This year’s AICPA National Not-For-Profit Industry Conference in Washington D.C. in June generated a lot of buzz with respect to Form 990’s Schedule K. If your organization has tax-exempt bond debt and files Form 990, you may be aware that the 2012 version of Schedule K featured some new questions. These questions were added to collect data on how closely organizations monitor their compliance with tax-exempt bond regulations. However, one of the biggest takeaways from this portion of the conference was that the IRS intends to use the answers to these questions as a potential trigger for an audit examination.
Arguably the largest area of focus for the IRS in the exempt organization world has been and continues to be unrelated business income (UBI). To that end, for a number of years, the IRS had been using the redesigned 990 to gather information about colleges and universities as there were perceived abuses specifically related to their athletic programs. Over the past couple of years the IRS used the information collected in annual 990 filings to examine these institutions for potentially unreported UBI. As the window on these examination projects begins to close, the IRS appears to be turning its attention to other types of exempt organizations – most notably hospitals and organizations maintaining tax-exempt bonds.
While the rest of the Form 990 saw minor tweaks after the rollout of the redesigned form in 2008, Schedule K remained relatively unchanged. However, with the 2012 form, the IRS added the following questions: Part III, Line 9, Part IV, Line 7, and Part V. Each question asks if the organization has adopted written policies and procedures to ensure that there is an appropriate level of oversight by the organization on the post-issuance use of its bond funds. Specifically, the questions ask if all nonqualified bonds are remediated in accordance with Regulations Sections 1.141-12 and 1.145.2 and if the requirements of Section 148 are monitored closely. Should there be a deviation in the use of its funds, the IRS also wants to know if the organization has written policies and procedures in place to make sure that the violation is remedied in a timely and appropriate manner.
At the Schedule K portion of the AICPA program, two tax-exempt bond specialists from two large universities offered their insights and experience on what they have seen since the 2012 redesigned Schedule K in terms of IRS activity in the tax-exempt bond world. The over-arching message they conveyed was one of caution. They stressed that organizations that have not adopted adequate written policies should consider doing so in the near future. They indicated that the IRS’s Tax Exempt Bond (TEB) office is prepared to be “very aggressive” in its quest to ensure that organizations are compliant with tax-exempt bond regulations. The TEB office is said to use answers to the new questions on Schedule K as well as issue additional compliance check questionnaires to determine which organizations will face an audit examination. The speakers mentioned that the TEB office’s sole purpose is to investigate compliance issues and that it can act upon its own discretion to examine an organization.
Now that most tax-exempt organizations filing Schedule K have filed their 2012 returns, we have noticed that the vast majority of these entities do not have written policies related to these requirements. Through our discussions with our clients on these matters, we have found that most do have some type of internal policy in place. However, we have found that most organizations’ policies involved only internal compliance reviews or relied solely on adherence to bond covenants or consultations with bond and legal counsel. In some situations this may be adequate to avoid violations of post-issuance bond compliance. However, the program speakers at the AICPA conference informed us that this is not sufficient to satisfy IRS expectations and avoid an audit investigation. As a result, we have been advising our clients to, on or before the end of their next fiscal year, establish and adopt written policies that have specific language addressing the requirements of the regulation sections mentioned above.
We strongly urge you to work with bond counsel and underwriters to adopt procedures that meet the IRS’s requirements. Furthermore, in adopting policies we would recommend that you review the IRS’s compliance guide for more specific information on what should be included as you draft the respective documents. The compliance check questionnaires mentioned above are available to download from the IRS website. The IRS welcomes organizations to access these documents to be used as a guide when drafting policies to make sure that the policies are in line with IRS expectations. We would advise, of course, that if you decide to download and fill out a compliance questionnaire on your own volition that you do not send it to the IRS.
We have already seen an uptick in the number of tax-exempt organizations being selected for audit examinations. While it is too early to tell with these cases how much of a factor the Schedule K questions were in the IRS’s selection process, it would appear that there was at least some weight given to this area. It should be noted that the ramifications of tax-exempt bond violations can be severe and can include fines on organizational staff as well as a loss of 501(c)(3) status. At the very least, it can be said that answering “no” to the new Schedule K questions can be viewed as a red flag. If you have any questions regarding Schedule K or post-issuance tax-exempt bond compliance please contact your BNN tax-advisor.