Two members of the ACTEC Charitable Planning Committee, Chip Parks and Bill Finestone, met with the IRS and proposed an alternate approach to addressing the 5% probability test: rather than measure the probability of exhaustion at the time the trust is created, add an early termination to the trust, tied to the actual value of the trust, such that the trust would terminate early if it was about to run out of assets (so it would never “exhaust”). They argued that such a provision should be considered a qualified contingency – IRC section 664(f) provides that if a trust would, but for a qualified contingency, meet the requirements for a CRAT, then the trust will not be deemed to fail by virtue of containing the qualified contingency.
Well, sometimes good things happen. The IRS just issued Rev. Proc. 2016-42, which adopts the general idea proposed by Chip and Bill. It includes sample language that can be included in a CRAT document which the IRS will respect as a qualified contingency and will not cause the trust to fail to qualify as a CRAT. If the language is included, the trust does not need to meet the 5% probability test.
A few cautions, though. First, the sample language only applies to trusts created after August 8, 2016. Second, the ruling only applies if the drafter uses the “precise language” set forth in the ruling – any deviation will not necessarily disqualify the trust, but it will not be assured of treatment as a qualified contingency. Finally, the sample language is not a straightforward calculation (as proposed by Chip and Bill), but instead a rather complicated formula. It would appear that the IRS wanted to guarantee that the charity gets the 10% minimum remainder value; this is more than the amount actually required to satisfy the 5% probability test, which only looks to whether the trust would “exhaust” before it terminates in favor of the charitable beneficiary). Still, this ruling should be a welcome development.
The IRS has finally caught up with Congress with respect to the new notice requirement for new organizations claiming exemption under Section 501(c)(4). Narrowly (?) missing its self-imposed July 1 deadline for implementing this requirement, the IRS last week released new temporary (and proposed) regulations, a Revenue Procedure (Rev. Proc. 2016-41) explaining the notification system, and an online, electronic-only form, Form 8976 (Notice of Intent to Operate Under Section 501(c)(4)) for providing the required notice (along with a $50 User Fee).
A social welfare organization’s obligations under the new rules depend on when it was (or will be) formed and whether it has already told the IRS of its claim to exemption under Section 501(c)(4):
An organization formed on or before July 8, 2016 must:
- Do nothing if the organization has either a) filed Form 1024 requesting recognition of exemption under Section 501(c)(4), or b) submitted Form 990 (any variant) claiming exemption under Section 501(c)(4), on or before July 8, 2016.
- Complete Form 8976 (including payment of the User Fee) by September 6, 2016 if the organization has neither filed Form 1024 requesting recognition of exemption under Section 501(c)(4), nor submitted Form 990 (any variant) claiming exemption under Section 501(c)(4), on or before July 8, 2016.
An organization formed after July 8, 2016 must complete Form 8976 (including payment of the User Fee) within 60 days of formation, even if the organization first submits a Form 1024 or any version of Form 990.
Providing notice under this system does not constitute an application for recognition of exemption, and the IRS’s acknowledgment of receipt of the notice does not constitute a determination that the organization is exempt.
Failure to submit Form 8976 exposes the organization to a penalty of $20/day, up to a cap of $5,000. If an organization fails to provide notice, the IRS may demand that the organization do so by a specified date, and failure to comply with such a demand can expose managers personally to the same penalties. Penalties may be subject to abatement upon proof of reasonable cause.
Watch for Changes
The IRS has requested comments on the temporary/proposed regulations and Rev. Proc. 2016-41, and there are some concerns about the application and enforcement of the new notice requirement under certain circumstances, so it is possible that the rules will change before the regulations become final. We’ll be watching for developments.
A while back, we blogged about a new notification requirement for organizations claiming exemption under Section 501(c)(4) imposed by Congress’s adoption last December of the PATH Act of 2015. The Path Act created a new section of the Internal Revenue Code, Section 506, which requires new and certain existing (see below) Section 501(c)(4) organizations to notify the IRS of their existence and claimed exempt status within 60 days of the date of formation. However, the new statute did not establish any procedures for that notification to occur. The IRS subsequently extended all of the relevant deadlines pending issuance of further guidance about the notification procedure.
You’ll be . . . pleased? . . . to know that the wait may soon be over. A well-placed source tells us that the IRS has publicly indicated, through an IRS representative’s comment at a recent meeting, its intention to roll out the new notice system on July 1.
According to what we have heard, the notification system will be online only. The IRS has previously indicated that the system will include instructions for organizations for whom the statutory deadline for notification has already passed.
Newly formed Section 501(c)(4) organizations, as well as those that have not yet either a) voluntarily applied for recognition of exemption or b) filed a Form 990 claiming exemption under Section 501(c)(4) will need to notify the IRS under the new system, so if your organization falls into one of those categories, keep an eye out for more information on July 1.
The US Department of Labor has issued new regulations, effective for most employers in December 2016, that will affect how employers, including nonprofits, determine which employees are exempt from certain wage and hour rules.
Since we’re not employment lawyers, these new rules fall outside of our areas of expertise, but our friends at California Association of Nonprofits recently released a very helpful summary that they prepared with the help of knowledgeable counsel.
Take a look, and consider consulting your own employment counsel to see what you need to do to prepare for the new rules. The CAN post also includes links for information about some upcoming webinars that might be helpful.
The Treasury Department and Internal Revenue Service yesterday released final regulations on private foundation program-related investments.
These regulations put in final form nine examples of investments that qualify as PRIs, initially proposed by the IRS in 2012.
The White House has been enthusiastic about impact investing as a tool to further social and charitable objectives, including the use of PRIs, and issued this blog post announcing the final regulations.
The nine examples in the final regulations illustrate the wide range of possible PRIs and reflect the following general principles:
- Charitable goals that may be accomplished through a PRI are broad; they include purposes such as combating environmental deterioration, promoting the arts, and advancing science.
- PRIs may fund activities both domestically and abroad.
- Many different kinds of investments may qualify as PRIs, including loans to individuals, loans to tax-exempt organizations (e.g., a 501(c)(4) social welfare organization), guaranties and other forms of credit enhancement, and equity investments in for-profit organizations.
- A potentially high rate of return does not automatically prevent an investment from qualifying as program-related.
These final regulations follow guidance issued last September by the Treasury Department and IRS (Notice 2015-62) clarifying that private foundations could consider the relationship between an investment and the foundation’s charitable purposes, even when making ordinary investments that are not PRIs, and that foundation managers are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity. (See our blog post on this topic.)
A few points from the Treasury Department and IRS written comments that accompanied the final regulations:
- Treasury and the IRS confirmed that the examples are intended as illustrations of investments that qualify as PRIs but that other fact patterns also may qualify, for instance, ones that are similar to but that do not contain all of the elements in any particular example. The examples therefore provide guidance but are not intended to be restrictive.
- Treasury and the IRS removed from the fact pattern of one example that the foundation would liquidate its stock investment if it became profitable, which is helpful to avoid a conclusion that a foundation must sell the equity it acquires in a business once it becomes profitable for the investment to qualify as a PRI. This is not a PRI requirement in the regulations. However, the comments did note that the establishment of an exit condition when making an investment that is “tied to the foundation’s exempt purpose in making the investment can be an important indication of” the foundation’s primary charitable purpose.
- We’ve previously commented that it would be helpful if we had an example of an equity PRI in an LLC (as opposed to a loan), which is a fairly common investment structure. However, we understood that the IRS viewed the complexity of such an investment to be outside the scope of these examples. The comments confirmed that this is the case, but also stated that the IRS and Treasury are considering issuing a revenue ruling addressing investments in partnership/LLC interests. We look forward to that future guidance.
Independent Sector, a leading national organization of nonprofits, will host a webinar on Tuesday, April 19, at 2:00 p.m. Eastern time (11:00 a.m. Pacific) on the topic “How 501(c)(3)s Can Engage with Candidates and Voters.”
On the panel, our own Greg Colvin will cover the basic do’s and don’ts, and describe nonpartisan ways that charities can inject their issues into campaign discussions and promote broader citizen engagement in our democracy at all levels of government.
For more information and to register for the webinar, go to https://www.independentsector.org/engagewithcandidates.
Our colleague, mentor, and friend Greg Colvin is having a significant birthday today, and we at Adler & Colvin want to wish him a very happy birthday! For more than 30 years, Greg has meant (and continues to mean) so much to our firm, shaping its vision and character. He has had a similar effect on the nonprofit sector as a whole, helping to clarify complicated issues and fighting for law reform.
Greg’s impact on our firm, our clients, and the nonprofit sector as a whole has been so broad and deep that we can’t possibly describe all of it here, but we do want to mention a few highlights:
- Aside from his client work, Greg has toiled relentlessly to bring clarity to the lobbying and political arena. He worked tirelessly to help shape and clarify the rules, set forth in IRC Section 501(h), governing lobbying by publicly-supported charities. With Greg’s help, these rules significantly expanded the practical ability of charities to engage directly in public policy, giving a greater voice to constituencies that too often are left out of policy discussions that affect them.
- Greg literally wrote the book on fiscal sponsorship. His “Fiscal Sponsorship: 6 Ways to Do it Right” is the definitive text on a tool that has dramatically lowered barriers to entry for fledgling nonprofits.
- When the Supreme Court opened the floodgates to corporate expenditures on behalf of favored political candidates with its 2010 ruling in the Citizen United case, Greg worked with members of the Senate to develop a Constitutional amendment to repeal the decision.
- Greg continues to be a leading participant in the Bright Lines Project, a collaborative movement seeking to bring clarity to the fuzzy limits on political activity by exempt organizations.
Like the Scarecrow, the Tin Man, and the Lion rolled up into one, Greg has a tremendous intellect, a huge heart, and the courage to be a leader both in our firm and in the Sector.
Happy birthday, Greg — we love you.
Adler & Colvin
On February 8, Tax Analysts published an article titled Confusion Over Judging Political Activity Still Reigns at IRS. In the article, Paul C. Barton describes the prohibition that appeared in the 2016 Consolidated Appropriations Act against using any fiscal year federal funds “to issue, revise, or finalize any regulation, revenue ruling, or other guidance … relating to the standard which is used to determine whether an organization is operated exclusively for the promotion of social welfare for purposes of section 501(c)(4)….”
According to Barton, as a result of the Republican-backed Congress’ restriction on IRS rulemaking, “many practitioners and other observers say [that] the future appears as clouded as ever when it comes to how to regulate the political activities of section 501(c) organizations and especially groups exempt under section 501(c)(4)….” Among the practitioners interviewed is Greg Colvin, who describes the rulemaking process as having become a “punching bag for those who would rather continue to operate in an environment of unclear rules and toothless enforcement for as long as possible, using tax-exempt 501(c)(4) and (c)(6) organizations to bend American politics in their direction.”
Authors on this blog have previously applauded the IRS’ effort to promulgate new regulations on political activity and Section 501(c) organizations. The Treasury issued a first set of such proposed regulations in 2014, and after unprecedented feedback from the public, the IRS had announced it would further revise and reissue proposed regulations by early 2016. The fact that these efforts are being forced to a halt – so that the second draft from the IRS won’t be seen and discussed at public hearings for many more months – is disconcerting to many practitioners and nonprofit organizations alike.
For additional insightful comments by both Colvin and other practitioners, the whole article is reprinted here with the permission of Tax Analysts.
Confusion Over Judging Political Activity Still Reigns at IRS
by Paul C. Barton
When the IRS announced in late 2013 that it was developing new rules to govern the involvement of nonprofit groups in political campaigns, the hope on all sides was that the long-used and much-derided facts and circumstances test was finally coming to an end.
But 26 months later, a Republican-controlled Congress has brought development of new rules to a halt, prohibiting the agency from any work on them in fiscal 2016, as conservatives continue to regard the IRS as biased against them when it comes to political speech. The prohibition was included in the omnibus spending bill passed in December.
As a result, many practitioners and other observers say, the future appears as clouded as ever when it comes to how to regulate the political activities of section 501(c) organizations and especially groups exempt under section 501(c)(4), the preferred means for gathering “dark money” that can be used to influence political campaigns without disclosing the names of donors.
Much will depend on the outcome of the 2016 elections, but legal action could also play a role, some stakeholders say.
For now, the facts and circumstances test still rules, even though a 2014 Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations report described it as a “time-consuming, case-by-case, non-transparent, subjective, and unpredictable method of evaluation that not only confused and delayed IRS processing of individual applications, but also invited public suspicion that IRS decisionmaking may have been influenced by politics.”
As a result of the work stoppage on the new rules, John Pomeranz of Harmon, Curran, Spielberg + Eisenberg LLP issued a warning.
“I think that many nonprofits involved in activities related to the 2016 elections should be terrified,” Pomeranz told Tax Analysts. “They’re facing an agency that has been left with no alternative than to try to enforce the current vague rules governing exempt organization election-related activities.” He added that he hopes politically active 501(c)(4)s start having to back up their claims to being primarily engaged in social welfare activities.
“I think there are some organizations — particularly those who have been advised by lawyers not familiar with IRS regulation of tax-exempt organizations — who will be in for a rude awakening,” said Pomeranz. “Perhaps then people will beg Congress to allow the IRS to complete the stalled rulemaking.”
An Intimidated IRS?
Others fear the IRS now stands too intimidated by the Republicans in Congress to attempt much enforcement in 2016 — or even later. Craig Holman, a reform advocate at Public Citizen, said that when Congress shut down work on the new rules, it made it “clear to any electioneering group that they are free to abuse the tax code and hide behind the veil of nonprofit status to wage secretly funded political campaigns, which is what the Republican congressional sponsors intended.” He added that “even in the most abusive cases, the IRS is likely to avoid the partisan politics and turn a blind eye.”
Similarly, Robert Maguire, lead nonprofit investigator at the Center for Responsive Politics, said Congress’s decision to freeze work on new rules “sent a pretty clear signal to wealthy individuals and corporations hoping to influence the 2016 elections anonymously. Not only will the lax oversight and confusion continue through the elections, but long after.”
Marcus S. Owens, former head of the IRS Exempt Organizations Division and now with Loeb & Loeb LLP, also doubts anything will come of the November 2013 initiative.
“I suspect that the draft regulations, and any administrative clarification of political activity, [are] unlikely to happen,” he told Tax Analysts. “Congress has not given any guidance to Treasury and the IRS on which a different standard could be based; thus, any regulations setting forth a new definition would be subject to challenge as having no basis in law by any organization adversely impacted.”
In any event, said Owens, “the IRS has successfully defended the facts and circumstances approach to political activity in court, and one or more of the groups like Crossroads GPS, if they still exist, may eventually challenge an adverse finding by the IRS. As a result, the IRS may let the courts decide.” Crossroads GPS is the politically oriented 501(c)(4) founded by Republican operative Karl Rove.
David Keating, president of the conservative Center for Competitive Politics, said the targeting scandal involving former IRS exempt organizations director Lois Lerner still looms large.
“The IRS is a tax collection agency with little understanding of First Amendment rights and should not be tasked with policing speech,” Keating said. “Previous efforts by the Service to act as the speech police resulted in the IRS targeting scandal — in which the agency systematically harassed and subjected to delay many groups applying for tax-exempt status so that they could more effectively participate in political and issue debates.”
“Ideally, the IRS should be taken off the speech police beat permanently,” said Keating, adding that “if that is not possible, however, then new regulations that respect First Amendment rights are needed to improve the current vague rules that helped create the scandal.”
According to Keating, the Obama administration has unfortunately demonstrated that “it is incapable of writing reasonable regulations on this topic,” so the best available alternative would be to freeze the regulations and “prevent additional damage to free speech rights.”
Similarly, Cleta Mitchell of Foley & Lardner LLP, who represents conservative 501(c)(4)s, said in an email, “I am very glad that Congress blocked the development and issuance of more speech suppression regulations for citizens’ groups, and my only wish is that they had made it permanent and had said the IRS can NEVER promulgate or issue regulations governing citizen political activity and speech. It is an outrageous overreach by the IRS to even contemplate such regulations.”
Beth Kingsley, also of Harmon, Curran, Spielberg + Eisenberg, said conservatives want a ruling articulating that express advocacy — arguing unmistakably for a candidate’s election or defeat — is acceptable for a 501(c)(4), “which I think goes way too far in a tax context.” In the meantime, she said, “I would think conservative groups should be as troubled by facts and circumstances as I am.”
According to the Center for Responsive Politics, most of the dark money channeled through nonprofit groups over the past six years has favored conservative over liberal 501(c)s — $382.9 million to $84.47 million.
New Rules Still Possible?
One of those not giving up is Gregory L. Colvin of Adler & Colvin, who also serves on Public Citizen’s Bright Lines Project, a nationwide coalition of interest groups that want clarified political rules for nonprofits. The rulemaking “is most certainly not derailed, although there are some who wish for that and are trying to characterize the congressional action that way,” Colvin said, adding that the freeze on new regulations lasts only through September 2016 and that the IRS can then proceed with seeking public comments again.
Colvin said, however, that by shutting the process down for fiscal 2016, Congress missed a valuable opportunity to have the rules debated during “an election cycle, when these issues are at the top of mind for everybody.” He also wondered why Congress was so concerned about stopping all work this year when IRS Commissioner John Koskinen had made clear that no new rules would be made effective before the 2016 elections. “The commissioner was emphatic about that,” Colvin added.
Instead, Colvin said, the IRS rulemaking has become a “punching bag for those who would rather continue to operate in an environment of unclear rules and toothless enforcement for as long as possible, using tax-exempt 501(c)(4) and (c)(6) organizations to bend American politics in their direction.” He added that “partisan political activity is not entitled to tax-deductible treatment under the Internal Revenue Code, and bright-line rules were supposed to be a remedy for the IRS Cincinnati review headache of 2013.”
So could it be facts and circumstances forever? “No,” Colvin said. “The vague facts and circumstances approach has run its course. The IRS cannot do its congressionally mandated job to distinguish taxable from tax-deductible spending, by businesses or by nonprofits, without fair and serviceable rules defining political intervention.”
As for getting political backing for the effort, Colvin said, “Campaign finance disclosure, at historical moments when the fundraising abuses are obvious and leading legislators are fed up with them, can find bipartisan support.” However, disclosure isn’t really the main issue with the current IRS rulemaking, he said, adding it is more about political intervention and how much of it should be allowed under each subsection of 501(c).
Colvin added, “Conservatives tend to want the line drawn at express advocacy, which would allow much more nonprofit speech tilted for or against candidates and parties than liberals would prefer. But both sides would be better off with a clear IRS interpretation, whatever that might be.”
UPDATE: In Notice 2016-09, the IRS indicated that the notification requirement will not go into effect until “at least 60 days from the date” it issues regulations implementing Section 506, and no penalties will be assessed against any Section 501(c)(4) organization that submits the required notice by the due date provided in those regulations.
On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”). The PATH Act contains several provisions of note for tax-exempt organizations. This post focuses on a new notification requirement for organizations operating as social welfare organizations under Section 501(c)(4) of the Internal Revenue Code (“Code”). (See our earlier post for information about PATH Act provisions addressing gift tax and certain charitable contribution incentives.)
Social welfare organizations exempt under Section 501(c)(4) are not organized for profit and are operated primarily to promote social welfare. They do not receive tax-deductible contributions and can lobby without limit, but partisan political activities (combined with any other non-social-welfare activities) must not be their primary activities. (The IRS has embarked on an effort to produce new regulations clarifying the boundaries of political activity by social welfare and other non-charitable exempt organizations. However, the Consolidated Appropriations Act, 2016 (which also includes the PATH Act) prohibits the IRS from using any funds appropriated during FY 2016 (Oct. 2015 – Sep. 2016) to “issue, revise, or finalize any regulation, revenue ruling, or other guidance . . . related to” the qualifications for exemption under Section 501(c)(4).)
Under prior law, an organization organized and operating as a 501(c)(4) organization could “self-declare” its tax-exempt status and begin filing annual returns on Form 990, without submitting a Form 1024 application for exemption and obtaining an IRS determination letter explicitly recognizing the organization’s qualification for such status, or otherwise notifying the IRS.
The PATH Act added new Code Section 506, which requires a social welfare organization to notify the IRS within 60 days of formation that it is operating under Section 501(c)(4). The new provision authorizes the IRS to establish a fee for filing the notice, although the IRS has not yet done so.
Section 506 states that the notice must include:
(1) The name, address and taxpayer identification number of the organization.
(2) The date on which, and the State under the laws of which, the organization was organized.
(3) A statement of the purpose of the organization.
The IRS must acknowledge receipt of the notice within 60 days. Both the notice and the IRS acknowledgement of receipt are subject to public disclosure under Section 6104.
Section 506 provides that organizations that are organized after the date of enactment, December 18, 2015, are subject to the new notice requirement. Organizations that were organized before the date of enactment but that have not yet applied for exemption or filed an annual return are also subject to the notice requirement, but have 180 days from the date of enactment to submit the notice.
However, as of the date of this post, the IRS has provided only minimal guidance regarding the manner of notice, stating that “Until these regulations are issued, organizations need not submit any notification.” In addition, the statement indicates that the regulations, once issued, will include “transition rules that extend the 60- or 180-day period, as may be applicable, in order to comply with the regulations.” We will monitor the IRS’s progress on the implementation of Section 506, and will post updates as more information becomes available.
Under Section 506, an organization that fails to submit the notice will be fined $20 per day until the notice is filed, up to $5,000. An individual manager of an organization that fails to submit notice after receiving a written demand from the IRS specifying a reasonable future date for submission will also be fined, personally, $20 per day up to $5,000.
As under existing law, 501(c)(4) organizations that want the additional certainty of an IRS determination may apply for recognition of exemption. Under the new law, however, such applications do not take the place of the required notice described in new Code Section 506. The Joint Committee on Taxation’s explanation of provisions (page 241) indicates that the application for determination of 501(c)(4) status will be “submitted on a new form (separate from Form 1024) that clearly states that filing such a request is optional.” As of the date of this post, this new form has not yet been released.