Tax Exempt & Government Entities – Compliance Program and Priorities

 

The Tax Exempt and Government Entities (TE/GE) Fiscal Year 2021 Program Letter lists our priorities and how those align with the IRS Strategic Goals.

In fiscal year 2021, we’ll continue to pursue our compliance program described in our FY 2020 Program Letter, and use this webpage to share information about other compliance program initiatives at the end of each quarter during the fiscal year. We will also share our findings from recently completed compliance program initiatives.

Here in TE/GE, we protect the public interest by applying the tax law with integrity and fairness to all.  We continue to move toward issue-based examinations and a compliance program that focuses on high risk issues using one or multiple treatment streams. A treatment stream is a single or a combination of compliance actions that we will implement to achieve an initiative’s goal. The idea is to respond with the right treatment stream to maintain high compliance across the TE/GE filing population. This approach makes efficient use of IRS knowledge and deploys the right resources to address noncompliance issues.

Our compliance program involves a thorough analysis of data to support the identification and evaluation of a compliance issue, a deliberate consideration of potential treatment streams, decisions about the resources to be deployed, identification of training, and tools needed, as well as a robust feedback mechanism to ensure all elements of an initiative are continuously improved. Our compliance program consists of six components that work together to promote tax law compliance by tax-exempt and government entities.  

Compliance Strategies

Issues approved by the TE/GE Compliance Governance Board to identify, prioritize and allocate resources within the TE/GE filing population, primarily through the examination treatment stream.

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This strategy will review worker classification to ensure taxpayers aren’t reducing their tax burden by incorrectly treating workers as independent contractors instead of employees. Worker misclassification results in employers underreporting and underpaying Federal Insurance Contributions Act (FICA) and Federal Income taxes and may also result in incorrect exclusion from employer retirement plans. The treatment stream for this strategy is examinations.

The focus of this strategy is to review retirement plans of small exempt organizations to determine whether the plan investments are properly administered, whether there are any party-in-interest transactions in the plan trust and whether any participant loans violate Internal Revenue Code (IRC) Section 72(p). Improper transactions between the plan and its participants can result in prohibited transactions under IRC Section 4975, deeming distributions as taxable income, or result in IRC Section 72(t) early distribution penalties. The treatment stream for this strategy is examinations.

This focus of this strategy is to review one-participant 401(k) plans to determine if there are operational or qualification failures, income and excise tax adjustments, or plan document violations. The treatment stream for this strategy is examinations.

The focus of this strategy are retirement plans of employers that were determined to have misclassified employees as independent contractors. These retirement plans will be reviewed to determine if coverage requirements of the Internal Revenue Code are satisfied. The treatment stream for this strategy is examinations.

This strategy is to ensure retirement plan sponsors comply with Internal Revenue Code (IRC) Section 401(a)(9) to begin distribution of benefits by April 1 following the calendar year an employee turns 70 ½. Failure to make these distributions could cause plan disqualification as well as a 50% excise tax on amounts not distributed. The treatment stream for this strategy is examinations.

This strategy addresses businesses that file Schedule C, Profit or Loss From Business (Sole Proprietorship), and a Form 5500-series return. We’ll examine whether these businesses with retirement plans have:

  • correctly taken the self-employed deduction on the Form 1040, Individual Income Tax, Schedule 1, Additional Income and Adjustments, rather than on Schedule C,
  • properly calculated the owner-employee’s earned income,
  • made correct allocations to plan participants, and
  • complied with the nondiscrimination requirements and IRC 415 contribution limits.

The treatment stream will be examinations.

This strategy is to ensure that participant loans comply with Internal Revenue Code (IRC) Section 72(p) rules on maximum loan balances and IRC Section 72(t) re-payment rules for early distributions before age 59 ½. We'll verify whether participant loans of retirement plans that hold a high percentage of participant loans to total assets of the trust are being repaid timely if the loan balance remains consistent or increases for more than one year. Noncompliance may result in deemed distributions under IRC Section 72(p) and/or prohibited transaction excise taxes under IRC Section 4975. The treatment stream for this strategy is issue based examinations.

The purpose of this strategy is to determine if officers and insiders of exempt organizations are claiming expenses of exempt organizations as Schedule C business deductions. Issues of focus are potential private benefit and inurement related to the exempt organization and potential adjustments to Forms 1040. The treatment stream for this strategy is examinations.

The purpose of this strategy is to determine if an exempt organization was eligible to file Form 990-N where related filings indicate the $50,000 gross receipts threshold was not met.  The treatment stream for this strategy is examinations.

This strategy is to review the impact of the new Internal Revenue Code Section 4960 excise tax on excess compensation. IRC Section 4960 imposes a 21% excise tax on tax-exempt organizations that pay over $1 million in compensation to any “covered employee.” On-going review of filing data shows there continues to be a high volume of exempt organizations that paid compensation of over $1 million to at least one “covered employee” but did not report IRC Section 4960 excise tax on Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code. The approved workstreams for this strategy are compliance checks and examinations of Form 4720.

This strategy concerns payors that have issued both a Form W-2, Wage and Tax Statement, and Form 1099-MISC, Miscellaneous Income, to the same payee in the same calendar year and focuses on misclassification of wages (distinguishing payments made to employees as independent contractors from those treated as wages on the Form W-2). The treatment stream for this strategy is examinations of Form 941, Employer’s Quarterly Federal Tax Return.

The purpose of this strategy is to review bond proceeds yield restrictions after the statutory temporary period to determine whether proceeds are restricted to the yield of the issue. If the issuer fails to yield restrict the investments after the temporary period, the bonds will be deemed arbitrage bonds and taxable. Additionally, the interest paid to the bondholders will be taxable. The treatment stream for this strategy is examinations.

The purpose of this strategy is to determine if the Internal Revenue Code Section 144(b) requirements are met to be considered a student loan bond. Failure to satisfy these requirements could result in the interest on the bonds being taxable to the bond holders. The treatment stream for this strategy is examinations. 

This strategy concerns potential arbitrage violations of Internal Revenue Code Section 148 by investment of bond proceeds in higher yielding investments beyond the allowable temporary period under Treasury Regulation (Treas. Reg.)1.148-2(e). Failure to meet the temporary period requirements and investing the proceeds in higher yielding investments could cause the bonds to be arbitrage bonds as defined in IRC Section 148(e). Treas. Reg. 1.148-2(e)(2)(i) states that proceeds expected to be allocated to capital projects may be invested at an unrestricted yield for a 3-year temporary period or under certain circumstances a 5-year temporary period. Beyond the temporary period, the investments must be yield restricted. The general rule under Treas. Reg. 1.148-2(d)(2)(i) states that if an investment purchased with proceeds of the bonds produces a yield at or above one-eighth of 1% above the bond yield, the yield on the investment is materially higher than the yield on the bonds. The treatment stream for this strategy is examinations of Form 8038, Information Return for Tax-Exempt Private Activity Bond Issues.

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Data-Driven Approaches

Data and queries based on quantitative criteria, used to identify high risk areas of noncompliance and focus on issues with the greatest impact.

We’ll continue to pursue the initiatives listed in our FY 2020 Program Letter.

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Referrals, Claims and Other Casework

Referrals of alleged noncompliance from internal and external sources, and claims for refunds, credits or adjustments.

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We’ll continue to pursue referrals received from internal and external sources that allege noncompliance by a bond issuer, exempt organization, government entity, retirement plan and Tribal entity.

We’ll continue to address requests for refunds or credits of overpayments of amounts already assessed and paid; they can include tax, penalties and interest, or be a request for an adjustment of tax paid or credit not previously reported or allowed.

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Compliance Contacts

Issues approved by the TE/GE Compliance Governance Board for correspondence contacts known as compliance checks addressing potential noncompliance, and educational letters to limit costs and taxpayer burden.

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With this strategy, we will determine if plan sponsors who reported plan liabilities on their Form 5500-series return are engaging in activities that result in taxable unrelated business income. Large, unusual and questionable liabilities may result from prohibited transactions, unrelated business income or failure to value assets properly. The unrelated business income tax provisions of the Internal Revenue Code ensure that exempt organizations are taxed on income earned from activities that are unrelated to the purpose for which they were granted exempt status. The treatment stream for this strategy is compliance checks.

This initiative determines if plan sponsors are completing financial information on Form 5500-series returns with complete and accurate information. It will focus on plans whose assets have increased beyond reasonable amounts from the beginning of the year to the end of the year. The treatment stream for this initiative is compliance checks.

This initiative identified employers whose Form 5500, Annual Returns/Reports of Employee Benefit Plan, indicates their plan has had a significant decrease in plan participants. We will review these plans to determine compliance with Internal Revenue Code Section 411(d)(3) vesting requirements and accuracy of other information on their Form 5500. The treatment stream for this initiative will be compliance checks.

This initiative is to review Internal Revenue Code Section 509 (a)(3) organizations that file the Form 990-N, Annual Electronic Filing Requirement for Small Exempt Organizations, to determine if they meet the eligibility standards to file the form. Misfiling of Form 990-Ns by 509 (a)(3) organizations limits the availability of activity and financial information otherwise contained in these forms. The treatment stream for this initiative will be educational letters informing 509 (a)(3) organizations of Form 990-N eligibility criteria.

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Determinations

Letters issued to exempt organizations on exempt status, private foundation classification and other determinations related to exempt organizations and qualified retirement plans that meet legal and regulatory requirements.

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We continue to expect a large volume of determination application receipts and will continue to look for process efficiencies.

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Voluntary Compliance and Other Technical Programs

The Voluntary Correction Program (VCP) enables a plan sponsor (at any time before examination) to pay a fee and receive IRS approval for correction of plan failures. Other technical programs, including Knowledge Management, work to ensure the quality and consistency of technical positions, provide timely assistance to employees and preserve and share TE/GE’s knowledge base.

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We’ll continue to process voluntary correction applications submitted electronically through Pay.gov under the Employee Plans Compliance Resolution Program (EPCRS) and enter into compliance statements with plan sponsors to resolve failures to comply with the plan qualification requirements, avoiding plan disqualification.

We’ll continue to resolve noncompliance in tax-advantaged bond issues through the voluntary closing agreement program.

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