IRS Tax Compliance

Private Benefit and Nonprofit Executive Compensation

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We hope to have several segments which address Tax-Exempt Compliance with applicable IRS regulations and the Internal Revenue Code.

A 501(c )(3) public charity receives tax exempt status upon demonstrating that it is organized and operates for a public purpose under 501(c )(3) of the Internal Revenue Code.  To maintain tax exemption, tax-exempt organizations must follow all laws and regulations pertaining to tax-exempt organizations.  The law provides that engaging in certain activities will jeopardize a nonprofit organization’s tax exemption.  The focus of this article is on a salient issue concerning executive compensation.  Can a nonprofit organization lose its tax-exempt status due to unreasonable compensation?  The answer is yes.

Briefly, the law provides that no part of a tax-exempt organization’s net earnings may inure to the benefit of an insider. An insider is a person who has a personal or private interest in the activities of the organization such as an officer, director, or a key employee.  The key here is net earnings of the organization privately benefited a key employee of the nonprofit organization.  Authorizing key employees, such as an Executive Director, Chief Executive or other key officers, to receive unreasonable compensation put the nonprofit’s tax-exemption at risk.  In other words, if compensation is given to any officer, director or key employee it must be reasonable or it can be deemed to be a private inurement jeopardizing the organizations 501(c )(3) status.  What is reasonable compensation depends of the totality of the circumstances.  Comparability data is one means of substantiating the reasonableness of executive compensation.  However, there are caveats with respect to its use, such as whether the data provides an accurate comparison.  The Exempt Organization section of the IRS has two useful articles on its Website on nonprofit compensation.  If you have difficulty finding them, you can e-mail us at info@scottpractice.com and will be happy to assist you.

IRS Automatic Revocation of Nonprofit Tax Exemption

Organizations that are required to file an IRS Form 990, 990-EZ or 990-PF or submit an annual electronic notice on Form 990-N are subject to automatic revocation if the exempt organization fails to file for three consecutive years.  The consequence of automatic revocation can be economically devastating for struggling non-profit organizations since the organization may be required to file a Form 1120 corporate income tax return or Form 1041 Estates & Trusts return and pay applicable taxes on income received.

 

Organizations previously eligible to file Form 990-EZ or Form 990-N for each of the three prior consecutive years that have lost their tax-exempt status may be eligible for retroactive reinstatement by filing for recognition of tax exemption on the required Form 1023 or Form 1024 and paying the appropriate user fee no later than 15 months of the date on the organization’s Revocation Letter (CP-102A) or the date the organization appeared on the Revocation List on the IRS Website, whichever is later.   This process is called the “Streamlined Retroactive Reinstatement Process”. 

 

The IRS will not impose a penalty for failure to file annual returns for the three consecutive taxable years that caused the revocation if the organization is successfully reinstated under the Streamlined Retroactive Reinstatement Process and files paper Forms 990-EZ for all 3 previous taxable years.  For organizations eligible to file Form 990-N, the organization is not required to file a prior year Form 990-N or Form 990-EZ to avoid penalties if reinstated.  

Organizations should contact a qualified attorney as soon as possible if they do not qualify for or need assistance complying with the requirements under the Streamlined Retroactive Reinstatement Process.