4.76.2  Special Features of IRC 501(c)(3) Organizations

Manual Transmittal

November 20, 2014

Purpose

(1) This transmits revised IRM 4.76.2, Exempt Organizations Examinations Guidelines, Special Features of IRC 501(c)(3) Organizations.

Material Changes

(1) Removed all § marks and converted all IRC references to citations, that provide links to the IRC when accessed via IRM Online.

(2) Converted the manual to plain language for compliance with the Plain Writing Act of 2010, P.L. 111–274.

(3) Replaced references to examinations with audits.

(4) Replaced examiners with agents.

(5) Changed from passive voice to active voice where applicable.

(6) IRM 4.76.2.1(4): Added IRM 4.76.51 to the list of manuals for IRC 501(c)(3) organizations. Inserted new paragraph 4.76.2.1(5) defining "Agent" .

(7) IRM 4.76.2.2(1): Added bullets concerning legislative activities and disclosures in order to complete the list of IRC 501(c)(3) issues.

(8) IRM 4.76.2.3: Inserted new paragraphs 4.76.2.3 (1) through 4.76.2.3 (5) and 4.76.2.3 (7) through 4.76.2.3 (10), in order to distinguish between private benefit, inurement and excess benefits. Also added these paragraphs to distinguish between private interests, insiders and disqualified persons respectively.

(9) IRM 4.76.2.3.1: Renumbered paragraphs in subsection. Inserted new paragraphs at 4.76.2.3 (1), 4.76.2.3 (4), 4.76.2.3 (5), and 4.76.2.3 (7) in order to provide a more complete list of audit steps.

(10) IRM 4.76.2.4: Inserted new paragraph 4.76.2.4 (2) to further define what isn't lobbying.

(11) IRM 4.76.2.4.1: Inserted new paragraphs 4.76.2.4.1 (1), 4.76.2.4.1 (2), and 4.76.2.4.1 (7) in order to provide additional audit guidelines for lobbying activities. Added note and bullets to 4.76.2.4.1 (5) for clarification. Revised and added bullets to 4.76.2.4.1 (4) to update methods of legislative action and to keep up with technological changes.

(12) IRM 4.76.2.5: Added note to 4.76.2.5 (1) to cite pertinent sources. Added new paragraph 4.76.2.5 (2) to remind employees of IRC 4955.

(13) IRM 4.76.2.5.1: Inserted new subsection to add political intervention audit guidelines.

(14) IRM 4.76.2.6: Added sentence to 4.76.2.6 (1). Inserted new paragraphs 4.76.2.6 (2) and 4.76.2.6 (3) to add additional audit guidelines for contributions and receipts.

(15) IRM 4.76.2.6.1: Inserted new paragraphs 4.76.2.6.1 (1) and 4.76.2.6.1 (2). Added sentences to 4.76.2.6.1 (4), 4.76.2.6.1 (6), and 4.76.2.6.1 (7) for more clarification.

(16) IRM 4.76.2.7: Converted text to bullets in 4.76.2.7 (1). Added list to 4.76.2.7 (2) for clarification. Inserted notes for both paragraphs for clarification.

(17) IRM 4.76.2.7.1: Inserted new paragraphs 4.76.2.7.1 (1), 4.76.2.7.1 (2), 4.76.2.7.1 (4), and 4.76.2.7.1 (6) through 4.76.2.7.1 (9), to add and clarify audit guidelines for fund-raising activities.

(18) IRM 4.76.2.8: Inserted new paragraphs 4.76.2.8 (2), 4.76.2.8 (3), 4.76.2.8 (4), and 4.76.2.8 (5) to add audit guidelines for unrelated business income. Converted list in 4.76.2.8 (8) into a table for clarification.

(19) IRM 4.76.2.9: Inserted new subsection, Tax Exempt Bonds.

(20) Exhibit 4.76.2-1: Inserted new table for a sample charitable remainder trust calculation.

Effect on Other Documents

This IRM supersedes IRM 4.76.2, dated 05-15-2003.

Audience

Tax Exempt and Government Entities
Exempt Organizations
Examinations

Effective Date

(11-20-2014)

Tamera L. Ripperda
Director, Exempt Organizations
Tax Exempt and Government Entities

4.76.2.1  (11-20-2014)
Introduction

  1. This IRM section contains specific audit guidelines for IRC 501(c)(3) organizations, including organizations classified as public charities described in IRC 509(a)(1), IRC 509(a)(2), or IRC 509(a)(3), and private foundations described in IRC 509(a) or IRC 4942(j). This expanded section provides updated audit techniques and examples to keep up with the new forms and technology.

  2. These guidelines provide specific guidance for auditing IRC 501(c)(3) organizations and are not all-inclusive. The purpose is to supplement the guidelines contained in IRM 4.75.10, Exempt Organizations Pre-Audit Procedures through IRM 4.75.16, Case Closing Procedures.

  3. This IRM provides general information for identifying issues. When identifying an issue, refer to IRM 4.76.3, Public Charities, or IRM 4.76.4, Private Foundations, for further issue development.

  4. See the following IRM sections for audit guidelines and procedures for specific types of IRC 501(c)(3) organizations:

    • IRM 4.76.5, Non-Exempt Charitable And Split Interest Trusts

    • IRM 4.76.6, Religious Organizations

    • IRM 4.76.7, Churches

    • IRM 4.76.8, Private and Charter Schools

    • IRM 4.76.9, Public Interest Law Firms

    • IRM 4.76.11, Educational Organizations Other Than Schools

    • IRM 4.76.12, All Other IRC 501(c)(3) Organizations

    • IRM 4.76.51, Fund-Raising Activities

  5. "Agent" refers to the EO employee assigned to work the case regardless of whether the employee is in the GS-0512, GS-0526, GS-0592, or GS-0987 series.

4.76.2.2  (11-20-2014)
Audit Scope

  1. An IRC 501(c)(3) audit should serve the following objectives to:

    1. Ensure the organization operates for public purposes rather than private interests.

    2. Determine if the organization engages in any substantial nonexempt activity, such as social or recreational activities.

    3. Ensure that the organization protects and preserves its assets exclusively for IRC 501(c)(3) purposes.

    4. Evaluate the organization’s procedures to account for funds disbursed to individuals or non-IRC 501(c)(3) organizations.

    5. Determine if the organization pays, directly or indirectly, any excessive compensation, fees, allowances or taxable benefits.

    6. Determine if the organization engages in legislative activities.

    7. Determine if the organization directly/indirectly participates in/intervenes in, any political campaign on behalf of/in opposition to any candidate for elective public office.

    8. Determine the organization's foundation status.

    9. Ensure the organization provided a fair and accurate disclosure of its activities and financial information on its returns, which may be relied upon by its contributors.

4.76.2.3  (11-20-2014)
Inurement, Excess Benefit Transactions, Private Benefit

  1. Private benefit involves benefits to anyone other than the intended charitable class. Such private interests may include insiders, related persons or unrelated third parties. "Inurement," on the other hand benefits insiders such as officers and directors. See Rev. Rul. 76-206, 1976-1 C.B. 154, for an analysis of private benefits.

  2. Be aware of the difference between "private benefit" and "inurement." Inurement is revocable, applicable to those on the inside or in control of the organization. Private benefit is revocable if the benefits to private interests are more than incidental. Thus, to retain a tax-exempt status under IRC 501(c)(3), private benefit must be qualitatively and quantitatively incidental to the accomplishment of exempt purposes. See paragraphs (2) and (3) of IRM 7.25.3.16.7.1, Incidental Private Benefit.

  3. Insiders, substantial contributors and their related persons can further be described as "disqualified persons" for excise tax and foundation classification purposes. Use IRC 4946 and IRC 4958 to determine which family members and entities related to a disqualified person are themselves disqualified persons.

  4. IRC 4958 imposes excise taxes (commonly referred to as intermediate sanctions) on transactions that provide excess economic benefits to disqualified persons with respect to public charities.

    Caution:

    See special rules for donor advised funds and supporting organizations described in the Instructions to Form 4720.

    Note:

    In some cases you can propose an assessment of these excise taxes on a disqualified person, as defined in IRC 4958 (f)(1), and propose revocation of tax-exempt status for inurement to an insider, where the disqualified person and the insider are the same person with respect to the same transaction. In determining whether to revoke exemption in addition to assessing IRC 4958 tax, refer to Treas. Reg. 1.501(c)(3)-1(f).

  5. Generally intermediate sanctions are proposed in those cases where an excess benefit doesn't rise to the level of calling into question the tax-exempt status of an organization. IRC 4958 encourages correction of the excess benefit transaction. For more on intermediate sanctions, refer to IRM 7.27.30, Taxes on Excess Benefit Transactions.

  6. During the audit of an IRC 501(c)(3) organization, determine if the organization engaged in any financial transactions, including payment of compensation, which may result in inurement, an excess benefit transaction, or an impermissible private benefit. An "excess benefit transaction" (EBT) is a transaction in which the organization provides an economic benefit, directly or indirectly, to or for the use of a disqualified person and the value of the benefit provided exceeds the value of the consideration (including the performance of services) received in return.

  7. For treatment of a benefit as consideration for the performance of services, the organization providing the benefit must indicate its intent to treat the benefit as compensation when the benefit is paid. The organization generally must provide contemporaneous written substantiation by reporting the benefit as compensation on a federal tax information return:

    • Form 990, Return of Organization Exempt From Income Tax

    • Form Schedule L, Form 990, Transactions with Interested Persons

    • Form 1099-MISC, Miscellaneous Income

    • Form W-2, Wage and Tax Statement

    Note:

    The recipient disqualified person can also report the benefit as income on his/her original federal tax return (e.g., Form 1040, U.S. Individual Income Tax Return). See Treas. Reg. 53.4958-4(c).

  8. Some of the compensation and fringe benefits to focus upon include:

    • Payments in a later year for services performed in a prior year.

      Note:

      Prior services may be taken into account in determining reasonableness. See Treas. Reg. 53.4958-4(a)(1).

    • Expense reimbursements (which may be disregarded if made pursuant to an accountable plan). See Treas. Reg. 53.4958-4(a)(4)(ii).

    • Loans. For special rules regarding below-market loans see Treas. Reg. 53.4958-4(b)(1)(ii)(B)(3).

  9. For purposes of intermediate sanctions, disregard fringe benefits excluded from income under IRC 132. These include:

    1. No additional cost services

    2. Qualified employee discounts

    3. Working condition fringe benefits

    4. De minimis fringe benefits

    5. Qualified transportation fringe benefits

    6. Qualified moving fringe benefits

  10. The above listing and discussion of fringe benefits is not exhaustive. See Pub. 15-B, Employer’s Tax Guide to Fringe Benefits, for more information about and discussion of many other fringe benefits.

4.76.2.3.1  (11-20-2014)
Inurement, Excess Benefit Transactions, Private Benefit Audit Guidelines

  1. Begin with the organization’s responses to Form 990 Part IV, questions 25-28. Follow up with a review of Schedule L.

    Note:

    If the organization filed Form 990 for the period when the excess benefit transaction occurred but didn't adequately report the transaction, the period of limitations may extend to six years. See IRC 6501(e)(3).Obtain a Counsel opinion as to whether the six-year statute applies.

  2. Review the meeting minutes, by-laws, and similar documents to identify all disqualified persons.

  3. An analysis of employees receiving compensation includes a look at all forms of cash and non-cash compensation including:

    • Salaries

    • Fees

    • Bonuses

    • Revenue sharing arrangements

    • Severance payments

    • Deferred compensation

    Don't assume that the employees’ contracts list everything.

  4. Review the employee handbooks, board minutes, etc. for "other compensation" which may include:

    • Payments for liability insurance premiums

    • Payments for the employee’s penalties

    • Tax expenses

    • Civil proceeding costs

    • Expenses resulting from an act or failure to act

    • Expense reimbursements paid under a non-accountable plan.

  5. Review the balance sheet for:

    • Foregone or below market interest loans

    • Lending of assets

    • Property transfers.

  6. You may disregard expense reimbursements made under an accountable plan for purposes of an excess benefit transaction analysis. You may still encounter the issue as part of the package audit or an employment tax audit. For a full discussion, see IRM 4.76.3, Public Charities.

  7. To successfully develop an IRC 4958 case, perform the following audit steps:

    1. Uncover clues in the preaudit analysis of the Form 990 balance sheets such as promissory notes, loans or the value of equipment.

    2. Use focused initial interviews to clarify the relationships with related parties, the existence of credit and charge cards, expense accounts and notes signed with disqualified persons.

    3. Determine disqualified persons by reviewing the initial application, bylaws and board minutes.

    4. Use information document requests to obtain and review legal documents including promissory notes, demand loans and agreements between related parties.

    5. Audit the general ledger, bank statements and cancelled checks, to compile tables of questionable expenditures, and to request receipts and information on the exempt purpose of those expenditures.

    6. Review the organization’s website and organizational brochures to clarify whether the charitable programs and outreach described by the organization ever existed.

  8. The term private benefit includes excessive benefits provided to persons other than private shareholders or individuals within the meaning of IRC 501(c)(3). Prohibited private benefit may involve non-economic benefits as well as economic benefits. Prohibited private benefit may arise regardless of whether payments made to private interests are reasonable or excessive. An organization isn't subject to the loss of its exempt status if an insubstantial part of its activities is found to be serving a private interest. Refer to IRM 4.76.3.11.3, Private Benefit, for a full discussion.

  9. Review bylaws and initial applications to determine if the board of directors is closely controlled. Review contracts and lease agreements for indications of private benefit.

4.76.2.4  (11-20-2014)
Lobbying Activities

  1. IRC 501(c)(3) states that no substantial part of the activities of an otherwise qualified organization may be the carrying on of propaganda or otherwise attempting to influence legislation. Identify legislative activities such as:

    1. Direct lobbying by the organization or its officers to directly influence legislators.

    2. Grassroots campaigns, in which the organization urges the public to contact legislators to express opinions concerning a piece of legislation for the purpose of proposing, supporting or opposing legislation.

  2. The following aren't considered lobbying:

    • Nonpartisan analysis, study, research and publishing the results for the benefit of the general public. See Rev. Rul. 64-195, 1964-2 C.B. 138 and Rev. Rul. 70-79, 1970-1 C.B. 127.

    • Testifying at the request of a legislative committee as an expert witness on pending legislation affecting the organization. See Rev. Rul. 70-449, 1970-2 C.B. 111.

4.76.2.4.1  (11-20-2014)
Lobbying Activities Audit Guidelines

  1. Read the organization’s minutes and newsletters for mention of legislative efforts or events.

  2. Use Internet search engines to scan media ads and announcements by the organization that are indicative of legislative efforts or events that constitute advocacy.

  3. Review itemized billings or reports by contractors retained by the organization to monitor legislation to determine the amount of lobbying conducted by the contractors.

  4. Review the organization's publications, websites, financial records. Interview the officers. Determine whether the organization engaged in the following in furtherance of their legislative interests:

    1. Articles or paid advertisements in newspapers or magazines, radio and television or the Internet.

    2. Television, radio, Internet or other public commentaries.

    3. Web pages with "mission statements" and related links advocating a legislative interest.

    4. Articles published by the organization.

    5. Direct mail campaigns.

  5. Analyze disbursements to determine if the organization:

    1. Made contributions to organizations engaged in legislative activities.

    2. Made payments to attorneys or other intermediaries for legislative purposes of the organization.

      Note:

      These payments are frequently charged to advertising or professional fees and services accounts.

    3. Directly leased or rented locations and/or equipment for legislative efforts and events.

    4. Reimbursed amounts relating to agreements and contracts entered into by the organization concerning the lending or sharing of equipment and facilities.

  6. Analyze dues paid to parent organizations and state or national organizations. Determine if any portion of the dues are used for legislative activities. You might impute this activity to the subsidiary organization paying the dues.

  7. Review payroll accounts and company time schedules. Look for evidence of any employees who may have worked on legislative campaigns for other organizations (shared employees).

  8. If the organization is a public charity and has engaged in legislative activity, determine if it made the IRC 501(h) lobbying expenditures test election. If not, it's governed by the substantiality test of IRC 501(c)(3). See IRM 4.76.3.12.3, Nonelecting Organizations, for more about non-electing organizations.

4.76.2.5  (11-20-2014)
Political Campaign Intervention

  1. An IRC 501(c)(3) organization is prohibited from participating in or intervening in any political campaign. This prohibition includes publishing or distributing campaign statements on behalf of or in opposition to candidates, as well as payments for campaign expenses. The sources set forth in IRM 4.76.2.4.1 also apply in finding evidence of political activity.

    Note:

    See Rev. Rul. 78-248, 1978-1 C.B. 154, Rev. Rul. 80-282, 1980-2 C.B. 178, Rev. Rul. 2007-41, 2007-1 C.B. 1421, and the 2002 CPE I. Election Year Issues, for a discussion of certain "voter education activities."

  2. Be aware of IRC 4955, subjecting IRC 501(c)(3) organizations to an excise tax on political expenditures. Refer to IRM 4.76.3.13.6, Resolution of Political Activities and IRC 4955, for a full discussion.

4.76.2.5.1  (11-20-2014)
Political Intervention Audit Guidelines

  1. Assemble a trail of information to substantiate any political activity you encounter.

  2. Review the organization’s website for "mission statements" as well as links to related sites that may advocate for or against a political candidate or party. Pay specific attention to links to non-IRC 501(c)(3) organizations or IRC 527 political action committees (PACs) that may engage in such activities.

  3. Research the use of multiple websites set up to receive petitions for candidates.

  4. Inspect contracts with Internet service vendors, noting what customized services they agree to provide.

  5. Review the organization’s minutes and newsletters for an endorsement of a political event or candidate for office.

  6. Review cash disbursements along with the corresponding checks for earmarks of payments to:

    • Candidates

    • Political parties

    • Political action committees

    • Labor unions

    • Trade associations

  7. Review contracts and agreements to discover leasing and sharing of equipment, facilities or employees by the organization.

  8. Use Internet search engines, to discover media ads and announcements by the organization sponsoring political events for specific candidates for office.

  9. Review expense reimbursements for campaign contributions or travel.

4.76.2.6  (11-20-2014)
Contributions and Receipts

  1. IRC 170 treats contributions received by an organization generally described in IRC 501(c)(3) as deductible by the donor unless there are restrictions on the use of the funds which benefit the donor or which further other noncharitable purposes. Donor-imposed restrictions on property reduce or eliminate the amount the donor can claim as the deduction . See Rev. Rul. 85-99, 1985-29 IRB 7 and Rev. Rul. 64-205, 1964-2 C.B. 62.

  2. Restricted contributions can result in the loss of all or a significant portion of the donor’s deduction. See IRM 4.75.28.3, Identifying Discrepancy Adjustments.

  3. For larger donations of restricted real estate, restrictive easements, restricted collections, artworks, etc., consider a Form 5666, TE/GE Referral Information Report, referral to another operating division. See IRM 4.75.28.2, Referrals to Other Operating Divisions. Look for Schedule M, Form 990, Noncash Contributions.

  4. Larger organizations have specialized departments that solicit contributions in the form of cash, stocks, bonds, property, as well as life estate and annuity programs.

4.76.2.6.1  (11-20-2014)
Contributions and Receipts Audit Guidelines

  1. In the preaudit analysis, review:

    • Form 990, Part I, Line 8

    • Form 990, Part IV, Line 2

    • Form 990, Schedule B, Schedule of Contributors

    • Form 990, Schedule D, Supplemental Financial Statements

    • Form 990, Schedule M, Noncash Contributions

  2. Review the analogous parts of Form 990-EZ if filed by the organization. organizations that submit Form 990-N won't have such parts to review.

  3. Review minutes, balance sheets and newsletters concerning contributions and grants received. Determine if their use is restricted. If so, determine if the restrictions serve donor's business or personal purpose.

  4. Review correspondence files for any acknowledgment letters provided to the donors of restricted contributions. Determine if the organization properly notified the contributor of the portion of the payment that represents a quid pro quo contribution. For more on quid pro quo contributions, refer to IRM 4.76.51.7.2, Quid Pro Quo Contributions.

  5. If a restricted grant is received, determine that the restricted use doesn't violate the organization's exempt purposes. A future interest in tangible personal property isn't an IRC 170 deduction until all intervening rights have expired.

  6. The charitable remainder annuity trust pays a specific amount to its non-charitable beneficiary every year. The amount of the contribution that actually passes to the charity cannot be determined until the expiration of the non-charitable interest. You may need to contact SB/SE division’s Abusive Tax Promoter Groups should the present value of the remainder interest show a depleted balance. Refer to http://www.irs.gov/Retirement-Plans/Actuarial-Tables for the location of actuarial tables and federal rates. (See IRM 4.76.5 for more on trusts).

  7. Determine whether all charitable remainder annuity trusts, charitable remainder unitrusts and pooled income funds meet the requirements of IRC 170(f), and IRC 664(d), and whether a reasonable valuation was placed on the contributed assets. For a sample calculation concluding that a charitable remainder trust wasn't valid, refer to Exhibit 4.76.2-1.

4.76.2.7  (11-20-2014)
Fund-raising Activities

  1. Under IRC 170, the donor is responsible for determining the value of his/her donation. However, some organizations give receipts to donors for the fair market value (FMV) of the donation based on either:

    • The organization’s appraisal of the donation.

    • The donor’s statement as to the value.

    Note:

    Refer to Pub. 561, Determining the Value of Donated Property, for more on property valuation.

  2. IRC 170(f)(8) specifies that no deduction shall be allowed for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement from the donee organization that includes the following:

    1. The name of the donee organization as well as the date of the contribution.

    2. The amount of the cash contribution.

    3. A description (but not the value) of a non-cash contribution.

    In addition to one of the following:

    1. A statement that no goods or services were provided to the organization in lieu of their contribution (if applicable).

    2. A description and a good faith estimate of the value of the goods and services (if any) that the organization provided in lieu of their contribution.

    3. A statement that goods and services provided in lieu of their contribution were actually intangible religious benefits.

    Note:

    See also IRC 170(f)(17) for a donee’s record keeping requirement for gifts of money, and Pub. 1771, Charitable Contributions-Substantiation and Disclosure Requirements, for more on record keeping.

4.76.2.7.1  (11-20-2014)
Fund-raising Activities Audit Guidelines

  1. Form 990 is becoming more transparent at disclosing fund-raising costs. Beginning with the 2013 return, organizations must include the salaries of professional internal fund-raisers in addition to contracted fund-raisers on Part I, Line 16(a).

  2. Review the answers to Part IV, Lines 14, 15, 16, 17, 18, and 29. Follow up with reviews of:

    • Schedule F, Statement of Activities Outside the United States

    • Schedule G, Supplemental Information Regarding Fundraising or Gaming Activities

  3. Review records of contributions, especially valuations of closely held stocks and bonds, personal property, and real property. Determine if assigned values are reasonably valued within the valuation guidelines in Pub. 561.

  4. Review Schedule A, Public Charity Status and Public Support, on Form 990 where publicly supported organizations must segregate their revenues from fund-raising activities. Be alert, especially on Schedule G, to the netting of fund-raising expenses against fund-raising income.

  5. If the organization sold any donated property soon after receipt, compare the sales price (if at arm's length, it's the most likely indication of FMV) with the value assigned on the receipt given to the donor. Refer to IRM 4.76.51 for additional guidelines on fund-raising activities.

  6. For larger donations that are more difficult to value (art and jewelry collections, real estate rights, etc.), refer to IRM 4.48.1, Overview of Engineering Program, on contacting a valuation expert.

  7. Be alert to organizations acting as fund-raising conduits for others. These organizations report contributions that the organization has never handled, skewing the accuracy of the percentage of fund-raising expenses. This may indicate that the organization tries to make itself more attractive to donors through deceptive means.

  8. Beginning the audit with fund-raising can uncover the possibility of inurement and private benefit. If applicable, document how the fund-raising efforts of the organization were pre-determined to benefit the interests of a selected class of recipients or recipient. See Capital Gymnastics Booster Club, Inc. v. Commissioner of Internal Revenue, T. C. Memo 2013-193) and Wendy L. Parker Rehabilitation Foundation, Inc. v. Commissioner of Internal Revenue, T.C. Memo. 1986-348.

  9. Impose penalties under IRC 6652(c) where appropriate. Refer to IRM 20.1.8, Employee Plans and Exempt Organizations Miscellaneous Civil Penalties, for descriptions and procedures for assessing penalties.

4.76.2.8  (11-20-2014)
Unrelated Business Income

  1. Any IRC 501(c)(3) audit includes a review of activities that generate revenue to determine if the organization has unrelated business income.

  2. Interview the directors, officers, trustees, key employees and the personnel conducting the activity. Determine the motive for conducting the activity. Find out how the activity was conducted.

  3. Review the organization’s website and its meeting minutes for:

    • Information relating the activity to the organization’s exempt purpose.

    • Expectations and progress reports on the activity.

  4. Follow up with requests to the organization for all documentation concerning the conduct of the activity. This can include written orders and procedures, publications and contracts.

  5. Compare the exempt organization's conduct of the activity to that of a for-profit entity performing the same activity. The comparison should be both financial and operational.

  6. Determine whether the business activity is regularly carried on, similar to comparable commercial activities of nonexempt organizations.

  7. If an unrelated business is regularly carried on, determine whether the business activity is substantial enough to jeopardize the exempt status of the organization.

  8. For possible sources of unrelated business income, analyze the following activities where appropriate:

    Activity Guidance
    Sales of mailing lists Rev. Rul. 72-431, 1972-2 C.B. 281
    Sales of pharmaceutical items by a hospital to non-patients Rev. Rul. 68-374, 1968-2 C.B. 242
    Sales of unrelated books and souvenirs by a museum Rev. Rul. 73-105, 1973-1 C.B. 264
    Commercially sponsored scientific research if the results aren't made available to the general public Rev. Rul. 76-296, 1976-32 IRB 6
    Operating a medical illustration department by a medical research foundation Rev. Rul. 57-313, 1957-2 C.B. 316
    Publication and sales of a book on a topic not related to the organization’s exempt purpose Rev. Rul. 69-430, 1969-2 C.B. 129
    Providing pet boarding and grooming services to the public by organizations preventing cruelty to animals Rev. Rul. 73-587, 1973-2 C.B. 192
    Sales of art objects at exhibits Rev. Rul. 76-152, 1976-17 IRB 18
    Sales of advertising space in EO journal Rev. Rul. 76-93, 1976-11 IRB 11
    Rentals universities of sports facilities such as stadiums, swimming pools, ski slopes, skating rinks Rev. Rul. 76-402, 1976-2 C.B. 177
    Sales of heavy duty appliances to senior citizens by an exempt senior citizens center Rev. Rul. 81-62, 1981-1 C.B. 355
    Rentals of university stadiums to professional football teams for several months of the year Rev. Rul. 80-298, 1980-2 C.B. 197
    Operation of health club facilities Rev. Rul. 79-360, 1979-2 C.B. 236
    Operation of miniature golf courses Rev. Rul. 79-361, 1979-2 C.B. 237
    Travel tour programs operated by university alumni associations Rev. Rul. 78-43, 1978-1 C.B. 164 and Treas. Reg. 1.513-7
    Hospitals conducting diagnostic testing for private office patients Rev. Rul. 85-110, 1985-30 IRB 18
    Operation of a horse racing meet by fair associations Rev. Rul. 68-505, 1968-2 C.B. 248
    Inspection, testing and safety certification of cargo shipping containers Rev. Rul. 78-426 , 1978-2 C.B. 175
    School leasing tennis facilities to the public Rev. Rul. 80-297 , 1980-44 IRB 11

4.76.2.9  (11-20-2014)
Tax Exempt Bonds

  1. Unique to IRC 501(c)(3) organizations is their ability to issue tax exempt bonds much like a governmental entity. Be aware of the existence of tax exempt bonds when conducting your audits. All proposed revocations of IRC 501(c)(3) organizations that issued tax exempt bonds require referrals to Tax Exempt Bonds (TEB). Refer to IRM 4.75.31.7.4, Effect on Tax Exempt Bonds and IRM 4.75.31.7.4.1, Referral to Tax Exempt Bonds (TEB).

  2. During an audit an organization may want to voluntarily come forward with bond related violations. Follow Notice 2008-31, 2008-1 C.B. 592 concerning the Voluntary Closing Agreement Program.

  3. Find more detailed technical information on bonds in Pub. 4077, Tax Exempt 501(c)(3) Bonds Compliance Guide.

Exhibit 4.76.2-1 
Sample Charitable Remainder Trust Calculation

To determine whether a charitable remainder trust is a valid trust, you must perform a series of computations, which can be segregated into two parts. Pub. 1458, Actuarial Valuations Version 3B. Examples A and B outline the computations for identifying an adjusted payout rate and a single life remainder interest.

In the first part, you identify whether an adjusted payout rate applies. If the unitrust makes the annual distributions in the form of installments paid periodically during the year, or if the unitrust makes payments annually at a time during the year other than one year from the annual valuation date, you need to adjust the payout rate to reflect the periodic installments and the period of time between the annual valuation date and the payments. This results in an adjusted payout rate, which you use to find the factors in the actuarial tables.

Example:

On March 1, 2012, a person who is nearest to age 57 contributes $5,000,000 to a charitable remainder unitrust. The trust pays to her the lesser of 15 percent per year of the annually computed value of the trust assets, or the trust net income, paid in equal quarterly installments at the end of each calendar quarter. After her death, the trust distributes the remaining corpus to a qualified charity.
We assume that the unitrust pays out 15 percent per year in equal quarterly installments at the end of each quarter, and that the standard annual valuation date is the last day of the trust year, December 31.

Note:

Whether or not the trust is initiated and funded on another date during the year creating a short trust year is irrelevant, as this initial short trust year isn't used to determine the period from the standard annual valuation date to the first periodic payment each year.

We assume that the unitrust interest involved is to be valued at the IRC 7520 interest rate of 1.4 percent (IRC 7520 rate for June 2013, found at http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Section-7520-Interest-Rates-for-Prior-Years#2013). Time periods are rounded to the nearest whole number of months. Based on these facts, the adjusted payout rate is 14.870 percent, determined as follows:

Adjusted Payout Rate Computation
Applicable IRC 7520 Interest Rate = 1.4 %
Quarterly Payout Adjustment Factor
Table F(1.4)
= .991356
(First payment made at least 3 months but less than 4 months from annual valuation)
Stated Annual Payout Percentage = 15.0 %
Adjusted Payout Rate = 15.0 %
  x .991356
  = 14.870 %

Under IRC 7520 , if a charitable contribution is allowed for a transfer of property to the trust, the taxpayer may elect to use either the IRC 7520 rate for the month of transfer or the rate for either of the two preceding months. We assume the taxpayer elects to use the rate for the month of transfer, 1.4 percent.

The trust pays the lesser of the stated payout rate of 15 percent or the trust net income . Under the provisions of Treas. Reg. 1.664-4(a)(3), we compute the remainder interest based on the trust’s stated payout rate of 3 percent. Using the method illustrated above, the adjusted payout rate is found to be 14.870 percent. The required remainder factor is found by using the remainder factors found in Table U(1) for adjusted payout rates immediately above and below this adjusted payout rate, and interpolating between these factors for the remainder factor at the adjusted payout rate of 14.870 percent.

Present Value of Remainder Interest Computation
Remainder Factor, Table U(1), at 14.8 % = .08147
Remainder Factor, Table U(1), at 15.0 % = .07980
Difference = .00167
(14.870% - 14.8 %)/(15.0% - 14.8%) = X / .00167
X = ( .00070 / .002 ) * .00167
X = . 00058
Remainder Factor at 14.8 % = .08147
minus X = .00058
Required Interpolated Remainder Factor at 14.870 % = .08089
times Initial Trust Corpus Value = $5,000,000.00
Present Value of Remainder Interest = $404,450.00

IRC 664(d)(2)(D) states that, with respect to each contribution of property to the trust, the value (determined under IRC 7520 ) of such remainder interest in such property is at least 10 percent of the net fair market value of such property as of the date such property is contributed to the trust.

Required Value of Remainder Interest Computation
Initial Trust Corpus Value = $5,000,000.00
Remainder Interest 10% = .10
Required Value of Remainder Interest = $500,000.00

Present value of remainder interest for the trust at 15%, as specified in the trust document, is $404,450.00. The required IRC 664(d)(2)(D) remainder interest value for the trust is $500,000.00 (10% of trust value at the date of contribution). This trust doesn't meet the minimum present value remainder interest required by IRC 664(d)(2)(D) and therefore isn't a valid charitable remainder trust.


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