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Hearing on Public Charity Organizational Issues, Unrelated Business Income Tax, and the Revised Form 990

July 25, 2012

Hearing on Public Charity Organizational Issues, Unrelated Business Income Tax, and the Revised Form 990










July 25, 2012


Printed for the use of the Committee on Ways and Means


DAVE CAMP, Michigan,Chairman

WALLY HERGER, California
PAUL RYAN, Wisconsin
DEVIN NUNES, California
JIM GERLACH, Pennsylvania
TOM PRICE, Georgia
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York

RICHARD E. NEAL, Massachusetts
JOHN B. LARSON, Connecticut
RON KIND, Wisconsin


JENNIFER M. SAFAVIAN,Staff Director and General Counsel
JANICE MAYS,Minority Chief Counsel

CHARLES W. BOUSTANY, JR., Louisiana,Chairman

DIANE BLACK, Tennessee
TOM REED, New York

RON KIND, Wisconsin



C O N T E N T S 



Panel 1:

The Honorable Steven T. Miller
Deputy Commissioner for Services and Enforcement, Internal Revenue Service

Panel 2:

Ms. Eve Borenstein
Borenstein and McVeigh Law Office LLC

Mr. Thomas K. Hyatt
Partner, SNR Denton

Mr. John Colombo
Albert E. Jenner, Jr. Professor, University of Illinois College of Law

Mr. Donald Tobin
Associate Dean for Faculty and the Frank E. and Virginia H. Bazler Designated Professor in Business Law, The Ohio State University Moritz College of Law


Hearing on Public Charity Organizational Issues,
Unrelated Business Income Tax, and the Revised Form 990

Wednesday, July 25, 2012
U.S. House of Representatives, 
Committee on Ways and Means, 
Washington, D.C. 


The subcommittee met, pursuant to call, at 9:30 a.m., in Room 1100, Longworth House Office Building, Hon. Charles Boustany [chairman of the subcommittee] presiding.

[The  advisory of the hearing follows:]



Chairman Boustany.  Welcome to this morning’s hearing on public charities.  This hearing is a second in a series of hearings exploring tax‑exempt issues and IRS compliance efforts.  The focus of today’s hearing is on 501(c)(3) public charities, the largest category of tax exempt organizations. 

In particular, for public charities, we are focused on transparency, compliance efforts, organizational complexity and commercial activities.  Over the past several decades, public charities have become increasingly complex organizations.  While universities and hospitals are notable examples of this, complexity has not been limited to these types of organizations.  A number of factors have driven this trend, including the Federal tax law itself and the expansion of the types of exempt and commercial activities that public charities engage in. 

About a decade ago, there was a growing recognition that the Form 990, the Federal return used by most tax‑exempt organizations, was not collecting the kind of information needed by the IRS or the public to understand the activities of this increasingly complex sector.  To ensure a greater level of transparency across the sector, the IRS substantially redesigned the Form 990, rearranging how information is reported and expanding the breadth of information requested to draw out critical issues, such as related party transactions, governance and commercial activities. 

We will discuss today how the Form 990 was changed, whether those changes have promoted compliance and transparency.  Today we have two panels that will help the subcommittee explore public charity compliance issues, such as the redesigned Form 990 sector transparency, organizational complexity and commercial activities.  This exercise also will provide important information to the subcommittee as it begins to look to the future and think about changes that will help tax‑exempt organizations work most effectively to meet their goals.  Now I am pleased to yield to my friend and colleague, the ranking member of the subcommittee, Mr. Lewis, for purposes of an opening statement. 

Mr. Lewis.  Thank you, Mr. Chairman, for yielding. 

This is the Subcommittee’s second hearing on tax‑exempt organizations in this Congress.  Today we will examine public charities and their complex structures. 

Public charities serve as an important role in our society.  They often fill the gap between what the government can provide and Americans’ basic needs.  These charities feed our hungry, care for our sick and preserve our culture and the arts.  

As public charities become larger and more complex, I am concerned that they may be engaging in activities that are not part of their charitable mission.  Some may be using for‑profit subsidies to engage in business that is not related to their charitable mission.  Some may be used in related organizations to engage in certain activity indirectly that they could not engage in directly. 

As we move toward tax reform, we should consider whether these rules are working as intended.  I look forward to hearing from our witnesses today about these issues.  I would like to learn more about how the Internal Revenue Service oversees nearly 2 million tax‑exempt organizations with a budget of about $100 million and about 860 employees. 

I also look forward to hearing how the new Form 990 helps both the agents and the public oversee the activities of charitable organizations.  And Mr. Chairman, I yield back my time.  And thank you very much again for holding this hearing.

Chairman Boustany.  Thank you Mr. Lewis. 

Chairman Boustany.  And next ‑‑ I would like to say, first of all, we have two very distinguished panels today, who will be excellent witnesses as we delve into these issues.  Today’s witnesses have extensive experience studying or working with tax‑exempt organizations, and their experience will certainly be very, very helpful as we exam the current state of the tax‑exempt sector.  Our first panel will be Deputy Commissioner Steven Miller. 

The committee has received your formal statement, Mr. Miller.  And as deputy commissioner for services and enforcement, we know that you are dealing directly with all these issues, the complexity of it, and so we are very eager to hear your testimony and to follow up with questions. 

So, Mr. Miller, you may proceed.


Mr. Miller.  Thank you. 

Good morning, Chairman Boustany, Ranking Member Lewis, members of the subcommittee.  My name, as indicated, is Steve Miller, Deputy Commissioner at the IRS. 

At the request of the subcommittee, my testimony this morning will offer an overview of one segment of the tax‑exempt community, specifically the 501(c)(3) charitable sector, and our role in regulating that community.  Let me begin with some observations. 

First, the charitable sector deserves to be commended for its vital role in our society.  Second, on the whole, we believe the charitable sector is or tries to be compliant with the Internal Revenue Code.  Finally, the sector is incredibly diverse in size and function, ranging from store‑front soup kitchens to large complex hospital systems.  This means our approach in regulation has to be flexible. 

Currently there are more than 1 million Section 501(c)(3) organizations.  In the tax‑exempt area, almost more than in any other area we cover, we serve more as a regulator and less as a revenue authority.  In light of this, we have a balanced program which ensures that congressional intent is honored and that the public confidence in the integrity of the charitable sector is maintained.  Our program is carried out, as Mr. Lewis says, by around 860 employees. 

Our approach in regulation is comprised of education, the determination letter process, Form 990 filing and a robust examination and review program. 

Let me touch on a couple of these.  In our Determination Letter Program, which is in many respects a continuation of our educational efforts, we review the intended operations of organizations seeking exempt status.  We receive more than 50,000 applications a year for charitable status.  Our specialists review them and, where appropriate, work individually with the applicant to ensure the organization understands and meets the requirements of the code. 

Most exempt organizations also have an annual filing requirement and must file one of the Form 990 series returns.  The Form 990 is a unique and essential part of our regulatory process.  It is an information return made widely available to the public.  We and other stakeholders use the information to review the operations of the organization.  The 990 is also utilized by nearly 40 States to satisfy at least a part of their filing requirements.  Given our limited resources, the Form 990 is particularly important.  It allows the public to review, rate, compare and otherwise make their own decisions about organizations.  Thus it promotes transparency and accountability. 

There has been much discussion of the Form 990 revision which we began in 2004.  The basic format and content of the form had remained essentially the same since 1979, while the community had grown dramatically in size, variety and complexity.  After two drafts were released to the public over several years and after hundreds of comments were received and acted upon, we made the form effective with a generous transition rule beginning with tax year 2008.  The process continues as the law changes and as we continue discussions with stakeholders. 

The last aspect of our work I will mention is our robust and multi‑faceted post‑filing compliance program.  We constantly seek more efficient and effective ways to conduct examinations or other reviews.  And we continuously refine our selection criteria to help apply compliance resources where they are most needed. 

I will wind up by talking about some of our challenges.  First, given the size, breadth and growth of the sector we have a great deal of ground to cover with the available resources we have.  Second, this is a difficult area to regulate.  That is because the law deals most often in general principles and not specifics.  The lines are not bright.  While this leaves a great deal of flexibility for organizations and how they operate, it also makes it harder to judge where noncompliance begins or to give the organizations the certainty that they need to operate within clear lines.  Third, with some key exceptions, the current law gives us limited options when we find noncompliance.  We are often left with the question of whether to revoke an organization’s tax exemption.  Revocation is a draconian step, one that may not be proportionate in any given case. 

Finally, the IRS role may at times not match the public’s expectations.  For example, it is difficult for the IRS to assess the quality of an organization’s performance or measure its comparative worth.  Thus it may be difficult for us to take action with respect to an organization that the public believes is not spending sufficiently on charity or is not doing a preferred type of charitable work.  An example, the IRS cannot differentiate between an organization that gives out candy to flood victims versus one that distributes food or clothing.  The IRS is neither equipped nor is it our role to make such determinations.  The best we can do is make all the facts available for others to see and make their own decisions.  That concludes my comments.  Thanks for the opportunity to testify.

Chairman Boustany.  Thank you, Mr. Miller. 

[The statement of Mr. Miller follows:]

Chairman Boustany.  I failed to mention earlier that your full testimony will be made part of the record. 

You very succinctly outlined a number of challenges, both with some of the generalities of a law that create problems, as well as the rapidly growing nature of this sector, both in terms of size and complexity.  The revision of the Form 990 was a multi‑year process involving comments from hundreds of stakeholders.  Clearly, it was a very important initiative of the IRS and the taxpayers.  Can you describe the compliance issues that gave rise specifically to the revision of Form 990?  Can you outline some of those? 

Mr. Miller.  Certainly, Chairman. 

In talking about how we dealt with the 990, as I mentioned in my testimony and is in my written testimony in more detail, we had not modified the form in any realistic way since 1979.  In 1979, organizations were much simpler, they were much smaller.  There was great diversity still, but it was a very different world.  As it is in the corporate world, the world of nonprofits truly has changed over time.  We did not have a good enough vision into things, such as compensation, things such as related organizations.  What did the entire organization look like, in fact.  We did not have a great deal of information on the largest of the organizations, colleges and universities, hospitals. 

So there were several areas that we did not have sufficient information really to regulate in and that as we revised the form decided to try to ‑‑

Chairman Boustany.  So these were some of the areas that were targeted from a compliance standpoint? 

Mr. Miller.  These were areas that we saw huge amounts of resources in the sector dedicated to, and we did not have a good enough vision into what was happening there.

Chairman Boustany.  With regard to the Form 990, are you satisfied with the progress, the type of information coming in, and from an administrative standpoint, has it been something that has worked both ways?  In other words, you are able to collate this data and use it effectively? 

Mr. Miller.  So I think it has been a success.  I also think it is an ongoing effort.  I absolutely don’t want anyone to come away from this thinking that we are done, that we haven’t ‑‑ what we did ‑‑ I will do it in three parts. 

First, was it necessary?  I think it absolutely was, and I don’t think you will get any argument about that. 

Second, did we engage in an extensive discussion with the industry?  Absolutely did.  It started in 2004 for a 2008 return, put out two drafts, significantly modified the second draft specifically for the comments that were made.  So I think if you talk to folks they will say, yes, it was a participatory process.  Are we done?  Is there too much burden on some of it?  Probably, is the answer to that, unfortunately.  It has got to be a living document, and we need to talk to folks and look at what they are saying in terms of have we gotten it right.  Because I think we have, but by no means is the discussion over.

Chairman Boustany.  Thank you.  Now I would like to pivot to a different issue and look at some of the compliance challenges with regard to unrelated business income tax.  The unrelated business income tax rules are an ongoing source of confusion and certainly a challenge from a compliance standpoint.  Can you describe for the committee the types of compliance challenges the IRS faces in enforcing UBIT and how the redesigned Form 990 addresses some of those concerns? 

Mr. Miller.  So this is probably less about the redesign than it is about a general rules here.  We have several problems and issues in addressing the Form 990‑T, which is actually the form that gets used here.  There are three generalized requirements for what is unrelated, and it starts with is it regularly carried on?  Is it a trade or business?  These are things that we sort of can deal with.  The third one, is it substantially related?  And that is a remarkably difficult and soft sort of issue to deal with.  Is it related to have a gift shop sell postcards of things that are in the museum that is attached to it?  These are the sorts of issues that we actually have to parse through in dealing with that particular issue.  Other issues also exist in the area.  A key issue is exactly what expenses are taken against the unrelated business income, especially where there are indirect expenses being taken.  Those are things that are very hard I think for the taxpayer to do and very hard for us to do as well.  So those would be the two things that are mainly our issue:  What is substantially related, and how do you deal with expenses, in particular indirect expenses? 

Chairman Boustany.  Is there any move on the part of IRS to start looking at revising some of those regulations, looking at those definitions and the complexity there? 

Mr. Miller.  I think it would be good if we had the resources to do that.  I don’t think that right now we are looking at that.  It is not at the top of our list of things that we can get to, to be honest with you.

Chairman Boustany.  From your standpoint, do you think ‑‑ is there anything Congress needs to do from a legislative standpoint to provide more clarity with regard to some of those areas that are murky? 

Mr. Miller.  I am more than happy for us to talk to staff on that issue.  I don’t know of anything off the top of my head.  As I said, substantially related is just a very difficult, difficult concept.

Chairman Boustany.  Right.  And I know there is a multi‑step process as you work through the Form 990 and sort of working through your entire compliance process.  How does the IRS determine whether an audit related to UBIT is warranted? 

Mr. Miller.  So we will be looking at the Form 990 itself to see what an organization is doing.  And then we receive about 40,000 to 50,000 Form 990‑Ts.  And that is where a particular organization will outline all of the necessary information that it has done in order to calculate whether it owes unrelated business income tax.  We will be looking at both of those in order to make that determination.

Chairman Boustany.  Were there any particular red flags that an auditor would ‑‑ you know, that would prompt an auditor to take a closer look at a public charity, for instance? 

Mr. Miller.  I don’t off the top of my head know what a red flag would be in this area, and I am not sure I would throw it out for public discussion.

Chairman Boustany.  I understand.  All right.  Thank you.  That is all I have. 

Mr. Lewis, you are recognized for questions.

Mr. Lewis.  Thank you, Mr. Chairman. 

Mr. Miller, thank you for being here today, and again welcome. 

I must tell you that I am deeply concerned about the IRS’s ability to oversee about 2 million tax‑exempt organizations when your budget has been cut.  Public charities alone have over $2.5 trillion in assets and $1.5 trillion in revenue each year.  I understand that the funding and number of employees for the exempt organization division have been cut this year.  Are you trying to do more or the same with less?  Could you explain to the Committee? 

Mr. Miller.  Certainly, Mr. Lewis.  Across the service, we have had to face decision making with respect to a declining budget over the last couple of years.  Probably at its height, in recent years, the exempt organizations division had about 950 people, 940, 950 people.  We are down to about 860.  We will be down from there by the end of this year. 

We are trying to maintain current levels as best we can, but it has been a challenge.  Now we are getting smarter, I hope, with the types of things that we do, and we have efficiencies that we are doing.  But it is a challenge, as it is across the service.

Mr. Lewis.  Could you tell me how many tax‑exempt organizations exist? 

Mr. Miller.  We have ‑‑ I think the latest data that I have publicly available is about 1.85 or something like that million organizations, 1.3 of which are 501(c)(3) organizations.  Now, those are somewhat dated numbers, but that is roughly right.

Mr. Lewis.  Now you have less money, right, you have less money? 

Mr. Miller.  We do. 

Mr. Lewis.  Less resources, fewer employees to monitor and oversee the sector.  Given the IRS budget constraints, how does the IRS oversee this sector — or do you think you are doing the best possible job with less money and less employees? Is something falling through the cracks? Are we missing something? 

Mr. Miller.  Mr. Lewis, I would be obviously remiss if I didn’t take you up on the opportunity to ask for more resources, which we could certainly use. 

Do I believe we are missing something?  I don’t believe so.  I believe we have to be efficient in the way we do business.  But we certainly could use more resources.  This sort of toggles back, Mr. Chairman, to your discussion of the Form 990.  We have always been somewhat understaffed in this area.  That has not changed.  We are a little more understaffed than we were.  We have always relied upon the transparency of the annual reporting to leverage other folks taking a look, finding problems, coming to us with the problems.  That has always been a help to us and an essential part of our regulatory regime in the exempt organizations area.

Mr. Lewis.  Thank you very much, Mr. Commissioner. 

Thank you, Mr. Chairman.

Chairman Boustany.  I thank the gentleman.  Lest anybody thinks this is quite as simple as just simply improving resource allocation, I think we also have to mention the complexity of tax law.  And in the spirit of moving forward with the tax reform, I am hopeful that our full committee in a bipartisan way will be able to move forward with the tax reform to lend greater clarity to the tax code, but also simplicity that will make compliance easier.  With that, I will yield to Ms. Jenkins. 

Ms. Jenkins.  Thank you, Mr. Chairman, and thank you for holding this hearing. 

Thank you for being here Mr. Miller.  What is the process for an organization that applies to be a public charity?  I am aware that you submit a Form 1024 and that begins the application on a review process.  But what are the specific steps an applicant can expect. 

Mr. Miller.  So, actually, if you are talking about a public charity it would be a Form 1023 that has to be filed by all, with the exception of very small organizations and churches and church affiliates.  But an organization would prepare the Form 1023, which basically outlines its prospective operations.  What are its budgets going to be?  What are its activities likely to be?  Who is going to run the organization?  What are they going to be paid?  All of these things so that we can take a look to see whether they meet the requirements.  Those are filed with us in Cincinnati, Ohio; Covington, Kentucky, and are reviewed in our Cincinnati office by specialists.  Some are very easy.  If they are small organizations, they don’t get a very detailed look.  We look, we say, okay, this seems right.  Some may be very simple but are being done by folks who don’t really have experience.  Those may take a little longer because we will work to have them understand exactly what their obligations are and what their rights and responsibilities are as a tax‑exempt organization.  Some come in and they are doing things that either are close to the line, impermissible, unclear as to which of those two that they might be and those may take a longer time still, and they will be referred to specialists in Cincinnati and elsewhere that will take a look to justify it and see whether or not the organization qualifies as a public charity.

Ms. Jenkins.  Okay.  Has the revision of the Form 990 led the IRS to approach the application process any differently? 

Mr. Miller.  I don’t believe so.  I will say that our advisory committee, which is a batch of specialists outside of the IRS, has come back and said, what you have done with the 990, you probably should do with the 1023.  And so at some point, we probably will take a good hard look.  We did redesign the 1023 in advance of the 990.  It is probably time to take another look at it.

Ms. Jenkins.  Okay.  Once an organization is approved as a public charity, can you explain how the IRS ensures that the organization remains in compliance and how do you ensure that the organization continues to engage in activities that further its exempt purpose? 

Mr. Miller.  So the primary way of our doing that would be through the Form 990, through the annual filing requirement of the organization.  And I mention there is a series of possible forms.  The very smallest organizations, which have less than $50,000 in receipts in a year, they are filing a postcard with us, an electronic postcard, with like six items as to, okay, how do we contact you and where are you.  It is sort of a fact of filing so that we can maintain our records in an intelligent fashion.  There is also a 990‑EZ which is a shorter form of the 990, which if you have less than $200,000 in gross receipts or half a million in assets, you will be filing that with us on an annual basis.  And then there is the Form 990 that was the subject of the large scale redesign for larger organizations.  And that really is the way we can take a look at these organizations across the country and see whether they are meeting the requirements.

Ms. Jenkins.  Okay.  Thank you. 

Mr. Chairman, I yield back.

Chairman Boustany.  Thank you. 

The chair now recognizes Mr. Kind for 5 minutes. 

Mr. Kind.  Thank you, Mr. Chairman, and thanks for holding this hearing today.  I think it is very important because it is such a fast moving area of IRS jurisdiction and oversight that I think it is incumbent on the Committee to pay a little more attention to.  I appreciate your willingness to do so. 

Mr. Miller, almost 2 million tax‑exempt organizations; obviously, Representative Lewis expressed concern about funding and resources and personnel in order to deal with such large numbers, and now we are starting to see a lot of tax‑exempt organizations engaging in blatant political activities.  I mean, how much is the IRS capable of reviewing these type of activities to make sure that these organizations are complying with the law, they are meeting their charitable purposes and that, given the plethora of other tax‑exempt organizations that you have to keep an eye on as well? 

Mr. Miller.  Well, we do maintain, and again, we are talking about public charities here, we do maintain a process by which we take a look at organizations that are either referred to us or come up in the papers as having done these sorts of political activities in the 501(c)(3) area.  Those referrals, that information, will make its way to our Dallas office, which is the examination function, where a team of three individual careerists will take a look and determine, is there enough here to start an audit or not?  So we do maintain a program in that area. 

Mr. Kind.  A lot of the casework that I see, I don’t know if my colleagues share this observation, but it is dealing with smaller charitable organizations back home trying to obtain tax‑exempt status and helping them navigate, make sure they are legally compliant and doing everything that they need to do.  Given the lack of resources that Mr. Lewis just pointed out, are you still able to provide sufficient service for the smaller charitable organizations and helping them comply with the law and everything that they need to do? 

Mr. Miller.  So we are trying, is I think a fair answer to that question.  Could we do more?  Absolutely.  We are trying by putting more of our work on our Web site so that organizations can reach out.  I would like to do more small, small organization conferences.  Right now, that is not really the most efficient use of the resources that we have.  But our Web work is good.  We have also begun to partner with local educational institutions, universities and such, to try to have them take the lift and bring small organizations together so that we can get our word out that way as well.  So we are trying.

Mr. Kind.  Also, the redesigned 990 now has a new schedule R.  Why was that necessary and how does that help you perform your functions? 

Mr. Miller.  So the R, unless I am mistaken, is the related entity schedule.  And that was essential we think because we needed to see ‑‑ we needed to have a window into what the entire organization looks like.  A hospital system is more than an individual corporation.  A college and university is more than the very college or university itself.  It is an endowment.  There are numerous things around that organization that we sort of needed to take a look at.  I will say it is probably one of the areas that we should be talking to people about.  Is it too much information or too many people having to do that? 

It is worth the discussion.  It is one of the areas that we are beginning to hear maybe there is burden there that we can alleviate.  But the concept is essential because the largest organizations, you need a complete window into what the organization looks like, what the web of organizations is.

Mr. Kind.  All right.  Great.  Thank you. 

Thank you, Mr. Chairman.

Chairman Boustany.  Thank you, Mr. Kind. 

Before I go to Mr. Marchant, I have a quick question I would like to ask you, Mr. Miller, in follow‑up to Ms. Jenkins’ questioning.  And that is, can you comment on whether the thresholds make sense with regard to the different forms?  I mean, or should that be revised? 

Mr. Miller.  So I am open to the discussion. 

It was placed there basically in conjunction with the discussion with the States who are using these numbers as well, but it is one of the things we ought to talk about.  So originally, there was no filing requirement for organizations with $25,000 or less in gross receipts.  The Pension Protection Act of 2006 modified that and said, no, everybody has to file.  We moved that group up to $50,000.  And we also modified the other numbers a bit as well to try to provide some relief from what we knew was going to be a somewhat more burdensome 990.  We are open to the discussion as to whether those thresholds are correct.

Chairman Boustany.  Fair enough. 

Mr. Marchant, you are recognized. 

Mr. Marchant.  Thank you, Mr. Chairman. 

In my discussion this morning, I would like to focus on some of the smaller local groups that are claiming tax‑exempt status.  And these are groups that are unapologetically politically involved.  I mean, in fact, they were formed around that idea.  What would a small group in a suburban town that might have 60 to 80 members, what is the most likely organizational tool that they would file in order to be tax exempt? 

Mr. Miller.  Are these organizations coming in as 501(c)(3)s, or would they be coming in as 501(c)(4)s? 

Mr. Marchant.  I think that is my question.  What would be the most efficient as far as compliance goes? 

Mr. Miller.  So if they are really doing politics, Congressman, they really can’t be a charitable organization under the Internal Revenue Code.

Mr. Marchant.  So would they be a tax‑exempt organization? 

Mr. Miller.  So they could be one of a couple of things.  They are permitted to have some politics in their business if they are a 501(c)(3) social welfare organization, although they need to primarily be engaged in other than politics.  They can do some work if they are a labor union to qualify that way or as a trade association.  Those are also able to do some politics. 

But really, if all they are going to be doing is politics, then they probably should be a political organization, that we would describe under Section 527, a PAC.

Mr. Marchant.  And so if they don’t file for the 527 PAC designation, many of these groups are now contacting our offices.  I can speak for myself.  I have been contacted by several of the groups in my district.  And they feel like they are being harassed.  I don’t have any evidence that that is the case.  But they feel like they have been harassed and feel like the IRS is threatening them with some kind of action or audit.  What kind of a letter or action is taking place at this time that you are aware of? 

Mr. Miller.  So if we are talking about social welfare organizations, (c)(4)s, 501(c)(4)s, then we did receive quite a few.  We received an uptick, an increase in the number of (c)(4) organizations that were advocacy organizations, they were advocating on various things, which is a fine thing for a 501(c)(4) to do.  It is politics that isn’t really considered to be appropriate 501(c)(4) behavior past a certain threshold because they can do politics.  And what is politics also, Congressman, is, you know, it may not be what you and I would think of politics as; it is politics under the Internal Revenue Code, which is really campaign intervention.  It is endorsing or arguing against a particular candidate for public office, that is politics. 

So you know I am aware that there is an uptick of organizations that came into us for exemption.  So it was the determination letter process, not the examination process. 

I am aware that some 200 501(c)(4) applications fell into this category.  We did group those organizations together to ensure consistency, to ensure quality.  We continue to work those cases. 

My understanding, Congressman, is something over 50 of the 200 have received exemption already, more will.  But many of these organizations fall into the category that I was talking about with Congresswoman Jenkins, where they are very small organizations and they are not quite sure what the rules are, and so we are working with them to ensure that they understand what the rules are.  It is my hope that some of the noise that we heard earlier this year has abated as we continue to work through these cases.

Mr. Marchant.  Yes, we have had many constituents call, and there is a lot of blog activity.  There is a lot of activity on the internet talking about potential legal fees in the hundreds of thousands of dollars in fines in this group.  So what is the potential if a group crosses over the line from being advocacy, advocating certain policy, over into the endorsement, the campaign endorsement realm?

Mr. Miller.  So if they are coming in for application to be recognized as a social welfare organization, and they don’t receive that recognition, then they would just not be a tax‑exempt organization.

Mr. Marchant.  So what about organizations that have already received the recognition but somewhere along the way have shifted their emphasis to where ‑‑ is there an audit process?

Mr. Miller.  There would be an audit process to determine what was their primary activity.  Was their primary activity good 501(c)(4) work, societal benefit, community benefit, social welfare or something else.  And the something else could include much more than politics.  It is just non‑‑ and so if we found that they were not primarily engaged in social welfare activities, we would revoke their exemption or work with them, as we do oftentimes, to move forward in an improved way. 

There also would be under the tax rules some possible tax based on the lesser of net investment income that they had or the political expenditure itself under the code.

Mr. Marchant.  Thank you, Mr. Chairman.

Chairman Boustany.  Thank you. 

I thank the gentleman.  Mr. Becerra, you are recognized for 5 minutes. 

Mr. Becerra.  Thank you, Mr. Chairman. 

Mr. Miller thank you for being here.  Is there a section on Form 990 that requires a social welfare organization to document what portions of that organization’s activity or portions of those activities are devoted to political activity specifically? 

Mr. Miller.  Yes, sir, I believe there is.

Mr. Becerra.  And does the IRS have a bright line in terms of how much of that 501(c)(4)’s activities can be spent as political expenditures? 

Mr. Miller.  We do not have a bright line, no.

Mr. Becerra.  Does the IRS plan to try to provide better guidance to 501(c)(4)s as to at what point that bright line is crossed? 

Mr. Miller.  So we have received obviously some inquiries, both from your colleagues and from others in the community, to look at the area.  I don’t think we have made a decision as to whether to do guidance one way or another, but we have agreed to take a look and have that discussion.

Mr. Becerra.  So for any organization that is looking to stay within the law and also wants to engage in some aspect of political activity, what guidance would IRS give that organization? 

Mr. Miller.  Well, they ought to get professional help, obviously, because this is not a ‑‑

Mr. Becerra.  We know they need professional help.

Mr. Miller.  We will move on from that. 

So the general rule, as I was mentioning to Mr. Marchant, the rule is that a 501(c)(4) organization must be primarily engaged in activities that further and promote community benefit, social welfare.  We have been asked to primarily test a bright line, and we don’t believe it is.  It is not a qualitative test ‑‑ or rather it is a qualitative test versus quantitative.  We would be looking at things like expenditures.  We would be looking at things like staff time, including volunteer time.  We would be looking at what dollars are being devoted to this activity, what dollars are being derived from this activity, what sorts of assets are being dedicated to this outside of fixed assets, what kind of building and equipment.  All of those things would come into sort of the conversation.  And that guidance is sort of out there in terms of both court cases and revenue rulings to give people sort of a guide way to make that determination on their own.

Mr. Becerra.  Now, what about this whole notion that social welfare should be the principal purpose of the activities of some of these 501(c)s, (c)(4)s, (c)(3)s and so forth, and the fact that it seems like some of these 501(c)(4)s are stretching what might be considered social welfare to the point where it is blurred and it looks nothing like a social welfare activity that most Americans would reasonably think can be applied to that term.

Mr. Miller.  So, again, the general rule would be a 501(c)(4) organization can do campaign work, but it must be primarily engaged in social welfare activities, and it can’t operate for the private benefit of a select group. 

To your point, first, there is no bright line, and we would take a look at organizations that were involved in politics. 

Secondly, this is an area obviously that for us is somewhat difficult, because for a 501(c)(4) organization, when I talk about how do you calculate out the primarily test, you look at the entire year.  So the fact that an organization is doing something today might be relevant to the inquiry, but it is not the end of the inquiry.  The inquiry is, what are your activities for the year?  What did you do, and how much of it did you do?  So it is almost always going to have to be after the year is up that we have sufficient information in a 501(c)(4) context to make a determination as to whether there is a problem or not.

Mr. Becerra.  And do you have the resources and staff to try to monitor and oversee all the different 501(c)(4)s and how they apply that social welfare test? 

Mr. Miller.  We could always use more resources.  I believe we have sufficient resources if we decide to place them in the places we need to place them, is sort of the answer there, Congressman.

Mr. Becerra.  I will try to decipher that answer.  Thank you very much. 

I yield back Mr. Chairman.

Chairman Boustany.  I thank the gentleman. 

This hearing is really intended to focus on the public charities and the (c)(3)s.  I know the activities with (c)(4)s is an issue, and it is something we will get to down the line.  But right now with this hearing, I wanted to keep the focus on the (c)(3) organizations and the complexities with regard to organizational structure, UBIT, and some of the vagaries that attend those issues and the problems that arise as a result.  So I appreciate the gentleman’s questioning, but hopefully, we will keep it to the public charities. 

Mr. Reed. 

Mr. Reed.  Well, thank you, Mr. Chairman. 

I was going to continue on that line of questioning, but I will back off to another day. 

But I am interested at some point in time if you could, Mr. Miller, get to my office, you referenced three careerists who make these decisions on political activity or not.  I would like to know who they are, how they are appointed, what their tenure is and what the process is that they use to adjudicate whether or not it is a political activity.  Do you mind doing that for me? 

Mr. Miller.  As to the names, I will have to see about that one.  Mr. Reed, these are careerists, these are lower graded folks who are managers, group managers at some point, and they cycle in and out.  It is not only a ‑‑ it is not one single three person. 

What we have tried to do in the area is make sure that one individual at the service can’t start an examination that is a politically charged type of examination.

Mr. Reed.  But if I understand your testimony, there are three individuals that are kind of the sounding board.

Mr. Miller.  There is a referring committee that as a normal course of its business and under established procedures of the Internal Revenue Service receive referrals, evaluate the referrals.

Mr. Reed.  That is what I would like to get to.  I am new here, so how you operate and what the background is.

Mr. Miller.  I would be glad to walk you through the referral process.

Mr. Reed.  I really do appreciate that.  It is more of an educational exercise for me and making sure that we are aware of it and getting up to speed on it. 

But I do want to challenge you on one thing, Mr. Miller ‑‑ and I appreciate the work you do.  I totally appreciate what the IRS is under and the burden that the IRS faces with managing the whole tax issue and revenue job mission that you have for America. 

But many witnesses come up here and they state a conclusion to us, and you have stated it again today.  You have stated that you are understaffed.  And my colleagues on the other side have raised that issue repeatedly.  I want to know from you as a deputy commissioner, a leader of a large organization, how do you determine that conclusion?  Are there metrics?  I mean, is your goal then ‑‑ and then also the flip side of that, what is fully staffed?  I can’t imagine you are advocating to have 2 million IRS employees added to monitor one for one each of the organizations.  So obviously to illustrate my point, I am taking it to the extreme. 

So I want to understand what allows you to state that conclusion to us as Members of Congress that you are understaffed?  What is not getting done that should be getting done?  And what is your definition of fully staffed? 

Mr. Miller.  So I will start with what I don’t have.  I don’t have a definition of fully staffed.  Congress determines what our full staffing is.  Are we understaffed?  We have enough people to do the job we need to do.  Could we use more?  Absolutely, Mr. Reed.  The way I would like, and it is not only staffing, right, it is IT money as well, I would like, I would very much like, especially for small organizations but for all organizations, to modernize the way they fill out an application form, to sort of have a 1023 that is online that they can fill out easily with help along the way, not unlike the tax software that we all sort of use; what does this mean, and there will be information right there for them to pull down and get that information.  I would love to be able to build that system.  And I would like to be able to say to you that I have better and more robust number of examinations that I am doing relative to the 1.3 million organizations that are out there. 

So my metrics are difficult, but my metrics would be how many people contacted my various education sites; how fast did I do my work for people, customer satisfaction again; how many people was I able to touch in a compliance fashion to try to influence future behavior by the whole of the group and not just the people that I touched; and am I doing enough of those?  And I would say that it is close, Mr. Reed, it is close on that one.  But those are the sorts of metrics we would look at.

Mr. Reed.  And I appreciate that.  So my takeaway is that essentially, from your testimony and just correct me if I am misunderstanding it, is that right now staffing resources, making do, you would like to have more, you would love to have more, I believe is your testimony, which I can appreciate, but you are making the best of what you have and you seem to be hitting the targets of the metrics of doing your job.  And so is that a clear understanding of your testimony? 

Mr. Miller.  So the last bit of it I would say we are getting to the point where I think it is taking us a little too long to get to determination letter requests.  I think we may not be doing everything we need to do in the educational area.  And we are getting to the point where I would worry about our coverage rate in the exam area.  But I am not going to quibble with the discussion.  That is roughly right.

Mr. Reed.  Okay.  Thank you.  I appreciate that, Mr. Miller. 

I appreciate the candor.  With that, I yield back.

Chairman Boustany.  Thank you, Mr. Reed. 

Dr. McDermott, you are recognized for questions. 

Mr. McDermott.  Mr. Chairman, I appreciate that you wanted to be on (c)(3)s, but some of my colleagues have gone down another alley.  And I see ‑‑ first of all, I want to ask a question.

Chairman Boustany.  Mr. McDermott, you don’t have to make the same mistake.

Mr. McDermott.  I think emulation is the high pride of authorship.  One of the things that is raised here is, are you doing your job?  You didn’t mention audits.  You sort of obliquely did, that is to get people to you know sort of do what ought to be done in the future.  But if you don’t have a lot of people, you just don’t audit people.  That is the place where you make cuts, right? 

Mr. Miller.  That and in the determination letter process.  There is education, there is ‑‑

Mr. McDermott.  You can’t avoid that.  If they call in asking questions, you got to answer them, right? 

Mr. Miller.  Well, I would like to reach out more.  I would like to have people available to reach out to these folks rather than wait for the questions.  

And the determination letter process is a customer‑driven process.  You will come in to me with a 1023 or a 1024.  I have to work that case.  How fast I work it will depend on how many folks I have.  And as the folks dwindle, that will suffer as well.  So it is more than just exam, but exam clearly is part of that.

Mr. McDermott.  And if you have these targets and something pops up to be audited, do you audit 100 percent of those people whose names come up along because of what something in their account? 

Mr. Miller.  We never did, and we never will audit everybody who comes onto our radar screen.  We have to make intelligent decisions about how far we can go based on resources and other topics.

Mr. McDermott.  Do you get back money when you audit? 

Mr. Miller.  So we do get back some money.  As I indicated in my oral testimony, Congressman, we regulate here more than derive revenue from the sector.  We seek to protect the investment that the United States Government has made in the tax‑exempt sector.  Mr. Lewis spoke about the amount of revenues.  Mr. Lewis spoke about the amount of resources, the $2.5 trillion in assets that sit out there.  We are there to sort of ensure not that we take more of that $2.5 trillion, but that it is being utilized within congressional intent.

Mr. McDermott.  When people fight back against you, I walked in here and the discussion was about the Tea Party and the Richmond Tea Party, and I am looking at the letter that you have and these questions — provide a resume for each member of your governing body, and provide copies for all your newsletters, provide promotional literature developed by your activist committee, provide a list and description of specific events.  What is unreasonable about those questions?  They say you are being unreasonable in asking for these.  Do you think those are unreasonable questions? 

Mr. Miller.  So I am not going to speak to the specifics of any given case because I can’t.

Mr. McDermott.  Right.

Mr. Miller.  We ask questions.  And in the cases that we talked about, we asked a series of questions.  We also went back afterwards and said, by the way, if these questions are too much for you, let’s talk.  And that is what we did in this case.

Mr. McDermott.  So these questions, this is kind of a standard letter here I have, which you send out to anybody you audit ‑‑ or you are questioning their exemption, is that correct? 

Mr. Miller.  So I don’t know the letter that you are looking at, Congressman, so I can’t say.  But we don’t send out a standard letter to everyone in any event.

Mr. McDermott.  It is from the IRS, dated 9-17‑2010.  And it is to this organization, and dear sir or madam.  So it sounds like it is a kind of a standard letter.

Mr. Miller.  It might have been standardized to a group of cases, sir, but I can’t really speak to this.

Mr. McDermott.  If they call in and say, this is too burdensome for us, we can’t do it, do you then talk to them orally.  Well, how do you do that?  Get them into the office or over the phone? 

Mr. Miller.  So these are almost always going to be over the phone because our folks generally are going to be in Cincinnati, and a lot of organizations aren’t and don’t have the ability to either hire somebody to wander over to Cincinnati or come themselves to Cincinnati.  These are almost always a review of paper and additional letters that go out, like the one you are talking about, and responses and a discussion on the phone in conference of right if we are going in a particular direction.  But these are more office audits than they are sort of a field audit.

Mr. McDermott.  And from that, you make a determination as to whether they are doing social activities? 

Mr. Miller.  Whatever the particular requirements are ‑‑

Mr. McDermott.  Under a (c)(3).

Mr. Miller.  So under (c)(3), it would be, are they charitable, and do they have a charitable purpose?  Under (c)(4), we would be looking at what they are doing, and does that promote social welfare?  Different requirements for different code sections.

Mr. McDermott.  And is the standard for promoting social welfare ‑‑ my time is up.  I would like to see the standard.  If you would send us the standard you use for determining social welfare.

Mr. Miller.  Surely.  We can do that, sir.

Mr. McDermott.  Thank you.

Chairman Boustany.  I thank the gentleman. 

Mr. Paulsen. 

Mr. Paulsen.  Thank you, Mr. Chairman.

And thank you, Commissioner, for being here.  I want to ask a question on a slightly different subject as well because we have heard a great deal from the IRS about a realtime tax system.  And there have been a number of public meetings that have taken place on this issue.  And many are concerned that this type of a filing system could lead to a very burdensome reporting component, similar to what we saw in the 1099 debate that took place not too long ago.  And I think this would be a nightmare for American companies, for businesses, whether you are small or large, and the IRS is going to now make this realtime system work.  If you are going to make this realtime system work, I am sure you are going to want to have all the data earlier to collect information than is required today, you are probably going to want to have more 1099 data.  Just looking at what has been discussed today, it seems that compressing the report and timeline and potentially increasing the reporting requirements would make an already onerous process even more onerous or more burdensome. 

And I sent a letter not too long ago, I think the Chairman followed up and sent a letter as well to Commissioner Schulman, about the realtime taxes a few months ago.  I haven’t heard back.  But can you help get a response to that in particular in looking at that, and do you have some comments on the realtime tax? 

Mr. Miller.  So we will certainly look at getting a letter back to you all.  On realtime, let me just say a couple of things.  First, we are very far away from making any decisions that would move up or even draw a picture of what this might look like.  But the conversation ‑‑ we can’t be scared of the conversation, because the concept of our having and the taxpayer having the information available earlier, we can’t shy away from that conversation because it is an important area.  And in a perfect world, all that information would be available.  It would be available for us to make a decision around whether the refund was a good refund or a bad refund going out.  And it would allow us to go back and say up front, by the way, you know, we have information that indicates you should have X here versus X minus Y here, do you want to work through that and finalize a return? 

But what I would say, again Congressman, is we are very far away from any sort of decision as to what exactly this would look like.  What we are doing at this point is building scenarios as to what this might look like for a given taxpayer?  We will then engage the public again and throughout this entire process, which will be a multiyear process.

Mr. Paulsen.  So you say you are far away; you are building scenarios.  Do you believe that the creation of such a system under it is authorized right now under the IRS charter? 

Mr. Miller.  It depends what the system looks like.  If we were moving the filing date, no, it wouldn’t be.  That is a legally set date.  Certainly there would be discussions with the Hill before we move forward with anything that even remotely touched on those issues.

Mr. Paulsen.  So you believe you need to have congressional authorization for those types of changes? 

Mr. Miller.  For some of the changes, absolutely. 

I also want to say, you know, and there has been concern about this, this is not in order to send out pre‑filed returns, that is not really what we are talking about here.  And I know there has been concern by some in the industry that this is a stalking horse for that.  It simply isn’t.

Mr. Paulsen.  Do you have any sort of estimates on what the cost would be, because given that we are talking about I had heard some conversation and testimony about resources and employees and staff and how ‑‑ the intention ‑‑ to be ‑‑ to pay for that or what the cost would be on a realtime system for preparing for that as well? 

Mr. Miller.  So absent a blueprint of what it would look like, we have no way of doing a cost estimate at this point, sir.

Mr. Paulsen.  Thank you, Mr. Chairman. 

I yield back.

Chairman Boustany.  Thank you, Mr. Paulsen. 

That concludes our questioning, Mr. Miller, and we thank you for coming before the committee once again, and I look forward to future visits, and this subcommittee particularly looks forward to working with you going forward to resolve some of these issues.

Mr. Miller.  Thank you.

Chairman Boustany.  I would like to call up the next panel.  Next we have four witnesses on our second panel, all distinguished witnesses who will lend some clarity to this debate.  We will hear from Eve Borenstein. 

Ms. Borenstein is a partner with Borenstein and McVeigh Law Office in Minneapolis, Minnesota, and is known as the queen of the 990. 

So we welcome you. 

Secondly, we welcome Mr. Thomas Hyatt.  Mr. Hyatt is a partner with SNR Denton here in Washington and is chair of SNR Denton’s health care practice focusing on tax‑exempt organizations. 

Sir, welcome. 

Thirdly, Mr. John Colombo. 

Mr. Colombo is the Albert E. Jenner, Jr., Professor at the University of Illinois, College of Law, in Champaign, Illinois.  And Mr. Colombo has written extensively on tax‑exempt organizations. 

Mr. Colombo, thank you for being here today. 

And finally, we will hear from Donald Tobin.  Mr. Tobin is associate dean for faculty and the Frank E. and Virginia H. Bazler Designated Professor in Business Law at the Ohio State University’s Moritz College of Law in Columbus, Ohio.  Mr. Tobin is an expert on campaign finance law and previously worked on the Joint Economic Committee. 

Mr. Tobin, welcome. 

You will each have 5 minutes to given us your oral testimony.  Keep in mind that your full written statements will be made part of the formal record, and so I ask you to keep your oral comments to 5 minutes so we can get to questions. 

Ms. Borenstein, we will begin with you.


Ms. Borenstein.  Thank you Chairman Boustany, Ranking Member Lewis, members of the committee. 

I thank you for inviting me to testify today.  I do not elaborate in my written submission as to why I believe that the redesigned Form 990 for the most part makes the right asks of those who are afforded tax exemption. 

There are four points I want to offer in that regard now.  One, because the filing is appropriately not just numbers, organizations must be proactive and collect from internal sources the various information the form seeks, as well as prepare written narratives.  Accordingly, the amount of resources and time that filers expend in favor of preparation has undoubtedly increased.  This is not a bad thing; it is just a fact. 

Two, the information the form provides the IRS is more thorough and descriptive than before, allowing the agency to more effectively apply its resources toward improved enforcement and education. 

Three, the fact that the filing is widely available makes filers transparent in ways they never were before, which is huge.  The public relations power of that transparency leverages the IRS’s limited resources as the reading audience brings their own potential “enforcement” forward. 

And four, while the new form does have a sharp learning curve, which has burdened the sector, filers are starting to master the form, and I am certain further improvement will be evidenced over the next few years, particularly if the IRS can help. 

It is this last point that generates the recommendations I make in my written testimony.  As to charges leveled of being overly burdensome, the new form makes multiple asks that its predecessor did not and imposes new architecture for the form- a core form with 15 subject schedules tailored to the individual topics that the IRS seeks information upon, not all of which are in play for most filers. 

But as a result, the form’s instructions comprise a new playbook for filers and those who assist them.  The need to master this new regime has clearly shocked many filers, but many of those had not properly understood or appreciated the form’s complexity in the years prior to the redesign.  Indeed, many filers have misperceived the prior form as only a financial statement report to the IRS belonging solely to the domain of the organization’s accountants. 

The new form is clearly a full information return for exempt entities that extends well beyond financial results.  It cannot be wholesale handed off to auditors or paid preparers.  Completion requires meaningful participation by the filer, whose staff or leadership must now provide firsthand data on the group’s output and operations, including information that resides outside of the finance staff. 

The understanding by groups of all sizes that this is the case and that they must have a preparer (either internal and/or external) who is committed to mastering more of the new form’s learning curve each year has been evidenced as we have moved from the form’s filing season in 2009 to today. 

Ms. Borenstein.  In the recommendations section of my written testimony, I make five specific suggestions and note that comments on overlapping burdens of two schedules should be opened.  I urge this committee and the tax press to read each of those six points not as signs of the redesign’s failure or overreach but as lessons from the field. 

In that spirit, I want to offer three realities that need to be taken into account before we start assigning final grades to the Redesigned Form and its results to date.  First, the IRS should not change the form now, midstream, but instead focus on the few areas where it is clear that burden could be decreased and take advantage of the opportunity to better the form by getting those areas right.  As set out in my recommendation, the first one, this is particularly urgent with respect to helping organizations and users of the form understand that the IRS’s semantics and reporting requirements are not necessarily value‑laden, especially in regards to reporting insider transactions and counting directors as “independent” or not. 

Second, we should not conflate the fact that reporting organizations will be burdened by the resources required to complete this annual filing ‑‑ that is a cost of exemption ‑‑ with the fact that many organizations do not and will not have access to an accountant or other professional who is qualified to assist in preparing this filing.  It is appropriate to keep the preparation challenge situated with filers at all times, regardless of whether they have access to competent paid or pro bono professionals. 

And third, the Redesigned Form does a great job of using the form’s transparency factor and the certainty of public access by funders, whistleblowers, competitors, reporters, et cetera.  The form sets out affirmative reporting responsibilities that I have seen promote far greater compliance and appreciation of tax mandates and charitable precepts than ever before.  This is notably evident in the management of compensation and certain other governance arenas, as well as in portions of the form’s most complicated schedule, the Schedule L, where filers are to disclose intersections with insiders.  That disclosure responsibility has, as it should, generated valuable
self‑reflection by reporting organizations as to the motives and results obtained from such opportunities. 

I can talk about the 990 for hours at a time, but I see my time is up.  I look forward to answering any questions you may have.  Thank you. 

Chairman Boustany.  Thank you, Ms. Borenstein.

[The statement of Ms. Borenstein follows:]

Chairman Boustany.  Mr. Hyatt, you have 5 minutes. 


Mr. Hyatt.  Thank you, Mr. Chairman. 

Chairman Boustany, Ranking Member Lewis, and members of the subcommittee, I really appreciate the opportunity to testify before you this morning.  I have been invited to testify as to the current state of complexity in the organization and operation of nonprofit tax‑exempt public charities.  As has been reported to this committee, there are some 1.6 million tax exempt organizations known to the IRS, give or take different sources of data.  Over 60 percent of these are 501(c)3 public charities. 

Now while many nonprofit organizations are small organizations, small staffs, small budgets, we usually are most familiar with the large institutional nonprofits, those with regional and national reach.  According to the IRS, large hospitals and universities dominate the financial activity of the nonprofit charitable sector.  In fact, by their stats, 9 of the 10 largest nonprofit organizations by assets were hospitals or university‑affiliated organizations.  It is this class of organizations that I describe today. 

Certainly, there can be no denying that these large nonprofit public charities are more complex in their structures and in their operations than they were say 40 years ago.  Today, it is not uncommon to have multiple business entities operating within an integrated system.  They may have a central parent organization charged with strategic oversight of the system; brother‑sister companies subsidiaries and subsidiaries of subsidiaries.  These entities may include nonprofit corporations, taxable
for‑profit corporations, nonprofit taxable corporation, limited liability companies, limited and general partnerships and joint ventures. 

Most institutions understand the cost as well as the benefit of operating multiple corporations and they try to err on the side of keeping it simple.  Still, some organization charts appear to be designed by engineers rather than business planners and would make Rube Goldberg proud. 

In addition to directly owned and operated business entities there has been a substantial increase in the use of joint ventures by nonprofits to achieve their goals.  The IRS over time has determined that joint ventures between public charities and for‑profit businesses in many different forms are consistent with public charity status if they are properly structured and properly operated. 

There are many reasons for the increased complexity of the corporate organizational structures in the modern nonprofit sector, often acting in concert.  In my statement, I have provided an overview of the key factors as I see them.  They include protection from liability, operation in highly regulated fields, restrictions imposed on public institutions, restrictions imposed by overseers,
chapter‑based organizations, improved governance, and Federal tax‑exempt organization law compliance. 

While corporate complexity is a reality in the institutional side of the nonprofit sector, in my view, this is not a problem that requires a change in the law to resolve.  Rather, it is an environment that both invites and deserves continuing scrutiny and transparency to ensure that these public charities are acting in accordance with their tax‑exempt purposes and with applicable law. 

There are already important checks and balances in place to ensure that a complex corporate structure does not impede achievement of charitable goals and legal compliance.  At the State level, this is primarily accomplished through the State Attorney General.  In recent years, State Attorneys General have been extremely active in overseeing the activities of nonprofit organizations within their State.  The IRS plays an important oversight role both towards enforcement of the Internal Revenue Code’s tax exemption requirements and implementation of the Form 990 with an increasing focus on transparency and accountability.

It should also be noted that the IRS has undertaken a considerable effort in the last few years to learn more about this large institution segment of the nonprofit sector through a series of what are called compliance checks.  The IRS in 2006 conducted a compliance check of hospitals and health systems, and in 2008 a compliance check on colleges and universities. 

When a change in the law is warranted, Congress has not hesitated to step in.  For example, one type of public charity, the supporting organization, was being used for private benefit in ways that the Congress never intended in the Internal Revenue Code.  Through the Pension Protection Act of 2006, Congress largely eliminated this type of abuse, including through the expansion of the IRS’s intermediate sanctions penalties authority. 

With that, I will close my oral statement.  I, again, appreciate this opportunity and would welcome any questions you might have.

Chairman Boustany.  Thank you, Mr. Hyatt.

[The statement of Mr. Hyatt follows:]

Chairman Boustany.  Mr. Colombo, you have 5 minutes.


Mr. Colombo.  Mr. Chairman, Mr. Ranking Member, and members of the committee, thank you for the opportunity to speak today about commercial activity by charities. 

Over the past 20 years or so we have seen a steady expansion of commercial activity by charities.  In most cases, commercial activity provides badly needed revenue to expand charitable outputs.  But the legal issues surrounding commercial activity are complex and I think hopelessly confused. 

When a charity engages in commercial activity, it raises two main issues.  The first is whether the charity loses tax exemption as a result.  If the charity does not lose tax exemption, then the second issue arises:  Whether the commercial activity nevertheless should be taxed as though it were a freestanding corporate business.  This latter issue is the providence of the unrelated business income tax. 

Underlying these issues is a third issue:  Does it matter what kind of business container the commercial activity is conducted in; that is, does it matter whether the business is conducted directly by the charity versus in a separate corporation or via a partnership with a for‑profit enterprise.  Under current law, each of these containers can have different tax consequences for the charity. 

With respect to the effect of commercial activity on exempt status, the main policy issue is straightforward:  How much, if any, commercial activity may a charity undertake without impairing exemption.  Unfortunately, the existing legal precedent and Treasury regulations are of little help in resolving this issue.  The regulations and precedent are clear that some amount of commercial activity is permitted, but beyond that we don’t know much. 

One part of the regulations, for example, suggest that charities cannot engage in more than an insubstantial amount of such activity, while another part of the same regulation states that a charity can operate a commercial business as a substantial part of its activities as long as that business is not its primary purpose and the business is in furtherance of its exempt purpose.  But concepts such as substantial and in furtherance of are left undefined. 

Think of it this way.  Suppose I incorporate a charity to operate a soup kitchen.  Everyone would agree that, properly operated, this organization is tax exempt under 501(c)(3).  But now suppose that I decide that to expand my revenue base I am going to can my soup and sell it to the public.  Is that okay?  Does it depend on the size of my soup business versus the size of my soup kitchen relief efforts?  If so, how is that measured, by gross expenditures, gross revenues, net revenues, number of people working in each activity, all of the above?  Does it matter how much profit I have and how that profit is used?  Does it matter whether my soup business is in a separate corporate container or is operated as a joint venture with a commercial soup company?  What if I don’t operate a soup kitchen directly but use profits from my commercial activity to make grants to other soup kitchens. 

The UBIT has a similar set of problems.  The UBIT was designed to tax certain commercial activities by charities but not all of them.  The main test for applying the UBIT is whether a businesses substantially related to accomplishing the charity’s exempt purpose.  If so, it is not taxed.  If not, it is.  In addition, there are specific exemptions for certain kinds of activities ‑‑ activities run completely by volunteers, for example, or activities such as a cafeteria run for the convenience of employees or patrons. 

Like the commerciality limitation, the UBIT also suffers from a lack of theoretical consistency and practical definition.  Though the classic rationale for the enactment of the UBIT was to avoid unfair competition, the test for taxation doesn’t depend on whether a charity is competing fairly or unfairly with the private market, but rather whether the business is substantially related to the organization’s charitable purpose. 

We know that substantially related involves more than just providing revenue for charitable purposes.  But beyond that, the test for relatedness is murky, at best.  To go back to my previous example, is my selling soup substantially related to my charitable purpose of providing a soup kitchen for the poor?  If a symphony orchestra sells its recordings through commercial channels, is that substantially related?  What if it has a gift shop and sells CDs by popular rock bands?  Can it sell musical instruments, too?  How about an upscale stereo system?  How about art?  After all, Modest Mussorgsky wrote a very famous musical composition called “Pictures at an Exhibition.”  So maybe art is substantially related to music. 

These questions go to the heart of what we want our charitable sector to look like, and in my written testimony I have provided both a structure of how we might analyze those issues as well as some suggestions on possible reforms.  But whether you agree with my suggestions or not, it is time for us to reconsider these issues from a policy perspective and provide clarity to charities regarding these activities. 

Thank you. 

Chairman Boustany.  Thank you, Mr. Colombo.

[The statement of Mr. Colombo follows:]

Chairman Boustany.  Mr. Tobin, you have 5 minutes.


Mr. Tobin.  Thank you, Mr. Chairman. 

Chairman Boustany, Ranking Member Lewis, and members of the committee, thank you for the invitation to testify today. 

Charities are not just using affiliated entities in the for‑profit context.  They are also affiliating with other tax exempt organizations, mainly social welfare organizations and political organizations.  I want to give you just a brief explanation of how these organizations interact. 

Public charities are exempt from tax under 501(c)(3) and donations to the charity are deductible by the donor.  Public charities are not allowed to intervene in a political campaign and can only engage in an insubstantial amount of lobbying.  Social welfare organizations are organized under section 501(c)(4) and must be operated exclusively for the promotion of social welfare, according to the statute.  Although the statute uses the term “exclusively,” Treasury regulations allow social welfare organizations to intervene in political campaigns as long as the organizations’ primary purpose is social welfare.  Amounts spent by organizations on political
campaign‑related activities are not considered a social welfare function.  The income of social welfare organizations is tax exempt but donations are not tax deductible. 

Then we have political organizations, which are exempt under section 527 and are primarily involved in influencing elections.  Contributions to 527 organizations are not deductible and political organizations are required to disclose contributions and expenditures. 

Public charities are allowed to create affiliates in order to engage in these different types of activities and the Form 990, Schedule R is important in helping the IRS and others understand the various activities that tax-exempt organizations are engaged in and their various associations.  It also helps ensure that the important policy goals of each section is honored. 

First, we have the subsidy that is received by public charities because the donors get to deduct their donations and we want to make sure that isn’t transferred improperly to a (c)(4) or a 527 political organization. 

Second, there needs to be a continued outlet for constitutionally protected speech, and the affiliated entity helps ensure that continued outlet exists. The congressional goal of having disclosure of amounts spent on political activity shouldn’t be obfuscated. 

Now when operated correctly, affiliated entities support these policy goals.  Affiliations between public charities and social welfare organizations help cordon off the subsidy to public charities while allowing organizations to lobby and engage in other activities with non‑subsidized dollars. 

So first we want to look at the restrictions that are on public charities because they are very important.  The restriction on lobbying and political campaigning by 501(c)(3) public charities is essential for maintaining the special role that charities play in our national life.  Providing public charities with a subsidy to lobby and intervene in political campaigns would put that special status at risk. 

The restrictions on lobbying and political intervention for public charities ensure that tax deductible donations are not used to promote political campaigns.  It requires organizations that wish to engage in lobbying or political activity to be on the same footing as other citizens.  Absent a ban on such activities, public charities could easily be used as a tax‑subsidized vehicle for political campaigns. 

Now these affiliated entities can be formed in very different ways.  You can have a public charity with a social welfare organization, which in turn has a political organization.  You can have a social welfare organization with an affiliated public charity and an affiliated political organization.  And you can have loosely affiliated entities who aren’t actually organizationally connected but have an affiliation.  The key is that the public charity is not allowed to subsidize the activities of the other organizations. We have had problems in this area in how we deal with them. 

The first is that this area is incredibly complicated.  The rules on affiliated entities are very complex.  The second is we have had very aggressive assignment of tasks between affiliated entities that may be inconsistent with our policy goals.  Third, the IRS has limited resources to enforce, and when it does, it is often accused of enforcing on political grounds.  Finally, the results of investigations by the IRS are not made public so it is hard to know what standards are being applied. 

I have some suggestions for the future.  We could examine the possibility of creating a public complaint and resolution process.  We could consider allowing the results of audits of exempt organizations to be made public.  We could streamline the rules regarding associated entities to reduce some of these regulatory burdens.  And we could create disclosure provisions that are consistent, or near so, among tax exempt organizations. 

I very much appreciate your invitation for me to be here today, and I am happy to answer any questions you might have.

[The statement of Mr. Tobin follows:]

Chairman Boustany.  I want to thank all of you for really excellent testimony, both written and oral.  We really appreciate what you have brought to the committee. 

Right now I want to start by looking at these complex interactions between UBIT rules, complex organizational structures, and reporting requirements.  It is my understanding that passive income, such as royalties and interest, is exempted from UBIT. 

So I would like to ask Ms. Borenstein, Mr. Hyatt, Professor Colombo several questions about what appears to be a relatively simple issue, but clearly is not. 

First, Mr. Hyatt, this committee has been told that often such income is generated in subsidiary organizations instead of the parent organization to protect the exempt status of the parent.  Oftentimes, joint ventures are formed.  So explain how this type of income can arise for a public charity. 

Mr. Hyatt.  Certainly, Mr. Chairman.  Obviously, the fundamental purpose of a charitable organization is tax exempt.  That doesn’t mean that it can’t entertain or carry on some level of commercial activity.  When it does so, the unrelated business income rules apply.  And back in the fifties when Congress first looked at this the idea was to have a level playing field.  So if you have some level of unrelated activity, perhaps you run a hotel to help families that are visiting your hospital or your campus, for example, there may be a legitimate reason to run that business enterprise as a part of your charity.  But if you are starting to operate it in a commercial fashion and one that looks to the layman like something a for‑profit concern would operate, you can do that as long as you pay taxes on that income. 

At some point, however, there is a line that you cross.  It is, as has been discussed by the panel, a facts and circumstances line.  It is not a bright line test.  But at some point that line is crossed where it becomes too commercial in nature.  And if you were to continue it and if it represents what the law calls a substantial nonexempt purpose, you could lose your tax exempt status.  That would then cause the organization to say the best way to protect our exemption and continue to carry on this activity is to spin it off into a separate corporation, a taxable subsidiary, for example, that we would control, and that taxable subsidiary might generate interest, royalties, annuities, et cetera, up to the parent as passive income. 

Chairman Boustany.  Thank you. 

Mr. Colombo, you went at great length in your written testimony, which I read, about these regulations and some of the conflicts, the definitional issues that have come up.  Clearly, I think we are going to have to work to provide more clarity there.  I know passive income is generally exempt from taxation under UBIT rules.  Just briefly, why does this exception for passive income exist? 

Mr. Colombo.  Well, I think that the answer to that has always been that passive income was consistent with the notion of charitable expenditures and funding charities.  You would get money in, if you needed it you would spend it.  If you didn’t need it, you would invest it in a diversified portfolio and put it in the bank and then you would use your earnings off of that.  Endowments have always been a feature of the charitable sector.  And I think we have always viewed the notion of passive investing as being particularly consistent with charitable expenditures and charitable operations in a way that we have not viewed the direct operation of a commercial enterprise as being necessarily consistent. 

Chairman Boustany.  Thank you. 

Ms. Borenstein, if a public charity does have passive income and it is generated through a subsidiary or involves a related party transaction, how is that income reported on the new Form 990? 

Ms. Borenstein.  Well, one of the points to make is that excess capacity is what generates passive income.  We have excess cash or extra office space, our budget is under stress a little bit and now we want to rent out some offices at the end of the hallway to other entities.  If we turn our building for liability purposes over to a for‑profit corporation or another nonprofit corporation, that we have control over it, we are going to report that other entity as a related organization.  And because of the 512(b)(13) rules — which I am sure everyone loves the complexity of that number even having to be cited – it is a loophole closer in the Code that requires payments of these types of passive, otherwise not subject to UBIT streams to be reached by UBIT, and thus so rents from real property paid by a controlled organization have to be reported on the 990.  This was an addition from the Pension Protection Act of 2006 requiring such receipts to be reported on the 990.  And so now the Schedule R not only gives detail of who are my related organizations but requires me to denote dollar amounts of all transactions that have passive streams from my related organizations that I control, as well as denote any other transactions, once they are large enough, by type and potentially amount. 

Chairman Boustany.  Thank you.  Professor Colombo, in your written testimony as well as oral testimony you discuss commerciality, the commerciality doctrine.  Commercial activities of public charities and tax exempt organizations in general have been an issue raised by members of this committee several times over the past year‑and‑a‑half.  And as you note, the policy question is how much if any commercial activity may a charity undertake without
impairing its exempt status. 

Could you elaborate?  The regulation seems very, very confusing.  We need more guidance on this. 

Mr. Colombo.  Well, it is very confusing and I think that is why we need to have a policy discussion about where we want charities to go with respect to commercial activities.  I am actually not opposed to charities being involved in commercial activities.  I would probably do so in a manner that, first of all, I would tax all commercial activities.  I would probably get rid of the related versus unrelated distinction. 

And second, I think maybe the more important piece would be that I would make sure that charities have to demonstrate to us that the commercial activity is enhancing their charitable outputs; that that is better for them in some way than simply investing in a diversified portfolio.  If it is not, if they can’t show that, then my response to them would be:  Well, then why are you doing this?  Go invest your money in a diversified portfolio and use the earnings to do your charitable activities. 

So I do believe the law is very, very difficult in this particular area and that I think there is an underlying policy question that I think Congress should engage. 

Chairman Boustany.  Well, I think Ms. Borenstein raised this issue of excess capacity and more efficient use of resources.  I think in your testimony you talked about empire building, on the opposite side of the scale.  If all commercial activity were taxed and we got rid of this distinction, would that ease the compliance burden for the IRS? 

Mr. Colombo.  Well, I think it would ease the burden in the sense that they would not be required to deal with this very difficult, as Mr. Miller pointed out, very difficult test of related versus unrelated.  Now pieces of the compliance, however, are not going to go away.  The issue of how you allocate expenditures, particularly how you allocate overhead and that kind of thing, are always going to be with us, no matter what, when you have a differentiation between charitable activities on one side and taxable activities on the other.  But it certainly would get us out of the business of scratching our heads and figuring out whether selling rock CDs is related or unrelated. 

Chairman Boustany.  I see.  Of course, you went at great length in analyzing commercial activities by charities and showing it is not a really easy task.  And to make sense out of the area, in your written testimony you talked about five categories.  And the first categories were commercial activity by a charity is also a primary exempt activity.  A prime example of this type of charity is a nonprofit hospital, for instance. 

Explain in more detail this particular category of commercial activity and how it applies to nonprofit hospitals. 

Mr. Colombo.  Well, the question in my category 1, there are certain charities which I would say do nothing except conduct a commercial activity.  I think the publishing cases are another example, where you have a religious publisher for example.  The question right now is:  Does that commercial activity further a charitable purpose?  Well, in some cases, we have said so, right?  So in the case of nonprofit hospitals, they sell services for a fee.  There is not any question that that is what they do.  But we have said that under certain ancillary rules and circumstances that that in effect will be a charitable activity. 

We have had a lot of litigation over religious publishers.  And so my sense of that one is we need to figure out what that policy rule is and apply it consistently across all sectors of our charitable operation.  I am not sure why you wouldn’t say publishing religious text is as much furthering a religious purpose as selling hospital services is furthering a health care purpose. 

Chairman Boustany.  Thank you. 

Finally, Mr. Hyatt, the last thing I would like you to do for us is if you would be so kind as to come up and use this white board we have set up to draw what I will call a simple complex structure for public charity and briefly explain the different elements. 

Mr. Hyatt.  I would be happy to, Mr. Chairman, if the committee will indulge me in any lack of artistic ability I might have in doing so.

Chairman Boustany.  We won’t criticize your artistic ability. 

Mr. Hyatt.  Simple.  A hospital, a college or university.  Not unusual still today to find a single hospital operating corporation running the full enterprises of a hospital or university.  However, I expect if you were to look at the internal organizational chart of that organization, you would see the Rube Goldberg scheme.  There are a lot of far‑flung enterprises, services being provided, primarily charitable, some taxable, that they pay unrelated business income tax on, but it is certainly possible to run it through a single operating corporation. 

If you wanted to have a multi‑corporate system for some of the reasons I mentioned in my statement to deal with competing reimbursement and regulatory schemes, to improve the governance by division of labor, by helping others get into the mix, to really focus on the knitting of particular activities, or perhaps to put out, as I mentioned a moment ago, a commercial activity that might threaten your exemption if it really took off, you might very well look at this type of corporation structure. 

Externally, this is a pretty common structure for large institutional public charities today.  So what would this box become then in that complex structure?  This would now be what is commonly called a parent holding corporation or a parent entity.  You would see this primarily in health care systems, less so in private universities.  You would see it in public universities, where there is a flagship overseer and then the individual colleges and campuses.  But commonly a parent corporation has its own board of trustees, it is a 501(c)(3) public charity as well, and its job is to do the strategic thinking here.  If each of these boards focuses on their own activities, someone has got to see what do we do in concert.  Are we all pulling in one direction.  That is what this board would commonly do. 

So, again, this is a public charity, the parent corporation.  This public charity here might be the primary organization in the system.  It is a hospital, it is a college campus, it is school of medicine or a school of law.  It is a separately contained organization that carries on that primary activity.  You might have a separate or distinct activity here that is also a public charity focusing on a distinct activity.  If you are a hospital system, this might be a home health agency or a cancer treatment center or laboratory.  If you are a college or university, this might be an alumni association.  It might be an investment management company to manage your endowment to grow revenues and funds for decreasing the cost of tuition and improving faculty, et cetera. 

This might be yet another public charity or it might be a taxable corporation.  It might be a credit union for your employees, for example.  Or, it may be some new technology that you are developing that you want to able to license and revenues to support your mission.  It may or may not be a public charity or a taxable enterprise. 

If you are a hospital system over here, this, again, would typically still be a public charity.  It could be a physician group that you now employ.  It has now become quite common.  The pendulum has come all the way back for hospital systems to employ doctors directly to provide services.  So now increasingly the IRS is seeing, again, applications for tax exempt status by physician groups, whereas they used to be solo practitioners and private practitioners in that area. 

Then you might also see joint ventures between
for‑profit entities, public charities through a joint venture entity.  The limited liability corporation, or LLC, is probably the most common vehicle for joint ventures today.  It could still be a taxable corporation.  It could even be another tax exempt organization.  But commonly you are doing that for one of three reasons.  You are trying to get access to capital that you wouldn’t otherwise be able to obtain.  You are trying to get access to expertise.  That for‑profit enterprise knows a lot about this business.  You need to get them to help you manage that so you can do it more effectively.  Or, you are trying to get access to a neighborhood, an area market where it is difficult because of barriers to entry economically to get in, logistically to get in, so you get the help of others to run that joint venture. 

So as you can imagine, this is the basic form of complex.  There can certainly be a lot more boxes under it.  The key there ‑‑ and I think this is where the Service has done a good job and can continue to do a good job ‑‑ is transparency.  And keep in mind that the Form 990 is a public record document.  And the IRS, while it is the regulator, is but one constituency for that document.  Because it is public record, you can see it online on, look at these 990s of organizations.  You want to make sure that regulators, donors, funders, staffs, patients, Members of Congress understand what each of these boxes are and it is very clearly reported and transparent.  And I think that is where we can continue to see progress in that direction. 

Chairman Boustany.  Thank you very much, Mr. Hyatt.  That is a very helpful description to get the committee focused on some of the complexities of these organizations. 

With that, I am happy to yield to the ranking member, Mr. Lewis. 

Mr. Lewis.  Thank you very much, Mr. Chairman. 

I want to thank each of you for being here, for your testimony.  Thank you so much. 

Professor Tobin, since you have been so quiet and you haven’t had an opportunity to respond, is there anything that you want to say, to just get it off your chest?  You have been waiting so patiently.

Mr. Tobin.  I think on UBIT and associated entities my colleagues have done quite well.  So I am happy to answer your questions regarding the tax exempt entities and the way that they affiliate. 

Mr. Lewis.  Professor Tobin, Schedule R of the new Form 990 asks for information about organizations related to a public charity.  This includes for‑profit subsidiaries and affiliated tax exempt organizations.  Why is this information so important and so necessary for the IRS and the public to know? 

Mr. Tobin.  So in the tax exempt situation it is very, very important, and that is because the public charities get a significant subsidy from the public.  Donations to public charities are deductible by donors.  And we see these organizations as special, as ones that serve some type of government function.  When they affiliate with other organizations there is a serious risk that that subsidy that we provide to them gets pushed off to those other affiliates.  And what we really want to make sure of is that public charities are doing public charity work and that these other organizations are doing what they are designed to do.  So if they are lobbying, if they are engaged in political campaigns, we want to make sure that is not being done by the public charity.  It is separated off.  And the Form 990, without it, it is very hard to figure out who the different affiliated organizations are and what role they are playing. 

So the Form 990, Schedule R serves a very important public function of letting us know who those organizations are and what they are doing. 

Mr. Lewis.  Could you really elaborate and make it simple and plain to this Member? Are there activities that an affiliated tax-exempt organization may engage in that a public charity may not? 

Mr. Tobin.  Sure.  So public charities are only allowed to engage in an insubstantial amount of lobbying.  And there is section 501(h), which helps determine how much that is.  So a (c)(3), a public charity, can engage in some little amount of lobbying, but not a lot.  And the idea here is they are doing their normal functions and they may doing some little thing that may be considered lobbying, and we want to let them do that.  But if they are going to be a lobbying organization, they are supposed to be a 501(c)(4) organization, a social welfare organization.  Because lobbying is considered a social welfare function. 

So it is perfectly fine for a 501(c)(4) to be a lobbying organization, and a (c)(3) can form a 501(c)(4).  And it happens all the time. 

Now a charity, a public charity, is not allowed to engage in a political campaign for or against a candidate for public office.  501(c)(3) makes that very clear.  We do not want the subsidy that goes to public charities to be going into campaign organizations.  So a 501(c)(3) is prohibited from engaging in political activity.  They should do that through an affiliated (c)(4).  Actually, they are not allowed to create an affiliated 527, but they are allowed to create an affiliated (c)(4), which is allowed to create an affiliated 527.  So that is how they get that done. 

Mr. Lewis.  In your testimony, you noted that there are serious enforcement problems.  Some big issues.  I know the Chairman and others do not want us to move into this political climate that we are in right now, but it seems like each time we pick up the newspaper, hear something on television or the radio, that there are real problems out there. 

Do you think the IRS is having a major problem in enforcment with limited resources, limited staff?  Who is watching?  Who is policing? 

Mr. Tobin.  This interrelated affiliation is a mess.  And it is a mess for a lot of reasons that are the faults of a lot of us and a lot of reasons that are not anyone’s fault.  The IRS is not set up to be a campaign watchdog.  They are not good at it and it doesn’t serve their primary purpose.  And so when they are placed in the position of having to get involved in these kind of political debates, it is very difficult for them to make these kind of determinations.  But in addition, we have seen really, really aggressive pushing by organizations and what they claim their activities are.  So the more aggressive organizations push, the more it creates problems for the IRS in enforcement.  If we talk about a public charity not being allowed to intervene in a political campaign, and the public charity starts doing it but claims they are not from some weird definition, it creates this enforcement burden on the IRS; have the engaged, have they not. 

We have seen in the social welfare context where the definition that organizations seem to be using appears to be the election law definition, not the Tax Code definition.  So you have a whole set of (c)(4) social welfare organizations who in my view are absolutely 527s.  Now who is supposed to police that, right?  If a social welfare organization says this political campaign activity is social welfare, who comes in and checks that?  And the answer is it has got to be the IRS.  And it is just very difficult for them to do that.

Mr. Lewis.  Thank you.  I notice my time has expired.  And the chairman has been so liberal here.  Thank you very much.  Thank you, Mr. Chairman. 

Chairman Boustany.  Thank you. 

Ms. Jenkins, you are recognized. 

Ms. Jenkins.  Thank you, Mr. Chairman.  Thank you all for being here. 

Ms. Borenstein, in your testimony you discuss the extensive changes to the Form 990 and note that some problems still exist.  Can you talk more about what challenges still exist for tax exempt organizations, preparers, and the IRS, and also maybe what recommendations might solve them? 

Ms. Borenstein.  Yes.  At basic ground level the difficulty with the form vests in a couple of places that have been vexing to preparers.  Again, I stress that there is many people who are doing a good job preparing their own form, especially when filing organizations do them on their own. 

My first suggestion is that the IRS should do more educational efforts to explain that some of the terminology used is not inherently value‑laden as we are finding a fear in the exempt sector: “that I should not have a board member whose company is providing us a good deal because then I have one less independent director and there is something inherently wrong with that director’s capacity to serve,” — which is certainly not the case.  Folks like myself can say that as much as we want.  Hearing it directly from the IRS would be helpful.  So I am asking for more educational outreach on the part of the Service to express that they are just asking the question, rather than saying there is anything inherently bad about disclosure of favorable transactions with insiders. 

The Schedule L, colloquially we refer to it as “lose your mind.”  The Schedule L has four separate parts.  One deals with a statutory regime regarding excess benefit transactions that there is to ensure public charities cannot be taken advantage of unfairly by people who have been in substantial influence at any point in the last 5 years.  You turn someone in if that has been the case.  So one part of the Schedule L filers have a definition of and disclosure asking “has that happened with a certain group of people?” Another part asks, “are there loans outstanding at year end with a different group of certain people?” A third part asks, “have there been grants or assistance provided to yet another group of certain people?” And then finally, one last part asks, “are there business transactions with certain people?”

I have strongly recommended that the IRS create some sort of educational materials or flow chart in the instructions to the end of simplifying the definitions, trying to make them easier to handle. Standalone they all make sense as bright lines in the sand, but paired together their combined weight creates a very daunting task for the sector. 

Past there: the Schedule F. I think there is much concern about the utility of the information being provided to the IRS about activities outside the borders of the United and widespread evidence that the info asks are burdensome (and potentially of questionable value).  So I am recommending that that schedule be either extremely streamlined or eliminated. 

And then there was a vestigial part of the old 990 that I think there was huge agreement had very value to the IRS.  It is there at the behest of States and requires groups to functionalize their expenses between program and fundraising and management.  There was an old‑school belief that I would give a dollar to a charity first who was going to spend 90 cents of that dollar on program, but I know that I might want to give a group a dollar who is going to spend only 60 cents on program because that is where they are in their lifecycle and they need to build up management or need to put some efforts into fundraising, et cetera.  That part/statement that has groups functionalize expenses should not be on the form.  It is subjective.  It doesn’t work, and it continues longstanding mythology in favor of giving money to groups who say more dollars are going to program. 

And then finally, it is clear that in spite of my saying groups can do their own Form 990, that small organizations can’t.  They are being very burdened.  We had a transition period in which small organizations did not have to file the full redesigned 990 for a period of years.  That finally ratcheted down to gross receipts of $200,000 as the level at which one must fill out the Form 990, or gross receipts at any level but owning assets of more than a half million dollars (requires the whole 990).  I am suggesting that those thresholds rise back to the first transition year of a million dollars of gross receipts or perhaps on average a million dollars of gross revenues a year or having assets of $3 million.  We have amateur athletic associations who have built a hockey and sports facility arena.  They own $3 million worth of real estate.  Well, $3 million might be the point at which they are filling out the full 990.  But if they own a million dollars or $2 million worth of real estate, I and many others think they are still a small organization if their budget is less than a million dollars a year.  On top of those increased thresholds by which groups could still fill out the Form 990-EZ, I am suggesting that the IRS come up with a third way to find ways in which that Form can be bettered in order to let more small organizations fill out a less comprehensive form. In sum total, that was my last recommendation. 

Ms. Jenkins.  Thank you. 

Mr. Chairman, I yield back. 

Chairman Boustany.  Thank you. 

Mr. Becerra. 

Mr. Becerra.  Mr. Chairman, thank you.  Thank you all for your testimony.  Each of you has to some degree focused some of your testimony on the growing complexity in this area and also the need for more transparency, a greater degree of disclosure, and so forth.  I know that Mr. Miller put the best light or best face he could on the capacities of the IRS to try to oversee the numerous organizations that are now popping up under the tax-exempt structure, but it seems like what we are doing is losing ground every day on the ability to seek transparency and reduce the complexity.  And so we thank you for your guidance and some of your ideas of how to try to make that better. 

I think, Mr. Tobin, you have also suggested some ways to try to enhance the ability for us to pursue the bad apples, those who make the rest of the nonprofit world look bad because they have done things that don’t conform with what we consider to be good mode of procedure for a nonprofit, the kind of things that we think of when we think of that charitable hospital or the cancer society or those organizations that are out there to do good for a lot of Americans. 

Can you tell us a little bit with more detail from what you say in your written testimony about how we can go about enforcing some compliance in the tax-exempt area where, for example, we deal with lobbying, political campaigning, and other activities that seem to go beyond what we typically think of the work of a charitable or a not‑for‑profit entity? 

Mr. Tobin.  So one of the problems in this area is that we have put the IRS in charge of policing and we haven’t really given them the tools that we would normally give an agency that is required to police in this way.  For example, the Federal Election Commission, you can make a complaint to the Federal Election Commission.  But the IRS, it runs, it does its audits.  You don’t complain that your neighbor has not been audited and have them all of a sudden audit your neighbor.  There are whistleblower statutes.  But for the most part the IRS does their audit and then they keep it all secret, because that is what they are supposed to do.  They are not supposed to disclose my tax return to anyone else, and we expect that kind of privacy. 

Well, that is happening in the tax exempt area, and I think there is a real question whether we need it to happen in the tax exempt area.  Tax exempt organizations are public charities.  They are public organizations.  They are receiving this public subsidy.  So I think that there are ways in which we can have a public complaint process, where the public are looking at what is going on, they find that there is a problem.  Right now they can send a letter to the IRS, but they don’t have any idea what is going to happen.  There is no requirement the IRS look at it.  There is certainly no requirement that the IRS tell you what happened in that process.  And they can’t, in most cases. 

And so I advocate that you have a public complaint process that you set up and that we have some transparency in that process because I think both sides of the aisle ‑‑ in my history, I have been a professor for 11 years, and before that have at DOJ for 4 years, and then I was a judge, and I was on the Hill for 7 years, so there is a good 20 years of this stuff ‑‑ and both sides of the aisle, when these things happen, you want to have some certainty that it is not political and that it very objective.  My experience is the IRS handles this in an objective way.  And the more we can be transparent in that, the better.

Mr. Becerra.  Are there any existing complaint processes that we could use to guide us in how you would form such a complaint process? 

Mr. Tobin.  It is nice when you are a professor and somebody asks you about something you wrote, you just have to remember what you said.  But I did an article on that in Georgetown’s Law Review on the process.  And I think having a panel of nonpartisan, of career service employees that could rotate through so that you weren’t doing something like the FEC, where you had three and three, which creates a possibility for deadlock, where you had transparency in the decisionmaking process so that you could have some sense of what was actually happening, is the best way to go forward. 

Mr. Becerra.  Thank you.  Thank you all for your testimony. 

Yield back, Mr. Chairman. 

Chairman Boustany.  I thank the gentleman. 

Mr. Marchant. 

Mr. Marchant.  Professor Colombo, it is easy to imagine an instance where a tax exempt organization would participate in a soup kitchen kind of scenario and then everybody liked the soup and so started canning the soup and then selling it and made that.  But can you describe in better detail how one analyzes a for‑profit activity and at what point the activity jeopardizes their tax exempt status? 

Mr. Colombo.  Well, I think in my world a commercial activity is one that competes in the private market with products and services available widely in the private market.  So I will use my example of selling soup.  I don’t know whether selling soup is related or unrelated to operating a soup kitchen, but I am quite certain that it is a commercial activity.  It competes in the private market with other soup makers. 

How about tuition charged by a private school?  Well, that one I would say is not a commercial activity because we have not yet reached the point where educational services are widely available in the private market.  There are a couple.  There is the University of Phoenix.  But we are not there yet.  So my view about that one is that tuition charged is not. 

So I would look to the private market and I would say that if what the charity is doing is selling a good or service that is widely available in the private market, that is a commercial activity. 

Where would I draw the line?  I actually wouldn’t draw the line.  I would say to charities, You can engage in as much commercial activity as you want, provided that all of it is taxed and that you show us that that commercial activity is generating revenue that is expanding your charitable outputs.  If it is not doing that, then why are you doing it?  Do something else.  Go sell your business and invest it in a diversified portfolio and use the money from the portfolio to operate the soup kitchen rather than selling soup.  You may not be good at selling soup. 

Mr. Marchant.  So in my State and many States are now experiencing expiration leasing income on the land that they own.  So that someone comes to a local university, simple, that first box up there.  They have never really even thought about getting out of that box.  And all of a sudden they discovered oil and gas on their campus or a piece of land that they have always considered to be their campus.  That income, is it clearly not taxable? 

Mr. Colombo.  I think under current law it is pretty clearly a royalty, if that is the way that it is structured.  I come from southern Illinois.  We have oil and gas in southern Illinois, too, but I forget how the oil and gas leasing is done in that situation.  But I think it is pretty clear that it would be passive income either as rental income from real estate or as a royalty arrangement. 

Mr. Marchant.  If they chose not to lease the royalty out and chose to drill, actually hire a rig and start drilling and producing their gas and oil, is that ‑‑

Mr. Colombo.  In my world, that is a commercial activity.  Now you are Shell Oil. 

Mr. Marchant.  And then, in your opinion, you would have an unrelated ‑‑

Mr. Colombo.  Yes. 

Mr. Marchant.  Ms. Borenstein. 

Ms. Borenstein.  If it were a school and you were teaching your students how to do that drilling and operate a business, you would be able to, under the current UBIT regime, talk about a substantial relationship to the conduct or accomplishment of your exempt purpose. 

Mr. Marchant.  Mr. Tobin, would you feel like that that fell outside the actual participation in the drilling and becoming the consumer, not just the royalty owner?

Mr. Tobin.  I agree with both examples.  In the first example I think if you actually engaged in the commercial activity and you became the driller, it would be much more problematic.  If you were able to make it part of your teaching process, then it would be less.  We are talking about a hypothetical here, but it would be less problematic.

Mr. Marchant.  Thank you, Mr. Chairman.

Chairman Boustany.  Thank you, Mr. Marchant. 

Mr. Paulsen. 

Mr. Paulsen.  Thank you, Mr. Chairman.  As you know, one of the issues that has come up at prior hearings actually deals with our learning about tax exempts and the ability of exempt entities to enter into partnerships, whether it is with another exempt entity or with a for‑profit entity.  Can you just explain maybe, Mr. Hyatt, in a little bit greater detail how a public charity would actually enter into a partnership or a joint venture with another organization and what are the specific issues in particular that have to be dealt with to ensure that an exempt organization actually remains exempt? 

Mr. Hyatt.  Certainly.  Thank you, Mr. Paulsen.  Joint ventures are really one of the areas of substantial corporate growth certainly in the last 20 years, since about the late seventies or early eighties, for the reasons I described.  Typically, what would happen is the exempt organization would look to this outside for‑profit party, look for a way of sharing mutual abilities and enter into a joint venture through a limited or general partnership.  A limited liability company, as I say, is the most common model these days. 

If you look back historically prior to about 1980, the IRS took the position that you couldn’t as a public charity engage in limited partnership joint ventures, for example, that it was too much of sharing of your activities with the for‑profit side and that was inconsistent with the tax exempt status.  The Tax Court overruled that position.  The IRS subsequently pulled back from that line and over the years has come up with a series of guidance that approved certain structures for entering into joint ventures. 

The essence of it is no matter how you do it, no matter how you structure that joint venture, your participation in it has to further a charitable purpose and you have to ensure that you haven’t unduly ceded control over the organization to for‑profit parties. 

So if you look back into the 1980s, for example, we were starting to see hospitals cede the entire operation of the hospital to a joint venture with a for‑profit party, what is sometimes called a whole hospital joint venture.  The IRS took a look at that and used a fact pattern that is not uncommon in these sorts of situations in a revenue ruling, the good situation and the bad situation.  And in essence, they said as long as you ensure that you haven’t unduly conceded control to the for‑profit parties, as long as you are doing this for a legitimate charitable purpose, perhaps you are, as many hospitals are, particularly academic medical centers, struggling to make ends meet, this is the way to remain as a charitable entity, you got a legitimate reason for doing that, and as long as you are not improperly benefiting private parties under IRS rules, that is an acceptable way to go.  But if you ceded so much control to the for‑profit party that they in effect are really operating the charity now, it no longer continues to qualify as a charity and the IRS has indicated we would take that away. 

Another version of that is what is sometimes called an ancillary joint venture.  The example in the most recent revenue ruling by the IRS in this circumstance was a college or university that wanted to do distance learning.  They wanted to ensure that teachers in the summertime could come and take courses without actually having to be on campus.  They said there are for‑profit companies out there who can do a better job at figuring out what cameras to choose, how to get the mikes set up, what halls should we rent, how do we go about doing that.  What we do very well is figuring out what our curriculum is, who our best teachers are, what the standards are for passing that test. 

So we will approve that kind of ancillary joint venture as long as you haven’t ceded control over to this for‑profit party and the for‑profit party is dealing with the business aspects, the charity continues to deal with the charity aspects of it.  If you break it up in that fashion, otherwise share risks and rewards, have shared governance of that organization, in the IRS’s view back in 2004, that is a legitimate way to do an ancillary joint venture as well for a public charity. 

Mr. Paulsen.  That is helpful.  Thank you.  Let me just dovetail into something real quick, Ms. Borenstein, if I can ask you a question.  Because in your testimony you noted that the changes have occurred for the Form 990 and entirely new information now is required and existing requirements have changed substantially.  What were the deficiencies of the old Form 990 and what particular concerns actually prompted all these substantial changes with 990

Ms. Borenstein.  Well, where should we start?  I mean, the director of the exempt organization division referred to the prior iteration of the Form 990 as a disaster, and it was perhaps the one time that the entire exempt organization community completely agreed with the IRS. 

The old form was built out very, very poorly.  Questions were asked as the topic du jour rose through hearings in this august body and through law changes.  There was no rhyme or reason to how it was structured.  And as I earlier stated, it was perceived as a financial statement because you largely saw numbers, but there were questions all over the place that said attach a schedule, and you had to read the instructions to know what to attach in the schedule.  The software providers for 990 preparation all had a different inclination as to what the schedules should provide.  You couldn’t find the data.  You would go to Guide Star and find a 300‑page return, and be endlessly searching for the list of directors, officers and key employees, or other common attachments without so much as a clue where that information was going to be.

It was widely understood that it was time to start over, which is why the IRS, starting in 2005 and 2006, went through what I thought was a very thoughtful process of engaging the entire sector to say if we have to ask questions about who you are and what you are doing and why you continue to be an exempt entity in terms of qualifying, “what would you want to see us put on the form?”  And there was a fair amount of back and forth.  The IRS proposals I am sure included items that they were ready to negotiate on, and they did jettison some completely.  They took a lot of suggestions.  The architecture of the form was agreed to for the most part by the sector.  The instructions are relatively plain English.  They worked very, very hard on that.  They continue to make corrections each year, resulting in improvements to the form.  But again, the notion is that we want an environment of transparency and accountability, particularly for public charities.  And so to annually report on the sum total of who they are, under whose watch are things being performed, what compensation is being paid particularly to those in charge — a full view — is what the new 990 affords.  The old 990 attempted to ask a lot of that information but only someone like myself understood those questions.

Mr. Paulsen.  Thank you, Mr. Chairman. 

Chairman Boustany.  Thank you. 

And Ms. Borenstein, just in follow up on what Mr. Paulsen asked, in your testimony, you had discussion of eight completely new areas on the revised Form 990.  For example, any information required on authority and management practices, related parties on Schedule R is one example.  Explain what specific information is now required there.  How the IRS or other interested parties may use that information to examine the organization.  And how have these requirements prompted public charities to make changes for compliance purposes? 

Ms. Borenstein.  Well, I am sorry, Mr. Chairman, are you asking about the Schedule R?  

Chairman Boustany.  Yes.

Ms. Borenstein.  I think the chief imperative behind the Schedule R was to afford a view into the linkages between the filing organization and organizations over which control existed in one direction or the other.  Also, in addition to noting where the linkages are, it gives the opportunity for the IRS and the public — the court of public opinion in my eyes is the third regulatory body to the States and the IRS – to see answers to the IRS’ asking the right questions, depending on whether the related organization is for profit and taxable versus exempt or a partnership – in each of those instances, there is different contextual information asked of.  So you and I as readers of the return see who those entities are with much more detail than that afforded by the prior 990. 

One of the things I don’t note in my testimony that is important to understand that the Schedule R serves to inform the compensation picture, too.  The very important people, the in‑charge people for the filer, for these individuals the Schedule R triggers visibility for what compensation they are paid by, and what hours they are providing to, the filer’s “related organizations.” In the good old days, before the current 990, if I had a complex organization that was comprised of a (c)(3) with a related (c)(4), I would not know from reading the 990 of either if an important person for the (c)(3) was also being compensated by or providing services to the (c)(4) or vice versa.  I would have had to read both returns together but now it is in one place on each organization’s return.

Chairman Boustany.  Okay.  Thank you.  That was very helpful. 

And finally, Professor Colombo, in your testimony, after discussing the many problems with the commerciality doctrine compliance IRS enforcement, you provide several suggestions for reform.  And I want to just focus on two of those options you had laid out.  First is to return to the commensurate in scope doctrine.  Explain to me in more detail what that proposal is and how it would actually work. 

Mr. Colombo.  Well, this is actually part of this question of how much commercial activity should a charity engage in.  In 1964, actually, the Internal Revenue Service took a look at this problem and wrote a ruling and basically said that you could engage in ‑‑ there was no limit on the amount of commercial activity you could engage in as long as your charitable activities were commensurate in scope with your investment in commercial activity. 

So this was the IRS’s check on making sure that the commercial activity was providing resources to the charitable side as opposed to just becoming, as I point out, empire building. 

I would resurrect that test.  I probably would resurrect it.  The IRS has sort of let it lie, and then they resurrected it in other areas, and now I am not exactly sure anymore what ‑‑

Chairman Boustany.  It is inconsistent.

Mr. Colombo.  Yeah.  I don’t know what it means anymore.  I am not sure they know what it means anymore, frankly.  So I would resurrect it for its original purpose. 

I might even add some kind of safe harbor rule, that if you earn a rate of return that is equal to the current Federal rate, medium‑term Federal rate or something like that, that you then redeploy on the charitable side, you are okay, it is fine, you go and you can engage in as much commercial activity as you want.  So that is the piece of it that I refer to as resurrecting the commensurate in scope doctrine.

Chairman Boustany.  Okay. 

And finally, second is to no longer use the relatedness test for UBIT and impose tax on all commercial activities by charities.  You kind of talked a little bit about that in our previous back and forth.  How would that work?  Would it make oversight easier?  And what kind of impact would this have on the tax‑exempt sector overall? 

Mr. Colombo.  Well, I think, first of all, if you just tell charities that all of your commercial activities are taxable ‑‑ you could actually I think do it either way, tell them they are all taxable or tell them they are all not taxable; I think that it happens to be not a good idea to tell them that they are all not taxable ‑‑ then again, you eliminate this, as Mr. Miller pointed out, very difficult to enforce line between what is related and unrelated. 

Now, there is still a definitional question, no doubt about that, there is a definitional question about what is commercial.  But my own view about that one is that is a pretty easy definitional line to meet, certainly much easier in my view than related or unrelated.  I am not sure at the end of the day that that will have much effect on charities other than giving them clarity that they can engage in commercial activities.  It will not cause them to lose their tax exemption.  They can then set up the corporate structure or the business structure that makes sense from a business perspective as opposed to worrying about, well, do I have to drop this thing into a corporate container because if I don’t, then someone from the IRS might come along and say, well, that affects your tax exemption.  No.  You know, let them make those decisions based upon issues that are not tax issues, that are issues of business issues.  So my own view is that that would in fact simplify oversight.  How much?  I don’t know.  But I think the system we have got, sort of anywhere is up.

Chairman Boustany.  Thank you. 

Mr. Lewis, do you have any follow up. 

Mr. Lewis.  No, Mr. Chairman.

Chairman Boustany.  Mr. Paulsen is gone. 

Well, that concludes our hearing.  Thank you very much.  Your testimony was very, very helpful to us.  Keep in mind that members may have some additional questions that may come up, and they would submit those to you directly for answers.  Both questions and answers will be made part of the official record.  And with that, I will now conclude the hearing.

[Whereupon, at 11:38 a.m., the subcommittee was adjourned.]

Public Submissions For The Record

American Bankers Association
Center for Fiscal Equity
Economic Research Institute
Elizabeth Boris-Thomas Pollak-Charles McLean-Jeffrey Falkenstein