Tax Takeaways for Tax-exempt Organizations
During AAFCPAs’ Nonprofit Seminar (April 2023), Joshua England, LLM, Esq. and Chris Consoletti, Esq. updated more than 400 attendees on the latest tax issues, laws, and procedures affecting tax-exempt organizations. In their presentation, they offered an overview of accomplishments made by the IRS last year and its objectives this year. They also discussed the Employee Retention Credit and the Inflation Reduction Act.
The full session was recorded and may be viewed at your convenience. >>
Opening the presentation was a discussion on approximately $80 billion in funding granted to the IRS through the Inflation Reduction Act, which has been earmarked for new staffing. Last year, the IRS Tax-Exempt and Government Entities Division was able to conduct just 3,425 examinations. Out of millions of nonprofit organizations, this translates into a less than .01 percent chance of being audited in any given year. Of those audits, 78 percent did not result in any sort of tax change. However, audits did strip 53 tax-exempt organizations of their nonprofit status. Most scrutiny seemed to involve employee 1099 versus W-2 status determination.
The Tax-Exempt and Government Entities Division at the IRS is also charged with the review of 1023 and 1024 nonprofit applications. In 2022, the IRS closed 136,708 applications. Of the 119,926 approvals, 113,850 were 501(c)(3) nonprofit applications. A recent shift to an online application process might have helped the IRS review such a substantial quantity.
What to watch in 2023.
- Group Exemption Letters. The IRS plans to look at regulations for group exemption letters, potentially revamping their model.
- Final Regulations on Supporting Organizations. The IRS is looking at regulations on supporting organizations. If you are a supporting organization, AAFCPAs can provide guidance on those regulations, which are expected to be finalized this year.
- The Unrelated Business Taxable Income (UBTI) Siloing Rules of Section 512(a)(6). The IRS is slated to issue regulations discussing the siloing of activities regarding the unrelated business income tax laws passed by Congress a few years ago. Specifically, for any unrelated business income tax activity, you may only deduct expenses for that activity against that activity’s income versus distributing deductions across all activities.
- Private Foundation Investments in Partnerships. For private foundations, the IRS is looking at rules for investing in partnerships in which disqualified individuals are also partners. This is to discourage nonprofit foundations from supporting partnerships that also benefit the Foundation’s donors.
- Donor Advised Funds (DAF). DAFs are only allowed to make distributions to 501(c)(3) organizations. To ensure DAFs only make contributions to 501(c)(3) organizations, the IRS might potentially assess a 20 percent excise tax on sponsoring organizations making distributions to individuals. The IRS is also considering a 125 percent excise tax on any distributions that could cause an incidental benefit to the donor plus a 25 percent tax on any individual receiving that benefit. Also being considered are regulations to require organizations to look through the DAF contributions to the underlying donor to ensure that the donation is not disqualified from the public support test. The IRS is further considering requiring DAFs to make minimum required distributions on an annual basis.
- Charitable Contributions. The IRS has been strict in its scrutiny on charitable contributions lately. We’ve noted two cases where significant charitable contributions were disallowed because the individual did not meet all of the requirements for deducting the donation on their personal return.
- Employee Retention Credit (ERC). The ERC is a valuable credit. However, AAFCPAs cautions clients and organizations from engaging with fly-by-night consultants who promise large ERC sums. Those consultants typically receive an upfront fee only to leave businesses on the hook when the IRS conducts an audit years later. Many consultants will claim that you qualify, but this might not be true. We strongly encourage clients to work with AAFCPAs’ Task Force to make sure you get the retention credit to which you are entitled.
The Inflation Reduction Act and Direct Payments
The Inflation Reduction Act extends, codifies, and creates many tax credits that in the past, absent filing a Form 990-T, tax-exempt organizations had little use for unless they constructed the eligible clean energy property themselves. In response, the Inflation Reduction Act lets certain non-taxable entities receive certain credits as direct payments effective in tax years after December 31, 2022.
Tax-exempt organizations are now allowed to receive certain tax credit amounts as direct payments. This includes not only 501(c)(3)s but 501(c)(4)s and 501(c)(6)s. What’s particularly important in Massachusetts is that state and political subdivisions are also included, making charter schools eligible to receive direct payments for certain eligible credits.
Of all the credits eligible for direct payments, perhaps the most relevant for nonprofits are the Production Tax Credit and the Investment Tax Credit, the latter of which may benefit the greatest number of tax-exempt organizations. This tax credit applies when certain eligible property is placed into service, which includes solar panels, wind turbines, or other renewable or clean energy products. This direct credit begins at six percent and can increase to as much as 30 percent of the cost of the clean energy property if certain criteria is met. This credit is set to sunset or go away by December 31, 2034, absent an extension. Tax exempt organizations must elect for the credit no later than the due date of the taxable year in which the credit is applied. No guidance has been provided as to how applicable credits will be substantiated. AAFCPAs can advise and assist clients in maximizing their credit.
AAFCPAs stays up to date on changing tax laws and procedures, and we will issue guidance as appropriate. We help clients determine whether they have eligible property that may entitle them to a credit or direct payment, and we also analyze whether future projects might qualify.
If you have questions, please contact Joshua England, LLM, Esq., Partner & Tax Attorney at firstname.lastname@example.org, Chris Consoletti, Esq., Tax Consulting Attorney at email@example.com—or your AAFCPAs partner.