EO Tax Journal

The EO Subcommittee of the Advisory Committee on Tax Exempt and Government Entities (ACT) released on June 15, 2011, a report titled “Exempt Organizations: Group Exemptions – Creating a Higher Degree of Transparency, Accountability, and Responsibility.”

The report has generated a fair amount of discussion in the EO sector. Critiques include comments of Milt Cerny of McGuireWoods LLP (printed in email update 2011-105), an August 1, 2011 letter to the IRS from PricewaterhouseCoopers (reprinted in email update 2011-132), and a July 14, 2011 letter to the IRS from the American Society of Association Executives (reprinted in email update 2011-141).

In response to the concerns generated by their report, four members of the subcommittee * joined a previous ACT member, Deirdre Dessingue, Associate General Counsel, United States Conference of Catholic Bishops, for an August 17 roundtable discussion moderated by Paul Streckfus. The transcript of this discussion is being made available to the public for free under “EO Tax Journal 2011-150” on the eotaxjournal.com website.

* J. Daniel Gary, Administrative Counsel for the General Council on Finance and Administration of The United Methodist Church, Nashville, TN; Karen A. Gries, Larson Allen LLP, Minneapolis, MN; James P. Joseph, Arnold & Porter LLP, Washington, D.C.; and Celia Roady, Morgan Lewis & Bockius, LLP, Washington, D.C.

Roundtable Discussion of ACT Report on Group Exemptions

Streckfus: This is a roundtable discussion involving Deirdre Dessingue, Dan Gary, Karen Gries, Jim Joseph and Celia Roady, to discuss group ruling exemptions. My understanding is that the current basis for group ruling exemptions is, for the benefit of readers, in Rev. Proc. 80-27, and it’s about all that is out there. This distinguished group put together a report [available on www.irs.gov] and it basically recommended keeping the current group exemption procedures with some enhancements to Rev. Proc. 80-27 but eliminate group returns. And then there has been reported in the press a statement by the IRS’s Holly Paz where she’s been quoted as saying the IRS is not sure it should maintain the group exemption program at all. And then following the report, there has been some push back. PricewaterhouseCoopers and others have made fairly strong statements that they don’t think there should be any significant changes in the group ruling process. So that’s my part of the discussion. Who wishes to start?

Dessingue: One thing I want to clarify is that I am not part of this particular ACT committee.

Streckfus: You’re a stakeholder

Dessingue: I am a stakeholder and a former ACT member.

Gary: The first ACT.

Dessingue: The first ACT and I have joined the group here today.

Roady: And you work for an organization that holds a group ruling.

Dessingue: Yes, one of the earliest.

Gries: A significant organization.

Dessingue: A significant group ruling holder with a group ruling that is now 65 years old and eligible for Medicare. The ruling, not I. One of the things that struck me in the press coverage afterwards was that the focus was all on the one recommendation about eliminating group returns rather than on the bulk of the report, which dealt with retaining and updating group rulings. I was wondering why you thought that was.

Gary: That surprised me, it really did. Paul mentioned Holly Paz’s comments. Her comments suggest that the IRS is looking at whether group rulings are still a good idea or not. Our Committee felt that they still serve a valuable purpose and should be retained. I thought that was the most significant recommendation of the Committee. We also did a lot of work on recommendations for revising Rev. Proc. 80-27 to improve the transparency, accountability, and responsibility of organizations covered by group rulings. Most of our report focused on these issues. The group return recommendation was an important recommendation, but it certainly wasn’t the primary one. The press coverage, however, was just the opposite.

Joseph: I thought maybe it’s easy to understand — eliminate group returns. You don’t need to understand much background.

Dessingue: It makes a headline.

Joseph: Yes. And so that was part of why I thought the press focused on that and I thought Holly’s comments which I thought, like Dan, they should have focused on, oh, the IRS is thinking about or at least considering eliminating group rulings altogether and here the ACT has recommended not doing that. But maybe they would say, given Holly’s comments, that eliminating group returns would move forward very quickly. If the feeling is that we don’t like a lot of these things, at least here’s something that we can do quickly that would change it, maybe without some of the other changes being implemented at the same time.

Gary: Also, we were surprised that there was such a reaction to it because we believed that if people were doing group returns as they should be doing group returns, eliminating them wouldn’t significantly increase the burdens on the affected organizations.

Joseph: And there’s about six or seven hundred filers of group returns filed.

Gary: Out of 4300 group exemptions.

Joseph: So it’s not a huge, it’s not even that big a number.

Dessingue: It would be a percentage.

Gries: But to that note, Dan, if in essence you look at the group return and what goes into the filing of the group return, subordinates are required to gather all of the data that is transcribed onto the group return anyway. So then you’re talking accountability being placed upon the group ruling holder who is filing the return.

Gary: It’s just a question of where to mail it.

Gries: Exactly.

Dessingue: Which gets back to the Pricewaterhouse comments.

Joseph: Exactly.

Dessingue: Maybe it was the first time I paid close attention to it because I am interested in the issue but were these the first comments in response to an ACT Report? I don’t remember that happening in the past.

Gries: I think it touched a nerve.

Dessingue: It must have.

Gary: Do you have a copy of their comments?

Dessingue: Yes, I do. I memorized them [the Pricewaterhouse comments]. It was surprising in and of itself that there were these comments, but I don’t understand the part of the comments that just baldly stated that eliminating group returns would increase the burdens of tax administration and preparation of returns, without any back-up. As you just mentioned, it seems to me that a subordinate has to fill out the form, send it into the central organization, and then they compile information from all the subordinates. So how much more burdensome would it be to mail it someplace else – specifically, to the IRS?

Roady: I think it’s important to note that before we reached the recommendation about group returns, we considered stakeholder input. One of the stakeholders that provided input was the state AGs. And the state AGs were very opposed to group returns because they felt like they did not give states the information they needed about the activities that were carried on within the state. A state cares about what goes on within the four corners of that particular state and needs to identify which charities are doing business within that state. They were not able to get that and use that information from group returns. I think it’s important to note that in addition to feeling like there were issues about the transparency of the group returns, there is an important stakeholder group that weighed in very strongly about that issue.

Gary: We did attempt to carefully balance the pros and cons of eliminating group returns, and we did not come to our recommendation easily.

Gries: In fact, I think there was a spirited discussion and some people were holding out an agreement.

Joseph: So we did debate this vigorously. But the factors that we took into account, as Celia said, one was an important stakeholder saying that they weren’t getting the reporting that they needed since they relied so heavily on the 990s. We looked at the relatively small number of group return filers. We looked at the instructions to the 990 which say that the individual subordinate should in effect be filling out the 990 on their own and sending that information to the central organization. So it shouldn’t be increasing the burden on the individual organizations because we were very concerned about that. One reason why we considered not eliminating group rulings overall is the added burden that would be put on organizations that would have to file a 1023 that now don’t. So the Pricewaterhouse comments surprised me. I wondered, did they look at the instructions of the 990 and how groups are preparing group returns if they’re not getting this level of detail from subordinates. And that’s what part of the concern is. I was concerned, too, about how you report certain things. We talked about the lobbying limits. If you were filing a group return of 30 members, 26 of them may be over their lobbying limits but, on average, the group is fine, but there’s no mechanism when you’re filing the 990 for dealing with that. Same thing with the public support test. You could have one group that is part of the return that has really good public support. All the others would be reclassified as something else, but they average out. That is not how it is supposed to work because these are separate organizations, and the rules are applied to them separately.

Gary: Back to Celia’s point, you could have a national aggregation in a group return but the regulators in, say, Connecticut, wouldn’t know what they need to know about the individual subordinate organizations in Connecticut and what they’re doing.

Roady: Right, that’s the problem, and I think it’s important to note, too, that the two main points of the report are really tied together. The report recommends retaining group exemptions and eliminating the filing of the group returns. Holly was quoted as identifying an IRS concern about the subject of group exemptions in general and whether or not they should be maintained. So to the extent an IRS concern about group exemptions is based on a lack of information about the organizations that are within the group, elimination of group returns helps address that concern. If you require a filing of a separate 990 for each member of a group, then the IRS gets real time data on an individual organizational basis and the IRS can do whatever audit or follow-up it wants to on the individual organization and it gives the IRS a higher degree of comfort that organizations that are part of a group ruling are maintaining their exemption and continuing to meet the requirements on an individual basis. So there’s a link between those two recommendations that I think a lot of folks may have missed in our report.

Gries: I wonder, though, you talk in terms of the accountability or the information with filing of the individual returns but it brings out the next point. I was surprised that we didn’t hear something from group ruling holders, the holders themselves saying, yes, we’d like to see more guidance as far as complying with general supervision and control. There really wasn’t anything about that aspect of the report positive or negative.

Roady: Maybe they feel like they are and they’ve got what they need.

Dessingue: Or they’re doing what they always do and this needs to continue.

Gries: Right, exactly.

Dessingue: Well, that segues into the whole history of the group rulings, which is really interesting. I think you noted in the report that the earliest one was 70 years ago.

Joseph: 1940.

Dessingue: So, 71 years ago. The USCCB ruling dates to1946. That’s one of the older group rulings. Some of the oldest group rulings are probably church group rulings. Researching this, there was no formal procedure at that time.

Gary: That’s correct.

Dessingue: And I could not find anything in our files; I have every single one of our group ruling letters.

Gary: You get a letter every year from the IRS.

Dessingue: We get one a year. We have every single one of those letters but not what was submitted to the IRS to request the group ruling. IRS simply accepted the Official Catholic Directory, which had been in existence for close to 150 years prior to that as an information directory, as what we now call a group ruling roster.

Gary: But more than that, you have documentary evidence from long ago suggesting the IRS wanted you to have a group ruling.

Dessingue: Yes. This is pretty funny, considering the state of affairs today. When the ACT put out a request for people to participate in interviews. I went back into our archives and I discovered the minutes of a bishops meeting from 1957 in which the legal office made a report to the bishops saying that IRS was annoyed with all the individual applications being filed. The bishops were told that Catholic organizations were supposed to be coming under the group ruling and to encourage their organizations to use the group ruling.

Joseph: Get those Catholics under control.

Dessingue: Right, right.

Gary: And this was prior to the first revenue procedure on group rulings in 1968, which announced general supervision or control as the undefined, and still undefined, standard. It was a very informal process, but the IRS definitely wanted groups to use it.

Dessingue: Right, and I think that all you can say about the very early group rulings was that you needed to have some affiliation with a denomination, the church that held the group ruling. Another interesting thing is the whole 990 issue with respect to group rulings. In the beginning, there was no 990 and then in 1954 there was a 990A. But when you go back and look at church group rulings, subordinates were exempt all the way through until the Tax Reform Act of 1969, where the 990 exemption was narrowed to churches and integrated auxiliaries and the other categories that we’re familiar with. But until IRS defined integrated auxiliary (those regs were effective in 1976) all the way through 1975, subordinates under a church group ruling were not required to file any 990s. It’s remarkable how many organizations still believe that’s true today. It hasn’t been true for 34 years.

Gries: A lot of those hospitals out there.

Joseph: One of the things that also influenced our decision on the group returns, or our recommendation on group returns, was the importance of the 990 and how it has changed. I mean, even not going back to 1954 or 1976 but even during my professional life, the 990s have become the primary instrument of disclosure for nonprofits and they’re relied on by all different sectors, from the attorney generals to donors to the IRS. So it really is a very important tool for the transparency, the accountability and the responsibility.

Gary: And it seems like having group returns goes the opposite way. It’s being less transparent.

Gries: It is interesting that a number of group ruling holders I work with decided that when the new and robust 990 came about they were no longer going to file a group return for the subordinates under their group exemption. So there are those group ruling holders that when they looked at the vibrancy or the breadth of information that is required in that form, they stepped back and said, we can’t be accountable to the public based on our subordinates’ activities if we look and address the filing in the manner required – answering each of the questions in the return in the context of each subordinate within their group.

Joseph: I have clients that did the same thing and said we just can’t collect this information and …

Gries: Sign the return under penalties of perjury.

Joseph: Right, and sign the return.

Dessingue: How do you vouch for the accuracy of these figures?

Gries: Well, you do have, I mean, you have the subordinates that come forward and they attest that the information and other disclosures are true and complete. I assume the group ruling holder also puts a penalties of perjury statement on the information.

Gary: Ask for an affidavit from all the subordinates?

Gries: Affidavit, yes, that the subordinates are actually asserting that everything submitted to the group ruling holder is accurate and complete. But if you are the signer of the group return that encompasses, whether it’s five or 45 subordinates, you still have to be comfortable in signing that document.

Gary: Also, Deirdre has an example of something really bad that can happen with group returns if people don’t follow the rules. It can be a mess.

Dessingue: Our group ruling is quite large and we have some overeager subordinates who themselves have a group of affiliates. I blame this primarily on return preparers who didn’t read the Form 990 instructions. But we discovered that there were a handful of subordinates under our group ruling that filed group returns for their own little sub-groups using USCCB’s group exemption number. And I also discovered what happens when you do that. If you check the box ….

Gary: Under the rules, only the central organization can file a group return.

Dessingue: Only the central organization has authority.

Gary: But you didn’t know.

Dessingue: The group ruling memo on our website now makes that abundantly clear. But if a subordinate answers the questions, first, is this a group return for affiliates, checks the box, yes, and then the next question asks, does the return cover all the affiliates, and checks the box yes. We discovered the hard way that all the subordinates under the entire group return have to have the same tax year. So what ended up happening, when the IRS accepted this return, was that it changed all tax years of all the subordinates in the system, not just the tiny subgroup of affiliates that were connected to the errant subordinate.

Gary: Tens of thousands.

Joseph: 30,000.

Dessingue: All of them in the system. So when a hospital went to file an electronic 990 it was told that it had the wrong tax year.

Gries: I think that was one of my clients who was informed by the IRS that their year end – which they always followed – was incorrect.

Dessingue: The IRS was really good in trying to get this straightened out, but I am obviously not a fan of group returns.

Gries: I must say that is not just the Catholics that have these types of issues with the group exemption.

Dessingue: Good, I’m glad to hear that.

Gries: Group returns, I have seen some others under different denominations.

Joseph: I also had one non-religious organization where ….

Dessingue: A subgroup did that?

Joseph: Yeah, filed it and then, again, they change everything in the system which, again, that is how the system works and it’s nice if the IRS ….

Gries: Follows their rules.

Joseph: The computer does something automatically.

Streckfus: In making your recommendations, were you assuming that there is non-compliance out there that would be addressed by having the individual subs file 990s or what was the main objective?

Gries: I don’t know that we discussed non-compliance by way of the subordinates. I think we went back to the whole premise of the purpose of the 990, accountability and transparency, just holding themselves accountable to the public in that public filing.

Gary: And implicit in the group return process is a lack of granularity in information about the individual subordinates. So it wasn’t so much that we knew or thought that there was a lot of non-compliance. Even if you did it perfectly, you wouldn’t have the kind of insight into the local subordinate organizations that you would have if they filed individual Form 990s.

Joseph: And the way the return is set up there is the opportunity for non-compliance. It’s not as if we assumed or knew that there was non-compliance but just the way the 990 is set up and the fact that there is not the equivalent of a consolidated return 990, it is, as we said in the examples, it can be very easy to not comply with some of the rules and have that not be apparent in the 990.

Gary: Karen, I’d like to hear your comments on this. A lot of people who reacted to our group returns recommendation were hospitals. Maybe you could speak to what their specific concerns are.

Gries: Well, some of the comments that I’ve heard concerning the group return recommendations centered specifically around Schedule H. For subordinates filing a group return, organizations included in the group are to aggregate the information for the purpose of Schedule H. But as perhaps group ruling holders or as individuals are choosing those subordinates to include in the group return, there is the possibility of a conscious decision of what entities are going to be included in the group return. The presentation of community benefit may be a significant driver in the decision-making process also.

Gary: Someone brought this up during our discussion of this issue, that if there is some group data that a central or subordinate organization wants to express in an aggregate manner, maybe they could do it on Schedule O.

Gries: As a practitioner, I always encourage organizations to use Schedule O to tell their story. However, Schedule O is only as good as the people who are looking at your return and will dig to find that information. It’s easy to compare a number on Schedule H and go to a competitor’s or a peer organization and look at that number on Schedule H.

I was having a conversation with a client in New Jersey who was looking at their Schedule H regarding community benefit reporting and then comparing to another peer in the community. The differences in the reporting, it was enormous, when you look at it and you say, okay, they’re comparable organizations and I would not have envisioned a swing in some of the numbers in the manner that we were seeing. It may not have anything to do with the group ruling process, but more to do with just are we accumulating comparable information even to go on the form, which is beyond the ACT report.

Joseph: Maybe next year’s report. After we retire.

Dessingue: I received one comment from a health care organization and it had to do with the ACT’s recommendation that Type III supporting organizations not be included in group rulings. I think that’s a brilliant recommendation because USCCB stopped including Type III’s after the Pension Protection Act, but we applied that rule prospectively. The comment was from folks in health care systems with Type III organizations. They were concerned that the Type IIIs would be thrown out of the group ruling and would effectively lose their tax exemptions. That wasn’t addressed too clearly in the report. How did you deal with the prospective application issue? What was your intention?

Gries: I do not recall that we differentiated between Type III functionally integrated or Type III other….

Gary: No. In fact, that was one of the issues. Do you want the group ruling holder to be getting into that level of analysis and deciding whether a subordinate is functionally integrated or not?

Joseph: Right, that’s why we thought it would be easier to just say no Type III’s and certainly I think we were thinking prospectively for the implementation of these things or our final recommendation is that there has to be a very significant transition period. So if changes like that were going to be made, there has to be enough lead time that everyone knows what they need to do and they’re able to file their own 1023 and you can review the burdens of that. That was one very important reason why we thought eliminating group rulings overall would have been very troublesome. Can you imagine the transition issues?

Dessingue: Yes. It would be utter chaos.

Joseph: Of the 550,000.

Dessingue: It would be absolutely chaotic.

Gries: You would be retiring early.

Dessingue: Yes, and I would set out my shingle.

All: Get your 1023s here. You’d walk around with a shopping cart. 1023s-R-Us.

Dessingue: I was a little surprised by Holly Paz’s comment as it was reported in the press. Again, I wasn’t there and I don’t know the context in which it was delivered, but I thought it was surprising. Although it received quite a bit of press, nobody dug into it and said what does this really mean? I can’t imagine the disruptions that would occur if group rulings were eliminated. Among other things, they’re relied on not just by the IRS to establish federal tax exemption, but also state tax regulators, donors of all sorts, and even immigration officials who rely on church group ruling rosters to verify eligibility for R-1 religious worker visas. It’s part of the immigration regulations that this is an acceptable method of verifying that an employer is an eligible employer to sponsor a religious worker.

Gary: In fact, the R-1 issue came up yesterday in my shop.

Dessingue: Group rulings are also addressed in the 6104(d) regs on public disclosure. There’s a process for what a group ruling subordinate is required to do. Unraveling group rulings would be mind boggling in its complexity.

Gary: And I think it’s important to know that we thought about what could be done to ease the transition period if group exemptions were eliminated. I think we mentioned some of these ideas in our report. But in the end, the Committee felt it wouldn’t be enough. It just wouldn’t work because it’s too large a universe and so many organizations have been relying on group rulings for such a long time.

Roady: I think any effort to come up with an expeditious transition would involve such a minimal level of review that you’re not really getting anything, whereas in a group ruling, if it’s done correctly, every year somebody has to sign and decide that you qualify to stay in the group. Somebody else is responsible for you and in a way you can get more oversight that way. When the IRS gives you your exemption, and then unless you get audited, the IRS is never looking. Nobody else is taking a second look at it. In the group exemption process that can happen, which is why if you beef up the revenue procedure on the group ruling standards and provide a little bit more clarity and look at some of the other suggestions that we made, there may be ways that you really do make group rulings something that carries potentially a higher level of scrutiny and exemption integrity than what you get if you just go through the regular exemption process.

Gary: That was one of the three main points we made in our report about the advantages of group exemptions. First, group exemptions obviously relieve administrative burdens on organizations covered by a group exemption, as well as the IRS, because the organizations do not have to file, and the IRS does not have to process, individual applications for recognition of exemption. Second, what Celia mentioned, there is an additional level of oversight and scrutiny that can be present in group exemptions. And third, group exemptions provide some assurance that similarly-situated entities will be treated consistently, which might not be the case if they all submitted individual 1023s. Again, this discussion about the advantages of group exemptions is an important part of the report that didn’t get a lot of attention.

Streckfus: You did recommend that subordinates file returns, I forget the figure, it would be like another 300,000 990s that would be coming in each year.

Gary: It was 600 to 700 group returns [currently being filed] but did we know how many subordinates were included in those group returns?

Gries: In each return we were not able to draw it out.

Gary: No, I don’t think we knew.

Joseph: And so if you look statistically, you could say it might be 60,000 [subordinates], but we knew only 600 to 700 group returns are filed per year and we looked at several years and they were always in that range. So we don’t know exactly. I can’t remember what number you just mentioned, Paul.

Streckfus: I said 300,000.

Joseph: I think that would be way too high.

Roady: I think that would be high. There are some groups that have only a couple, there are some groups that have one.

Streckfus: For the church groups, the subordinates wouldn’t have to file at all.

Gary: We don’t file a group return.

Dessingue: We don’t file a group return because the central organization doesn’t have to.

Streckfus: So this wouldn’t affect churches at all.

Dessingue: No, this issue doesn’t affect us, except insofar as our subordinates are filing improper group returns.

Joseph: There are a number of very small groups that file group returns. I know some that will have three or four. I have a couple of clients in that range that file them.

Gary: I want to throw the Publication 78 issue out there. We talked a lot about that, too.

Dessingue: Are we going to talk about the standards for supervision and control?

Gries: I think that would be very helpful.

Gary: That was also a very important part of our report.

Dessingue: I was intrigued by what you had to say in the report, particularly as it recognized that churches are different, and that the standards of supervision and control are different for theological reasons, with constitutional overlays. When the ABA dealt with this issue back in the nineties, the EO Committee also recognized that supervision and control wasn’t the same for churches. I believe you suggested a facts and circumstances type of approach that’s similar to the facts and circumstances test in the integrated auxiliary regs.

Joseph: Right, and we referred to them on the church side.

Gary: And remember that Rev. Proc. 80-27 says nothing about what general supervision or control really means. We thought it was very important to flesh out that standard.

Dessingue: Right, it’s not defined at all.

Joseph: It’s not defined at all under current guidance.

Gary: We developed a facts and circumstances kind of test for group rulings with some special considerations for churches. We talked a lot about this because we thought it was essential that the standard have some meaning.

Gries: It’s hard to be compliant if there’s not guidance to assist you in complying.

Gary: How do you audit compliance with an undefined standard?

Joseph: That was one of the big concerns I had, how can the IRS audit a central organization on whether it’s fulfilling, in effect, this delegation of authority from the IRS? The IRS has in effect delegated to the central organization the ability to become a mini-IRS in granting or revoking exempt status. But they did it without giving them standards so how could the IRS audit them?

Dessingue: I’ve never heard of an instance in all these years where the IRS challenged the eligibility of a subordinate to be included in somebody’s group ruling.

Joseph: I think we felt that having some guidance in that area was very important because there are a lot of groups that we talked to. We talked to a number of church organizations, which helped the non-church members of our group understand much better some of these theological reasons why churches might need to be treated differently for the supervision and control. But we also talked to a number of non-church group ruling holders to understand how they exercised this control. The examples that we gave or some of the facts and circumstances we laid out were what we thought were some of the best practices that we saw from these organizations.

Dessingue: Also very interesting is your observation, particularly in the context of the church group rulings, how eliminating them would leave IRS with less information.

Gary: Less information than what they have through the group ruling.

Dessingue: And less opportunity for compliance than exists with the group rulings because the group ruling central organization has the ultimate weapon, the ability to remove an organization from the group ruling. Sometimes the issue can be a matter of branding. The central organization is concerned with its “brand” and it wants to make sure that the organizations affiliated with it maintain the integrity of the brand, so to speak. And, the central organization doesn’t have to concern itself with section 7611.

Joseph: That was a very important factor we put in for exercising supervision and control is that the central organization owns and monitors the trademark because in the groups that I work with, that is the primary reason. If you ask the parent organization, why are you concerned with what your subordinate in Poughkeepsie, New York, is doing and they’re like, well, they have our name and if they do something bad, it will be in the newspaper and people won’t understand that they are this teeny little part and they’re not really affiliated, they’re not part of this national organization. So that control of the brand is really a very important way that they exercise the responsibility and control. It’s a good motivation, too, for the parent.

Gary: In the church context, in many denominations, higher level ecclesiastical authorities can summarily remove the clergy leadership of lower level church entities if there is a problem. And that’s a very powerful way to supervise churches that doesn’t have anything to do with the usual corporate model of board control. Also, in the church context, and we make this point in the report, churches, integrated auxiliaries and conventions or associations of churches are not required to file 1023s or 990s. They’re basically invisible to the IRS. Were it not for the group ruling through which the IRS learns who they are, what they do, and so on, the IRS would have little or no information about them. And the additional oversight exercised in the group ruling context, especially in many church group rulings, is more than what the IRS would be able to do itself short of an audit pursuant to 7611.

Joseph: And this feeds into your Publication 78 discussion because if churches wanted to be listed and their subordinates want to be listed in Publication 78, having a central organization submit the listing of who their subordinates are, again that’s more information than the IRS would otherwise get.

Dessingue: Did I read things correctly that the IRS was not eager to embrace the issue of putting subordinates into Publication 78 and the reason was what?

Gary: In the old days, one reason was because it would have made the paper version of Publication 78 too thick.

Joseph: Publication 78 is a listing of organizations that the IRS has approved, that they have blessed, and technically they are correct that they have not blessed the subordinate organizations. One question is, is Publication 78 really a listing of the organizations the IRS has blessed or is it groups that are exempt under particular Code sections and these subordinate organizations that are part of a group are exempt under these particular Code provisions and the IRS has in effect delegated their authority to someone else.

So we had a bit of a philosophical disagreement about Publication 78 and I certainly, from my perspective, approach it on a very practical level. People are using Publication 78 in a very practical way. Matching gifts from corporations, it’s all done by computer so it’s this automatic process of feeding into GuideStar and the IRS system and checking. If you don’t list these groups, these subordinates in Pub 78, it gets kicked out and it’s a much more difficult process.

Dessingue: Right, that’s been a big factor for our subordinates since the Internet became ubiquitous; it’s only gotten worse since the Pension Protection Act. After PPA, private foundations weren’t satisfied with knowing that a subordinate organization is a public charity. These donor issues are becoming increasingly difficult to deal with. IRS has attempted to ameliorate the situation with Publication 4573 on group exemptions.

Gary: Which did help.

Dessingue: And I know Lois has addressed this issue when she was speaking to groups, particularly foundation groups, reminding them that group rulings are different.

Joseph: That was very helpful.

Dessingue: It was helpful as far as it went, but some of our subordinates have withdrawn from the group ruling because they’re fund-raising groups and they need to get into the EOBMF. The only sure way to do that is to file the 1023. There has been an uptick in organizations leaving the group ruling and obtaining their own exemption directly from IRS

Gary: And it’s my understanding Publication 78 is no more than an extract from the EOBMF. The EOBMF contains information for many subordinates, but when they perform the extract, if you’re a subordinate in a group ruling, you don’t make the cut, and you don’t show up in Publication 78. And this seems odd because 501(c)(3) subordinates are indeed coded as such in the EOBMF.  Anyway, that is my understanding of the way it works. And of course churches have a long history of submitting their annual listings and them not being entered into the EOBMF.

Dessingue: Yes, that’s a problem. We filed our annual information updates every year, only to discover many years later that the IRS never did anything with them. That policy has changed but you’ve got maybe 50 years of information that was not entered.

Joseph: In the IRS’s defense, there is a burden, this would impose a burden on them and they do not have the money for anything that is related to technology or manpower for inputting this kind of data. So we were sympathetic to these concerns but we did feel very strongly as a group that the IRS should try to work with group ruling holders to come up with a solution, be it some sort of added explanation that is part of Publication 78 or appended to Publication 78 about group rulings, something that where group ruling holders, central organizations, could be linked to or there could be some listing of group ruling holders that can be extracted from existing IRS data so that then group ruling holders could list their covered subordinates on their website. There are lots of ways that you might help donors, in particular, understand group rulings and who are covered subordinates.

Dessingue: There is that helpful language that was included in the hard copy Publication 78, and also appears on the IRS website that explains all of this, but somehow folks don’t seem to find it or believe it.

Gary: These days, in my experience, donors are just searching Publication 78 and either the organization is in or it’s out. Period.

Dessingue: And if the name doesn’t come up, you’re out.

Gary: If the name is not in Publication 78, then it’s all up hill after that, trying to convince the donor that the organization is, nonetheless, eligible to receive deductible charitable contributions.

Joseph: Right, and it’s frequently done by a computer program for a lot of these groups. The other thing that we did talk to the IRS about is making sure that the IRS staff people who answer particular phones are educated about this and that they have access to easy to find information about group rulings because we heard stories about donors and others getting incorrect information when they called the IRS with questions about group ruling holders.

Gary: We’ve certainly had that experience in the church world.

Dessingue: At some point over the years, I’ve suggested that IRS might consider dedicating some staff to church issues or to group ruling issues. When you get to the call center, you’d have an option if you’re calling about a church or a group ruling where you could speak with a specialist on those issues.

Streckfus: In my conversations with agents over the years, I’ve never heard one of them mention churches other than staying away from them. Their concerns usually are with entities such as the VFW and other fraternal organizations whose subordinates can be troublesome because some of those posts are running bars and dining facilities open to the public with maybe gambling as an added attraction. I know of one case where agents went after a VFW post and the post complained to the local newspaper about being audited. I assume the local post was not filing a separate 990.

When you’re talking about supervision and control, my sense is that there’s probably not too much coming down from above in some of these veterans and fraternal organizations. Did you all get into that or did the IRS give you any feedback on what was going on there?

Gries: I think we all have all our examples of perhaps where we believe that maybe there was not quite as much general supervision and control occurring that should have been. I shared with the group my private college client in the Twin Cities area that was notified by Vanguard Charitable Fund that a donor wished to contribute to the institution, but was unable to do so because it did not have (c)(3) status. Upon investigation, it was discovered that the 501(c)(3) private institution was changed to a (c)(4) organization in the IRS’ system because a group ruling holder submitted their subordinate’s name – this was a student organization on campus — with the college’s EIN number on the annual notification. The IRS appropriately took the information that was signed by this group ruling holder reflecting the subordinate as being under the group ruling.

Your earlier example of the changing of your year-end for your organization, it’s a situation where computers don’t catch those types of errors and the IRS must rely on the submitted information being accurate. In the college situation, that group ruling holder should have known that the student organization on campus has a different EIN number this year from what we submitted in past years or that the people who put together the group return for that subset of subordinates in your organization, Deirdre, should have known that you’re not supposed to do that.

Dessingue: They know it now.

Joseph: And we thought that by adding more guidance about what is supervision or control would give standards to the central organizations. It would educate the subordinates and then it would give the agents information as well so that they could audit to an express standard.

Streckfus: I think that would be the biggest benefit of having individual 990s. My view is that most audits now occur because somebody has written the IRS saying we’ve looked at an organization’s 990, usually tipped off by an insider or someone familiar with the organization. So if I know the local VFW post is not following the rules, and my restaurant and bar is competing with them, I could complain to the IRS and presumably under your proposal the IRS could see what was being reported by that post.

Gary: That leads to another point I wanted to make. When one hears the words general supervision or control, one typically thinks about a corporate paradigm where one entity is, say, naming all the board members of the other entity. But that’s not the essence of what needs to be present. It’s that the central organization should be in a position of getting regular and reliable information about the activities of its subordinates so that it can use its ultimate leverage to bring them into compliance or remove them from the group. I think we can have very compliant group structures that don’t involve a corporate model of supervision or control. And we developed a facts and circumstances test that reflects this idea.

Streckfus: Deirdre, do you feel you have leverage over your subordinates?

Dessingue: Indeed. When the church lady speaks, people tremble.

Streckfus: They know they’re in trouble.

Dessingue: What have I done wrong now?

Gary: The final point I’d like to make is that the last formal guidance from the IRS on group exemptions was 30 years ago. Why is that? Because it’s a very tough issue that affects several hundred thousand organizations.

Dessingue: It was difficult.

Gary: It is a difficult issue for the IRS and it was a difficult project for us. In fact, we don’t even like each other anymore, and we’ve made enemies everywhere we go.

All: Death threats by e-mail.

Gary: It has destroyed all of us.

Dessingue: Do you remember Dave Flavin?

Streckfus: I was going to bring up his name up because when I was talking to Connie Rosenberg, I asked him why there was this 30-year gap since he and Dave had worked on group rulings.

Dessingue: Every person who touched the group ruling process has retired – first Dave Flavin, and then Jay Rotz got stuck with it.

Streckfus: Dave was the only one who was sincere about it. Everybody else tried to ignore the area.

Joseph: It was a very tough project and the ACT has taken on tough projects before. I think we didn’t know where we were going to come out when we started and we did have disagreements and discussions as a group but there were certain core principles that we agreed on throughout the entire process. Certainly, I think we all agreed very strongly that group rulings should be retained. We thought very strongly that we needed more guidance on supervision and control and that we needed to increase the transparency to make the system work better.

Gries: And the other item that we felt very strongly about was the Pub 78 issue — that organizations should be included in Pub 78.

Joseph: We were afraid of what Dan would do to us.

Dessingue: Did the IRS respond to that particular issue in the public meeting?

Roady: No, I don’t recall that they said anything about Pub 78.

Streckfus: And you’re also recommending a long transition period with lots of public input?

Roady: Yes, that’s the thing. Anybody who thinks that now that the ACT Report has been submitted, the IRS is going to something in the next month or year hasn’t been here for very long. There’s a regulation that authorizes group returns. So nothing can happen unless that regulation is changed and that’s a process that requires public comment. We did a lot of talking to people, talking to different stakeholders, but we think the IRS should get the broadest perspective that it can on this subject and then it would have input from everybody. So I don’t think anything would be likely to happen right away and not without lots of public input.

Dessingue: IRS can’t simply eliminate group returns.

Streckfus: They have to follow the Administrative Procedures Act standards, which now includes Treasury review.

Dessingue: Right. Group rulings, on the other hand, are administrative creations. They’re not in any statute. There’s reference to them in certain regulations, but it would be a tough argument to make that, because of the 6104(d) regs, IRS can’t do anything about group rulings. What is your thinking about the ability of the IRS to eliminate group rulings and what effect that would have?

Streckfus: To do what?

Dessingue: To announce that as of some date group rulings are no longer valid. Would that not be tantamount to a revocation of exemption for every organization in the group?

Roady: I can’t imagine the IRS would do that without issuing a notice and an opportunity for public comment. That is my personal opinion.

Joseph: I agree with Celia. We learned from the whole 990 revocation process and anything the IRS learned, and that was forced on them by Congress. That was not of their making but they learned a lot through that process, I think.

Roady: I’ll just say one more point. There are serious consequences if you get rid of group exemptions, people’s tax exemption goes away and you just can’t do that very lightly at all. The decision would require a lot of thought and analysis and certainly, I would hope, public comment. And then, we make the point that whatever changes there are, you need transition because you’re affecting organizations.

Joseph: A huge number of organizations.

Gary: Hundreds of thousands.

Joseph: 500,000, 600,000.

Roady: And we know that as with 990-Ns, there can be a lot of confusion about this subject because churches, whether they’re in a group ruling or not, they’re tax exempt. So are religious auxiliaries and there are lots of organizations that are covered by a group ruling that don’t need the group ruling to be tax exempt.

Gary: But they do use the group ruling to verify their exempt status to donors.

Roady: They have it for donor verification but any efforts to deal with changing that whole process would have to have a lot of guidance to make it clear that there are a lot of organizations that still wouldn’t have to come for exemption so it could be quite complicated.

Gries: Not that churches get a pass or anything, but to Celia’s point of saying let’s say the IRS were to choose to eliminate group rulings or the group exemption itself, churches are still exempt.

Joseph: And it’s not only churches, though, because (c)(4)s, (c)(5)s, (c)(6)s, they don’t have to go in for the exemption process. So it’s not just the churches that wouldn’t then have to go in.

Gary: On the other hand, there are church related organizations in group rulings that are not churches or integrated auxiliaries, and they would have to individually apply if group rulings were eliminated.

Gries: Right, exactly, so it would impact those organizations that are not churches or integrated auxiliaries.

Gary: Yes, some church related organizations would have to apply to the IRS.

Roady: Would churches or integrated auxiliaries that are on the EO business master file get stripped off of the EO business master file if you got rid of group rulings?

Dessingue: Probably because they’re not coded in any way.

Gries: But ideally your integrated auxiliaries shouldn’t have to.

Gary: But they’d have to be coded properly in the EOBMF.

Everyone speaking in unison: ***

Dessingue: And what about 7428? Has exemption been  revoked? Is there a right to seek redress in the courts?

Streckfus: Besides that one published comment of Holly’s, has anyone heard anymore from the IRS or is that all that is out there?

Roady: Yes, that’s all that’s out there. This is reflective of the analysis that our group went through when we talked about whether you should have group rulings or not. We went through the whole thinking process among ourselves about what the world be like without them.

Joseph: And we did think of 7428 and we thought about constitutional arguments which I think we put in a footnote so you could have constitutional claims made, you could have these revocation arguments made. So, again, it would be very messy.

Streckfus: Is the public justified in thinking that maybe the IRS does not agree with your recommendation not to eliminate group rulings?

Roady: I don’t think we know anything more than what Holly said and she just noted that the IRS thought it was time to look at it, too. I don’t think we know anything more than that.

Gary: As we said earlier, our Committee thoroughly discussed and debated the group return issue. But our primary focus was on group rulings themselves, should they continue and, if so, how should they be reformed?

Joseph: Right, and once we laid out all of the reasons, what would be the problems, how would we move from the current world to no group rulings? The number of problems and difficulties and hurdles just grew. I think we agreed after a lot of thought and discussion but still fairly quickly that that would not be the appropriate way to go.

Gary: And not to put too fine a point on it, but if group rulings are eliminated, so are group returns.

Dessingue: That would be interesting. Well, I have to admire you folks for addressing this issue because it’s been lurking about for a long time, even if only in the context of updating Rev. Proc. 80-27. You’re the first ones who have had the courage to tackle it head on.

Everyone speaking in unison: ***

Gries: It was an interesting topic.

Streckfus: I’m sure folks reading the transcript of this discussion will find it of interest and so on behalf of the sector I thank you all for taking the time to expand on and clarify your views on what has become a somewhat controversial topic. Dan can probably expect to get grilled when he participates in an ABA panel discussion on October 21, but he’s now well prepared. Thanks again.
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1 – ACT Reports Now Available

2 – Forms 990 and 990-T Developments (Part 2) Continue…

1 – Annual ACT Public Meeting

2 – Hank Williams the Greatest

3 – PPA Changes Stifling Federal-State Coordination

4 – ABC News Report on Newt Gingrich

5 – Forms 990 and 990-T Developments (Part 1) Continue…

1 – Two New EO ACT Members Selected

2 – More Deja Vu Continue…

Weekend reading thanks to Victoria Bjorklund and Phil Hackney. Their outline was sent out yesterday.

Update on Supporting Organizations and Donor-Advised Funds

What follows are the April 28 remarks of Victoria Bjorklund, Simpson, Thacher & Bartlett, New York, and Phil Hackney, Office of Chief Counsel, Internal Revenue Service, Washington, as delivered to attendees of the annual Georgetown Law program on Representing & Managing Tax-Exempt Organizations. The moderator is Celia Roady, Morgan, Lewis & Bockius, Washington. Continue…