Tag: IRS

New IRS Guidance on 40% Excise Tax Previews Future Regulatory Complexity

Although public opposition to the 40% excise tax on high-cost health care is rapidly growing, the IRS continued to develop a regulatory framework for administration of the excise tax through its issuance of Notice 2015-52 on July 30, 2015. Similar to the first notice on this topic, Notice 2015-52 merely identifies various administrative challenges without providing concrete guidance. If nothing else, the new guidance provides another preview into what will undoubtedly be a complex regulatory environment.

By way of background, the Affordable Care Act (or “ACA”) added Section 4980I to the Internal Revenue Code (the “Code”), which imposes a 40% excise tax (the “40% Excise Tax”) on the excess, if any, of the aggregate cost of applicable coverage provided to an employee over a set dollar limit (the applicable dollar limits will be adjusted for inflation and are subject to additional increases based on age and gender or for certain individuals in high risk professions). The 40% Excise Tax is imposed on the “coverage provider,” which is the health insurance carrier in the case of an insured group health plan, the employer with respect to a health savings account or Archer medical savings account, or in all other cases, the “person that administers the plan benefits.”

In February 2015, the IRS released the first notice, Notice 2015-16 (discussedhere), which was intended to initiate the process of developing regulatory guidance under Code Section 4980I. Notice 2015-16 described potential approaches related to the definition of applicable coverage, the calculation of the cost of applicable coverage and the applicable dollar limit.

The new IRS guidance proposes additional approaches related to (1) identification of the person or entity responsible for paying the tax, (2) determining the cost of applicable coverage, (3) age and gender adjustments to the applicable dollar limit and (4) notice and payment of the 40% Excise Tax. Although many of the approaches described by the IRS could work in the single-employer plan context, the approaches create a number of issues for multiemployer plans and the employers that contribute to them. These issues will be addressed in a future blog. Below is a summary of the key approaches described by the IRS in Notice 2015-52.

Identification of the Coverage Provider

As noted above, Code Section 4980I imposes a tax on the “coverage provider.”  The coverage provider is easily identified in the case of an insured plan or a health savings account. However, in all other cases, the coverage provider is the “person that administers the plan benefits.” Because neither the ACA nor ERISA contains guidance on identifying the person or entity that administers plan benefits, the IRS has proposed two approaches to assist in identifying the coverage provider.

Under the first approach, the coverage provider would be the person or entity responsible for performing day-to-day functions related to administration of the plan (e.g., processing claims or handing participant inquiries). In many cases, this would be a third-party benefits administrator. Under the second approach, the coverage provider would be the person or entity that has the ultimate authority or responsibility with respect to administration. Usually, this would be the plan administrator that is defined in the plan, such as a benefits administration committee that has been delegated administrative duties.

Either approach will present challenges for employers. For example, a single third-party rarely administers all benefits considered “applicable coverage” under Code Section 4980I. It is not uncommon to have separate administrators for medical benefits, pharmacy benefits, mental health and substance abuse benefits and flexible spending benefits. Employers would need to determine which portion of the 40% Excise Tax should be allocated to each administrator.

Calculation of the Cost of Applicable Coverage

Similar to the first notice, much of the guidance in Notice 2015-52 focuses on issues related to determining the cost of applicable coverage. Below are the key proposals.

  • Timing Issues. In order to timely pay the 40% Excise Tax, coverage providers must determine the cost of applicable coverage shortly after the taxable period (which the IRS indicated will likely be the calendar year for all taxpayers, regardless of plan year). This presents challenges for self-insured plans that cannot determine the cost of coverage until claims incurred prior to the end of the taxable period are submitted. Therefore, the IRS requested comments on whether a claims run-out period would be appropriate. Additionally, experience-rated insurance policies often provide payments or discounts following a policy year. The IRS has requested comments on how these payments or discounts should be applied to the cost of applicable coverage.

  • Excluding Income Tax Reimbursements from the Cost of Applicable Coverage. If an entity other than the plan sponsor is responsible for paying the 40% Excise Tax, that entity will likely pass the cost of the tax through to the plan sponsor in the form of increased service fees. Code Section 4980I provides that the cost of applicable coverage does not include amounts attributable to the 40% Excise Tax. However, Code Section 4980I does not address what happens when the same parties that pass on the cost of the 40% Excise Tax also seek reimbursement of income taxes incurred due to the receipt of additional service fees. This raises an important question – should the amount passed-through in the form of increased service fees to reimburse for income taxes (in addition to the 40% Excise Tax reimbursement) be excluded from the cost of applicable coverage? The IRS has requested comments on administrable methods for excluding income tax reimbursements, including what tax rate to use. The IRS anticipates that excise tax and income tax reimbursements will be excludable from the cost of applicable coverage only if separately billed and identified.

  • Annual Contributions to Account-Based Plans. The cost of applicable coverage includes employer and employee contributions to account-based plans, such as health savings accounts. The IRS recognized that annual contributions (as opposed to contributions made monthly or per pay period) could trigger a 40% Excise Tax in the month of contribution because the cost of applicable coverage is determined on a monthly basis. To avoid this result, the IRS indicated that it is considering an approach that would allow employers to apply annual contributions on a pro rata basis over the course of the taxable period when determining the cost of applicable coverage.

  • Flex-Credits and Carry-Overs under Flexible Spending Arrangements. The cost of applicable coverage for benefits provided through a flexible spending arrangement (FSA) is the greater of the employee’s contribution to the FSA or the total reimbursements made from the FSA. The IRS stated that when an employer contributes non-elective flex credits to an FSA on behalf of an employee, the cost of applicable coverage includes (1) the employee’s contributions, and (2) the amount of non-elective flex credits actually used for reimbursements. This would prevent unused non-elective flex credits from being included in the cost of applicable coverage. The IRS also stated that it is considering a safe harbor approach for amounts carried-over from prior years to prevent double counting. Under this safe harbor, amounts carried-over from previous years will not be included in the cost of applicable coverage. The IRS plans to restrict the availability of this safe harbor if non-elective flex credits are available.

  • Inclusion of Amounts Taxable under Code Section 105(h). Code Section 105(h) provides that the value of a discriminatory self-insured benefit provided to a highly compensated employee must be included in the employee’s income. However, under 2012 guidance related to disclosing the cost of coverage for Form W-2 purposes, the IRS provided that the amount included in income should be excluded. Addressing this discrepancy, the IRS stated that it is the “coverage,” not the resulting tax benefit that constitutes “applicable coverage” under Code Section 4980I. In other words, although a highly-compensated employee is taxed on the value of the discriminatory coverage, that coverage must be included in the cost of applicable coverage under Code Section 4980I.

Other Proposed Approaches

The IRS also described potential regulatory approaches related to the following:

  • Age and Gender Adjustments to the Applicable Dollar Limit. The applicable dollar limits used to determine whether there is an excess benefit may be increased upward based on the age and gender characteristics of all employees of an employer. The IRS is considering rules allowing employers to determine these characteristics based on a “snapshot” on the first day of the plan year. The IRS also indicated that it is developing age and gender adjustment tables to assist employers in applying the adjustment.

  • Notice and Payment of the 40% Excise Tax. Under Code Section 4980I, employers are required to calculate the 40% Excise Tax and notify the coverage provider and the Treasury of the amount of the tax, if any. The IRS has not yet determined the form of this notice, but has indicated that coverage providers will likely pay the 40% Excise Tax using Form 720. Form 720 is a quarterly-filed form, but similar to payment of the PCORI fee, the 40% Excise Tax will only be paid once per year.

The IRS set October 1, 2015 as the due date for comments on the latest notice. Given that late date, it is not likely that proposed regulations would be completed before 2016. Employers considering filing comments on IRS Notice 2015-52 should begin to consider those comments now so they can be filed by the due date.

ARTICLE BY Damian A Myers & Douglas W Dahl, II of Proskauer Rose LLP

© 2015 Proskauer Rose LLP.

How Does the King v. Burwell Decision Affect the Affordable Care Act?

The Supreme Court handed the Obama administration a key victory, upholding the tax credits that allow many low-income Americans to purchase health care insurance in states where the federal government is running the insurance marketplace. These tax credits, available to Americans with household incomes between 100% and 400% of the federal poverty line, operate as a form of premium assistance that subsidizes the purchase of health insurance.

The petitioners in King v. Burwell, No. 14-114 (U.S. June 25, 2015), challenged a ruling from the Internal Revenue Service (IRS) and claimed that a phrase in the Affordable Care Act (ACA) indicating that the subsidies are only available to consumers buying insurance in a state-run exchange prohibited the federal government from providing tax credits where states have not established their own exchanges. Arguing that the text of the law should be read literally, they challenged an IRS regulation that makes these tax credits available regardless of whether the exchange is run by a state or the federal government.

But the Supreme Court sided with the Obama administration in its 6-3 decision, emphasizing that language allowing tax credits for health insurance purchased on “an Exchange established by the State” must be interpreted in context and within the larger statutory scheme. Chief Justice Roberts, who authored the majority opinion, wrote that the phrase “an Exchange established by the State” was ambiguous, and therefore required the Court to look to the broader structure of the law. He wrote that the larger statutory scheme required the Court to reject the petitioners’ interpretation, which would have destabilized the individual insurance market and would create the exact same “death spirals” of rising premiums and declining availability of insurance that the law was crafted to avoid. In passing the law, he added, Congress sought “to improve health insurance markets, not to destroy them.”

The Supreme Court’s analysis went a step beyond the traditional framework used by courts to review agency actions. This two-step analysis, first announced in Chevron U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984) and widely known as the Chevrontwo-step, first considers whether the statutory language is clear—and if it is, the inquiry ends there. But if the language of the law is silent or ambiguous, a court next considers whether the agency’s interpretation of the statute is reasonable, granting considerable deference to the agency’s interpretation. Because the tax credits under the ACA are central to the reforms created by the law, Chief Justice Roberts explained, Congress would not have delegated such an important question to any agency, and especially not to the IRS, which lacks expertise in crafting health insurance policy. He wrote that in this case, the task of determining the correct reading of the statute belonged to the Court.

For most providers and companies involved in the health care system, the result of this decision means business as usual. But the decisive victory for the law today means that the ACA is here to stay, and will have a permanent effect on how patients access care. Insurers and providers still must overcome hurdles to achieve affordable premiums and provide improved care for patients across the country. And as more laws are sorted out in the courts, the Supreme Court’s reliance on context in interpreting the statute today could set an important precedent of emphasizing the purpose of major legislation when analyzing its trickier provisions.

ARTICLE BY Anna S. Ross of Foley & Lardner LLP

© 2015 Foley & Lardner LLP

Nonprofit Hospitals Face Additional Regulatory Burdens in Financial Assistance and Debt Collection

Poyner Spruill LLP Attorneys at Law, a North Carolina Law Firm

Roughly 60 percent of hospitals nationwide either have received or are seeking tax-exempt status under the United States Treasury Department (Treasury) and Internal Revenue Service (IRS) rules and regulations. With new final rules and regulations adopted by the Treasury and the IRS effective December 29, 2014, nonprofit hospitals (referred to in the Federal Register as “charitable hospitals”) now face a number of additional requirements when attempting to collect debts owed for care provided to patients and face additional mandates related to financial assistance policies and qualification of certain low-income patients for financial assistance.

The final rules and regulations clarify the broad provisions of the Patient Protection and Affordable Care Act of 2010 (PPACA), which added Section 501(r) to the Internal Revenue Code (Code) imposing the following four additional requirements on charitable hospitals to maintain tax-exempt status:

  1. Conduct a community health needs assessment (CHN Assessment) at least once every three years and adopt an implementation strategy to meet those community health
    needs, or be subject to a $50,000 tax penalty.

  2. Establish a written financial assistance policy which prescribes the eligibility criteria for assistance, how patients apply for assistance, and how they are charged for care under the
    policy, and a written emergency medical care policy requiring emergency care to individuals regardless of their eligibility for financial assistance.

  3. Limit the use of gross charges and the amounts charged to those patients who qualify for financial assistance for emergency or other medically necessary care to not more than the amounts generally billed to individuals who have insurance covering such cases.

  4. Make reasonable efforts to determine whether an individual is eligible for assistance under the financial assistance policy before engaging in extraordinary collection actions (EC Actions).

Additionally, the PPACA insists that a charitable hospital organization meet each of the above requirements separately with respect to each facility it operates.

Below are some requirements from the new rules and regulations that may be potential areas of focus for regulators in their review and enforcement actions against charitable hospitals.

    • The CHN Assessment process requires careful documentation of each of the multiple levels of need assessment, community input and collaboration, and a hospital’s plan for addressing the need with an adopted strategy for implementation.

    • A hospital’s financial assistance policy must contain all eligibility criteria, all financial assistance and discounts available under the policy, and methods to apply for financial assistance, as well as any actions that may be taken in the event of nonpayment under certain circumstances.

    • Hospitals must continue to take certain measures to make the financial assistance policy, the policy’s application form and a plain language summary of the policy available upon request, available in certain areas of the hospital for visitors and patients (e.g. emergency department and hospital intake areas), available on a website, and available to members of the community served.

    • Certain additional written notices with financial assistance policy information, summaries and hospital contact information for policy-related documents must be provided to patients against whom a hospital actually intends to engage in EC Action.

    • Hospitals must limit the costs for any care for which financial assistance policy-eligible individuals will be personally responsible to not more than amounts generally billed (AGB), and the criteria and method for calculating the AGB must be clearly defined by a hospital in its financial assistance policy.

    • Reasonable efforts, as defined in the new regulations, must be followed and carefully documented by hospitals during each step of an EC Action assessment application, including notification and further billing and collection communication(s) with financial assistance policy-eligible individuals. The regulations define EC Action as including, among other things, reporting adverse information about the individual to credit bureaus; requiring or deferring medically necessary care because of nonpayment of bills for previously provided care; and instituting legal process such as liens, foreclosure, attachment of property, or garnishing wages.

The full Treasury and IRS rules and regulations related to the additional requirements on charitable hospitals contain specific regulatory changes and other nuances not touched on in the “big picture” points mentioned above. The full text of the new regulations can be found at:  http://www.gpo.gov/fdsys/pkg/FR-2014-12-31/pdf/2014-30525.pdf.

Charitable hospitals may lawfully bill for and collect funds they are owed for patient care. However, the new rules and regulations in this area mean hospital leadership and experienced legal counsel should closely review all related policies, procedures, and facility practices to ensure all billing and  collection policies and practices fully comply with the law.

ARTICLE BY

David R. Broyles
Poyner Spruill LLP

The Affordable Care Act—Countdown to Compliance for Employers, Week 1: Going Live with the Affordable Care Act’s Employer Shared Responsibility Rules on January 1, 2015

Mintz Levin Law Firm

Regulations implementing the Affordable Care Act’s (ACA) employer shared responsibility rules including the substantive “pay-or-play” rules and the accompanying reporting rules were adopted in February.  Regulations implementing the reporting rules in newly added Internal Revenue Code Sections 6055 and 6056 came along in March. And draft reporting forms (IRS Forms 1094-B, 1094-C, 1095-B and 1095-C) and accompanying instructions followed in August.

With these regulations and forms, and a handful of other, related guidance items (e.g., a final rule governing waiting periods), the government has assembled a basic—but by no means complete—compliance infrastructure for employer shared responsibility. But challenges nevertheless remain. Set out below is a partial list of items that are unresolved, would benefit from additional guidance, or simply invite trouble.

1.  Variable Hour Status

The ability to determine an employee’s status as full-time is a key regulatory innovation. It represents a frank recognition that the statute’s month-by-month determination of full-time employee status does not work well in instances where an employee’s work schedule is by its nature erratic or unpredictable. We examined issues relating to variable hour status in previous posts dated April 14, July 20, and August 10.

An employee is a “variable hour employee” if—

Based on the facts and circumstances at the employee’s start date, the employer cannot determine whether the employee is reasonably expected to be employed on average at least 30 hours of service per week during the initial measurement period because the employee’s hours are variable or otherwise uncertain.

The final regulations prescribe a series of factors to be applied in making this call. But employers are having a good deal of difficulty applying these factors, particularly to short-tenure, high turnover positions. While there are no safe, general rules that can be applied in these cases, it is pretty easy to identify what will not work: classification based on employee-type (as opposed to position) does not satisfy the rule. Thus, it is unlikely that a restaurant that classifies all of its hourly employees, or a staffing firm that classifies all of its contract and temporary workers, as variable hour without any further analysis would be deemed to comply. But if a business applies the factors to, and applies the factors by, positions,  it stands a far greater chance of getting it right.

2.  Common Law Employees

We addressed this issue in our post of September 3, and since then, the confusion seems to have gotten worse. Clients of staffing firms have generally sought to take advantage of a special rule governing offers of group health plan coverage by unrelated employers without first analyzing whether the rule is required.

While staffing firms and clients have generally been able to reach accommodation on contractual language, there have been a series of instances where clients have sought to hire only contract and temporary workers who decline coverage in an effort to contain costs. One suspects that, should this gel into a trend, it will take the plaintiff’s class action bar little time to respond, most likely attempting to base their claims in ERISA.

3.  Penalties for “legacy” HRA and health FSA violations

A handful of promoters have, since the ACA’s enactment, offered arrangements under which employers simply provided lump sum amounts to employees for the purpose of enabling the purchase of individual market coverage. These schemes ranged from the odd to the truly bizarre. (For example, one variant claimed that the employer could offer pre-tax amounts to employees to enroll in subsidized public exchange coverage.) In a 2013 notice, the IRS made clear that these arrangements, which it referred to as “employer payment plans,” ran afoul of certain ACA insurance market requirements. (The issues and penalties are explained in our June 2 post.) Despite what seemed to us as a clear, unambiguous message, many of these schemes continued into 2014.

Employers that offered non-compliant employer-payment arrangements in 2014 are subject to penalties, which must be self-reported. For an explanation of how penalties might be abated, see our post of April 21.

4.  Mergers & Acquisitions

While the final employer shared responsibility regulations are comprehensive, they fail to address mergers, acquisitions, and other corporate transactions. There are some questions, such as the determination of an employer’s status as an applicable large employer, that don’t require separate rules. Here, one simply looks at the previous calendar year. But there are other questions, the answers to which are more difficult to discern. For example, in an asset deal where both the buyer and seller elect the look-back measurement method, are employees hired by the buyer “new” employees or must their prior service be tacked? The IRS invited comments on the issue in its Notice 2014-49.

Taking a page from the COBRA rules, the IRS could require employers to treat sales of substantial assets in a manner similar to stock sales, in which case buyers would need to carry over or reconstruct prior service. While such a result might be defensible, it would also impose costly administrative burdens. Currently, this question is being handled deal-by-deal, with the “answers” varying in direct proportion to the buyer’s appetite for risk.

5.  Reporting

That the ACA employer reporting rules are in place, and that the final forms and instructions are imminent should give employers little comfort. These rules are ghastly in their complexity. They require the collection, processing and integration of data from multiple sources—payroll, benefits admiration, and H.R., among others. What is needed are expert systems to track compliance with the ACA employer shared responsibility rules, populate and deliver employee reports, and ensure proper and timely delivery of employee notices and compliance with the employer’s transmittal obligations. These systems are under development from three principal sources: commercial payroll providers, national and regional consulting firms, and venture-based and other start-ups that see a business opportunity. Despite the credentials of the product sponsors, however—many of which are truly impressive—it is not yet clear in the absence of actual experience that any of their products will work. It is not too early for employers to contact their vendors and seek assurances about product delivery, reliability, and performance.

‘Jersey Shore’ Star Pleads Not Guilty to Tax Fraud

McBrayer NEW logo 1-10-13

C’mon, admit it: you’ve watched at least a few minutes of MTV’s “Jersey Shore.” Okay, fine, not all of us have let our curiosity get the best of us, but for those who have, one of the main characters of the series is currently making headlines for a tax fraud case.Mike Sorrentino, whose nickname on the show was “The Situation,” is currently facing charges that he and his brother failed to pay $8.9 million of taxes between 2010 and 2012.

According to the IRS, the brothers filed false income tax returns, failing to report personal and business income and claiming false business deductions. Those earnings were largely from public appearances for which potentially thousands of dollars were paid. Authorities also accused Sorrentino of altering accounting records or having them altered after a grand jury issued a subpoena.

Sorrentino denies the allegations and has pleaded not guilty to the charges. His attorney made a public statement last month that Sorrentino “denies that he criminally violated the tax laws.” In effect this means that he is claiming the violations were due to negligence rather than fraud.

The difference between tax negligence and tax fraud is pretty significant, not only in terms of the mental state of the taxpayer at the time the filing was made but also in terms of the penalties attached. Penalties for fraud, of course, are much more significant.

While the IRS usually has a pretty good idea of when an individual has committed fraud or negligence, this is not always the case. Those who have been wrongfully accused of tax fraud need to work with an experienced attorney to ensure their rights are protected.

ARTICLE BY

McBrayer, McGinnis, Leslie & Kirkland, PLLC

Full D.C. Circuit to Rehear ACA Premium Tax Credit Case

Mcdermott Will Emery Law Firm

The full U.S. Court of Appeals for the D.C. Circuit has vacated the 2-1 panel decision issued July 22, 2014, in Halbig v. Burwell, which struck down the Internal Revenue Service (IRS) Rule providing for Affordable Care Act (ACA) premium tax credits to be available to lower income exchange customers, regardless of their state of residence.  The government’s brief is due October 3, 2014, and the plaintiffs’ opposing brief is due a month later on November 3, 2014, to precede oral arguments on December 17, 2014.  It is likely that the full D.C. Circuit would not render its opinion before mid- to late Spring 2015.  This has the effect of preserving the status quo with respect to the availability of premium tax credits, at least until the full D.C. Circuit renders its decision.

Meanwhile, the plaintiffs have sought review by the Supreme Court of the United States in King v. Burwell, Halbig’s sister case in which the U.S. Court of Appeals for the Fourth Circuit upheld that same IRS Rule.  The Clerk of the Supreme Court has granted the government an extension until October 3, 2014, to respond to the petition for certiorari.  The plaintiffs have urged the highest court render its decision as quickly as possible to resolve the circuit split.  If the Supreme Court accepts King for review before mid-January, it could issue a ruling in the current term, which is scheduled to end in late June 2015.

Among the highest profile legal challenges to the ACA, Halbig and King seek to invalidate a May 2012 IRS Rule providing that health insurance premium tax credits will be available to all taxpayers nationwide, regardless of whether they obtain coverage through a state-based exchange or a federally facilitated exchanges (FFE).  The plaintiffs (represented by the same lawyers in both cases) argued that the plain language of the ACA limits the availability of premium tax credits to only those taxpayers who reside in the 14 states (plus the District of Columbia) that set up their own exchanges, and thus nullifies the IRS Rule’s application to the 36 states operating exchanges through the FFE.  Plaintiffs’ argument is based on language providing that premium tax credits are only available for plans “enrolled in through an Exchange established by the State under section 1311 of the [ACA].”  ACA § 1401(a), enacting 26 U.S.C. § 36B(c)(2)(A)(i) (emphasis added).  The government counters that other provisions of the ACA make clear that the subsidies are to be made available in the FFE states as well.  

There are also two similar cases awaiting decisions by federal trial courts on motions for summary judgment.  First, in Pruitt v. Burwell, pending in federal district court in Muskogee, Oklahoma, the state complains that the availability of the premium tax credit in FFE states forces the state to choose between the costs of providing coverage to its employees or paying the IRS a significant financial penalty.  Second, in Indiana v. IRS, pending in federal district court in Indianapolis, the state and 39 of its public school districts argue that the IRS Rule directly injures the state and school districts in their capacities as employers by subjecting them to increased compliance costs and administrative burdens.  On August 12, 2014, the plaintiffs survived the government’s motion to dismiss based upon lack of standing inIndiana v. IRS, although the court dismissed one aspect of the case because of the delay in enforcing the employer mandate.  Oral arguments on the merits are set for October 9, 2014.

ARTICLE BY

Lauren D’Agostino
J. Peter Rich
 
OF 
McDermott Will & Emery

IRS Ruling Creates Opportunities for Tax Savings by Companies With Substantial Real Estate Assets

Katten Muchin Law Firm

On July 29, Windstream announced that it plans to spin off certain telecommunications network assets into an independent, publicly tradedreal estate investment trust (REIT). Windstream made the announcement after it obtained a favorable private letter ruling from the Internal Revenue Service (IRS) regarding the tax-free nature of the spin-off and the qualification of the spun-off entity’s assets as real property for REIT purposes.

Under the transaction, Windstream will spin off its existing fiber and copper network, real estate, and other fixed assets into a publicly traded, independent REIT. The REIT’s primary activity will be to lease the use of the assets back to Windstream through a long-term “triple net” exclusive lease. Windstream shareholders will retain their existing shares and receive shares in the REIT commensurate with their Windstream ownership. The transaction is intended to effectively enable Windstream to deduct, for federal income tax purposes, the amount of rent paid to the REIT without a corresponding corporate level income tax inclusion in income by the REIT—estimated to generate up to a $650 million annual overall reduction in taxable income between Windstream and the REIT.

Particularly notable about this transaction is that the private letter ruling obtained by Windstream is seemingly an indication by the IRS that it will respect the tax-free transaction of a spin-off even when coupled with an election for REIT status. The fact that the ruling recognized transmission infrastructure (e.g., wires and cable), in addition to the related real estate, as qualifying assets for REIT purposes is also a key development. The IRS issued proposed regulations in May that provided more specific guidance on what types of assets would be considered “real property” for purposes of meeting the requirements for making a REIT election, and Windstream’s private letter ruling is among the first to address the issue in light of the new regulations.

These developments mean that a REIT spin-off transaction might be available to many kinds of businesses. Companies (other than master limited partnerships) with similar assets, such as telecommunications, cables, fiber optics, and data centers, may be wise to explore opportunities to realize substantial tax savings through a similar transaction. However, there are several challenges that must be overcome to execute a successful REIT spin-off transaction.

ARTICLE BY

Jill E. Darrow
Reid A. Mandel
Glenn S. Miller
Saul E. Rudo
 
OF
Katten Muchin Rosenman LLP

IRS Introduces New Form 1023-EZ to Streamline Applications for 501(c)(3) Tax-Exempt Status

Drinker Biddle Law Firm

On July 1, 2014, the Internal Revenue Service (IRS) launched a new Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, that is intended to enable small charities to more easily apply for recognition of tax-exempt status under Internal Revenue Code Section 501(c)(3). The IRS has described the new form as a “common sense approach” to easing the filing burdens for small organizations and to shorten the time delays associated with IRS processing. Although not expressly stated, the new form is undoubtedly part of the IRS’s current effort to alleviate the huge backlog of pending applications awaiting IRS review.

What’s the general idea behind the new form?

The concept associated with the Form 1023-EZ is that the existing 26-page Form 1023 is simply unnecessary in the case of most small organizations. As designed, the new form becomes effectively a “registration” for exemption, rather than a comprehensive description of an organization’s activities, operations, governance, finances, etc. The IRS has clarified that the new forms will not undergo substantive review by IRS personnel. Rather, the IRS will defer that review until a later date when organizations are up and running; at that point, the IRS will evaluate whether organizations are functioning as described in their original filings.

When the new form was announced in draft form earlier this year, many industry experts voiced concern about foregoing the important educational and compliance opportunities associated with completing the full Form 1023 in its standard form. Others expressed doubt as to whether the IRS would be able to effectively and consistently perform the type of follow-up reviews asserted as the means for ensuring compliance with exemption standards. Nonetheless, the IRS has forged ahead, presumably under pressure to address its internal processing challenges and perhaps to present some much-needed “taxpayer-friendly” news from the Exempt Organizations Division.

Concurrent with issuing the new form, the IRS released Revenue Procedure 2014-40, which sets forth the procedures for using the new form and IRS’s processing of the same.

Who is eligible to use the new form?

The Revenue Procedure describes the scope of organizations that are eligible to use the form, consisting generally of organizations whose annual gross receipts have not exceeded $50,000 during any of the past three years and whose projected gross receipts for the current year and next two years are below that threshold. In addition, eligible organizations may not have total assets exceeding $250,000. Notably, when the draft Form 1023-EZ was initially announced earlier this year, the thresholds were appreciably higher – annual gross receipts of $200,000 or less and assets of $500,000 or less. In setting the final eligibility requirements, the IRS reduced those thresholds, presumably in response to exempt community (and possibly state charity official) voices expressing concern about this new approach being poorly suited to ferreting out actual or intended noncompliance, as discussed above.

The Revenue Procedure goes on to list other criteria that render an applicant ineligible to use the new form, including foreign organizations, successors to for-profit entities, churches, schools, colleges, universities, hospitals, supporting organizations described in IRC Section 509(a)(3), HMOs, ACOs, and entities maintaining donor-advised funds.

Notwithstanding the foregoing restrictions, the IRS has estimated that as many as 70 percent of organizations applying for 501(c)(3) status will be eligible to use the new form.

What does the new form look like?

Anyone who has tackled the process of preparing a Form 1023 in the past will recall the burden associated with wading through the standard 26-page application, which by necessity has traditionally covered a vast range of organizations (by size, scope and character) falling under the umbrella of 501(c)(3) status. By comparison, the new Form 1023-EZ is only three pages long and calls for:

  • Identifying information;
  • Form of entity under applicable state law, including check-box attestations regarding inclusion of appropriate language in pertinent organizational documents;
  • General information regarding the organization’s activities, using NTEE classification codes, check-box attestations regarding compliance with basic exemption requirements, and yes-or-no answers to high-level questions presumably aimed at fleshing out potentially at-risk conduct;
  • A check-box approach for attesting to public charity status; and
  • A check-box approach for organizations seeking reinstatement after losing their exemption due to failure to file annual information returns for three consecutive years.

A copy of the new form is available here. The accompanying instructions can be found here.

How is the new Form 1023-EZ to be filed?

Form 1023-EZ must be filed electronically, using the www.pay.gov website. A $400 user fee applies. Once filed, the IRS process will consist of determining whether an application is complete, meaning that the applicant has provided a response to each line item in the form. If a form is incomplete, the IRS may request additional information accordingly. Once complete, the IRS will accept the form for processing.

What if we have a pending Form 1023 already in the queue at the IRS?

If an organization has already submitted Form 1023 to the IRS, it may nevertheless submit Form 1023-EZ if its Form 1023 has not yet been assigned for review. In that case, the IRS will treat the Form 1023 as withdrawn and will instead process the organization’s Form 1023-EZ.

Corey Kestenberg contributed to this article.

Article By:

Linda S. Moroney
T.J. Sullivan
Taylor A. Romigh
Of:
Drinker Biddle & Reath LLP

New York Nonprofit Revitalization Act Rollout Challenges

Proskauer

As the July 1, 2014 compliance date of the New York Nonprofit Revitalization Act of 2013 (the “Revitalization Act”) quickly approaches, many charities operating in New York are confronting some difficult rollout challenges. While parts of the Revitalization Act are clear and welcomed (such as new rules that broaden the use of electronic communications and eliminate the need for supermajority board approvals of routine property transactions), other new requirements are puzzling to many of these charities’ officers and directors. Indeed, as we counsel our clients, we are finding that certain new Revitalization Act rules that concern board operations are causing some charities, in particular family foundations and corporate foundations, to wonder whether operating through corporations formed in New York is desirable.

The charities that seem to be facing the hardest issues are foundations with small boards, and with directors that either directly and appropriately exert substantial influence over foundation operations (such as in a family foundation), or are employed by the businesses that have founded and fund these charities to do their good works.

We are finding that many, but not all, of the requirements causing concern are tied to vague drafting in the Revitalization Act. The good news is that we have also identified what we believe are reasonable interpretations of the law that align with workable solutions for many clients.

This client alert notes just a few of the more pressing Revitalization Act issues, as well as relevant potential solutions, as they appear to us today. We will be highlighting other aspects of the Revitalization Act rollout over the coming year. We stress that the New York State Attorney General’s Charities Bureau may issue clarifying Revitalization Act guidance, and it is also possible that follow-up legislation may address some of these issues. Importantly, it is possible that this guidance or future legislation will not support our interpretations, although we hope that it does. Stay tuned.

Three Independent Directors

The Revitalization Act will require many charities to identify at least three individuals that satisfy detailed requirements of “independence” to serve as directors and oversee specified audit and financial reporting activities. (Three are needed because that is the fewest number of directors required by New York law to perform delegated board-level functions.) For many family foundations, corporate foundations, and labor/management charities – with small boards that are typically composed of individuals tied in some way to the charity or related entities – this requirement has created concern. This concern may be heightened when membership on the board has been finely balanced to achieve acceptable approaches to shared governance.

Most important for these charities to keep in mind is that the requirement is limited to charities that raise or “solicit” funding from the general public. However, some of these charities, in their annual charities filing with the New York Attorney General, may have been filing as soliciting charities even though they do not actually solicit funding. We suggest that such charities consider amending their filing status and we urge that any change in filing status in response to the Revitalization Act be made in consultation with corporate and tax counsel, closely assessing individualized factors and risks. For example, part of the analysis may be to examine whether the charity has been filing its annual Form 990 with the Internal Revenue Service (“IRS”) as a “public charity” (based on “public support” concepts of the IRS that differ from the New York concepts of “solicitation”). While we do not believe that the New York charitable solicitation concepts match the IRS concepts, tailored assessments should be made with both New York charitable solicitation laws and U.S. federal tax laws in mind.

For those charities that do solicit within the meaning of New York law, and whose small boards are populated by individuals employed by related entities, it will be worthwhile to take a hard look, again guided by counsel, at the kind of control exerted by a charity’s affiliated corporate entities over the charity. Under the Revitalization Act, whether that employment disqualifies a director as “independent” will depend on whether the particular corporate or other entity that employs the director “controls” or is “under common control with” the charity. Notably, the Revitalization Act does not define “control.”

Conflicts Policy Quagmire

Although the Revitalization Act is clear that the requirement for independent-director oversight of auditing and financial matters is limited to “soliciting” charities, the law is less clear about whether independent director oversight also applies to the law’s requirements on conflicts policies.

Essentially, the Revitalization Act codifies the widespread practice already adopted by many charities – many motivated by the IRS Form 990 conflicts policy checkbox – to have a written conflicts policy. It also requires oversight of adoption, implementation, and compliance with the conflicts policy by the Board or the audit committee. Certain provisions of the Revitalization Act can be read as requiring these oversight functions to be handled by independent directors only. While our interpretation is not free from doubt, we believe that to the extent there is an obligation to have independent directors oversee conflicts policy administration, a close and reasonable reading of the Revitalization Act supports the interpretation that such requirement is also confined to soliciting charities. If not, many private foundations will be forced to make drastic board changes for conflicts policy oversight, while permitted to use directors that do not satisfy independence criteria for what is generally viewed as the critical audit oversight function – a seemingly absurd result.

Charities with conflicts policies based on the IRS form are probably already aware that they will need to amend those policies to satisfy Revitalization Act requirements, since the IRS form does not track all of the components of a conflicts policy required by the Revitalization Act. As these policies are drafted, special attention should be paid to the annual conflicts questionnaire required by the Revitalization Act. Many charities already distribute an IRS Form 990 annual questionnaire to directors, officers and key employees. Revitalization Act questionnaires will now be covering some, but not all, of the same territory. To avoid bombarding individuals with duplicative annual forms, consideration should be given as to whether to use a single questionnaire that reasonably covers both IRS and Revitalization Act requirements.

Approval of Director, Officer, and Key Employee Compensation

The Revitalization Act imposes significant new requirements concerning related-party transactions. Among other things, the Revitalization Act imposes a new requirement to “contemporaneously document in writing the basis for the board or authorized committee’s approval” of a related party transaction, “including its consideration of any alternative transactions.” The Revitalization Act also provides the Attorney General with enhanced enforcement authority to void, rescind, seek restitution, and remove directors in connection with a transaction that is not properly approved or that was not reasonable or in the best interests of the corporation at the time the transaction was approved.

Because the Revitalization Act broadly defines a “related party transaction” as “any transaction, agreement, or any other arrangement in which a related party [including a director, officer or key employee] of the corporation has a financial interest and in which the corporation or any affiliate of the corporation is a participant,” there is some question as to whether compensation arrangements with directors, officers, and key employees are related party transactions. While the matter is not free from doubt, we believe that there is a reasonable basis for considering these compensation arrangements to be regulated in a manner distinct from related party transactions under the Revitalization Act. Clarification on this issue, however, would be helpful.

In addition, the Revitalization Act appears to define all directors as “related parties,” and prohibit all related parties from participating in deliberations and voting pertaining to related party transactions, without specifically distinguishing between directors who have an interest in the particular transaction and those who do not. Guidance clarifying that the Revitalization Act will not be construed or enforced in such an impracticable manner would be helpful.

Also, certain ambiguous language in the Revitalization Act can be read as expressly prohibiting any director from being present at or participating in any board deliberations or vote concerning director compensation, while apparently requiring director approval of the compensation. While we believe that such a reading of the Revitalization Act would be unreasonable and contrary to principles of statutory construction, clarifying guidance would help avoid uncertainty on an important governance issue. In the interim, boards may wish to approve director compensation arrangements prior to July 1.

Extraterritorial Application of Revitalization Act

Finally, some commentators have raised concerns that certain provisions of the Revitalization Act relating to board composition and operation may be applicable to charitable organizations formed outside of New York, such as Delaware non-stock corporations. We have not found this to be a reasonable interpretation of the Revitalization Act. Again, however, clarifying guidance would be welcome.

Article By:

Jacob I. Friedman
Edward S. Kornreich
Amanda H Nussbaum
Richard J Zall
Herschel Goldfield
Ellen H Moskowitz
Of:
Proskauer Rose LLP

Tax Tip: Free Federal Filing Program

Dickinson Wright Logo

Did you know that an individual may use free online tax preparation software and e-filing if he or she qualifies? This may be useful knowledge for your young adult children, even if you are not eligible.

The Free File Alliance is a nonprofit coalition of industry-leading tax software companies that have partnered with the IRS to help millions of Americans prepare and e-file their federal tax returns for free.

There are more than a dozen software options (brand-name software) available to assist a taxpayer with a 2013 adjusted gross income (“AGI”) of $58,000 or less at no cost. Choose your software carefully because some companies offer free state tax preparation and e-filing, whereas others do not.

Even though an individual’s gross income may be higher than $58,000, the individual may still qualify for this service because his or her gross income (e.g., salary, dividends, interest, alimony, and rental income) is reduced by various deductions, the most common being contributions to an IRA or qualified plan, to calculate the individual’s AGI.

70% of American taxpayers are eligible for this service and 98% of users would recommend this program to others.

If your AGI is higher than $58,000, free File Fillable Forms are available for federal returns only, including free e-filing. This service was recently extended to be available for use until October 2015. Go to www.irs.gov/freefile to begin.

Article By:

Robin L. Miskell
Of:
Dickinson Wright PLLC