CMAA Leadership/Legislative Conference

1. CMAA Leadership/Legislative Conference Tax Update September 8, 2012

2. Presented By: James P. Sweeney, CPA, MBA, MTAX Partner, National Lead, Exempt Organization Technical Tax Services Washington, D.C. james.sweeney@mcgladrey.com

3. Agenda Current affairs Revocation of Exempt Status What happens when you are audited by IRS – the need for management operational reviews Form 990 Update – common foopahs FIN 48 Update – what we see out there

4. Learning Objectives After completing this program, you should be able to: • Understand current affairs that are occurring in the industry from a tax perspective.

5. Current Affairs of Importance

6. Current AffairsProposed Legislation • Ending Tax Breaks for Discrimination Act of 2012 • HR 4376 – set forth by Ms. Maloney • Proposed amendment to the IRC to deny all deductions for business expenses associated with the use of a club that discriminates on the basis of sex, race, or color. • Applies to any private discriminatory club (as defined in previous bullet point)

7. Current AffairsProposed Legislation • Ending Tax Breaks for Discrimination Act of 2012 • Deductions disallowed for the use of services or facilities, for transportation, meals, lodging and other travel expenses associated with such use • Deductions disallowed for any amount incurred for advertising of any event held at such a facility, or advertising of any product or service if the advertising occurs on any broadcast media during, or in association with, such media’s coverage of any such an event. • All receipts from the club MUST include the following statement: “The expenditures covered by this receipt are nondeductible for Federal income tax purposes.

8. Current AffairsPLR 201138054 This was a social golf club with a restaurant, bar, pool, tennis courts and golf course Revocation of exempt status was the result of an audit of activities and Form 990 Organization exceeded the safe harbor thresholds provided for in P.L. 94-569 35%/15% safe harbor (no more than 15% nonmember use) Examination yielded the club failed substantiation requirements of Revenue Procedure 71-17, 1971-1 C.B. 683

9. Current AffairsPLR 201138054 Club’s investment income was substantially below the 20% threshold, but nonmember use violated the 15% threshold There was also advertising on the Internet and in the Yellow Pages advertising banquet facilities for events like weddings, corporate functions, parties, graduations, reunions, anniversaries, Bar/Bat Mitzvahs with accommodations for up to 300 persons. Any advertising “prima face” evidence running a business and not formed for social purposes

10. Current AffairsPLR 201138054 • Operation of the 35/15 test • If no nonmember income: may have up to 35% investment income • Unusual sale items are not included in the 35% figure • Exceeding the 15% test does not necessarily establish a nonexempt purpose (facts and circumstances test) • Member-sponsorship arrangements will taint exemption (Rev. Rule. 60-324)

11. Current AffairsPLR 201138054 • Facts and circumstances test • Actual percentages of investment and nonmember receipts • Frequency of use by nonmembers (an unusual or single event [nonrecurring on a year to year basis] that generates all nonmember receipts is viewed favorably as opposed to frequent use by nonmembers • Record of nonmember use over a period of years, i.e. a high percentage in one year with other years being in permitted levels is favorable [consistent pattern of exceeding even by a small amount is unfavorable] • Generating net profits is private inurement to club members

12. Current AffairsPLR 201138054 • Failed arguments • Declining membership due to past and current economic conditions prompted the need for additional nonmember receipts to operate • Exceeded 15% limitation for at least three consecutive years (25%, 23% and 19%) • Advertising facilities was dagger and the evidence to deny continuing exempt status • Reverted to a 277 club, filing Form 1120 annually • UBIT issues: ad income generated at its annual member-guest golf outing; continual losses in bar, restaurant, greens fees and golf cart rental losses come under the hobby loss rules (losses in 3 out of 5 previous tax years) • END

13. Current AffairsPLR 201146022 This ruling looked at a c7 with a related c3 audit results The c3 operated charitable gaming activities Both organizations had the same BOD Club facilities were used to conduct the bingo activities Rental income from the general public renting facility Annual receipt of donations to the c7 from individuals and businesses Fundraising income from sale of donuts to the general public Result was an inordinate amount of nonmember income, as some of the receipts of the c3 were inured to the c7 because of commingling

14. Current AffairsPLR 201146022 • Outcomes • Revocation of exempt status • Government reminded taxpayer that a c7 may rent out its facilities to a charitable organization if only direct costs ONLY are charged for such use then such use will not be deemed private inurement to the members of the club • In the instant case the c3 paid for all operating expenses of the club when it used such facilities • What prompted aggressive actions were the members unwillingness to pay higher dues • Nonmember taxable activities were: gaming activities, sales of markers, food and drink sales, rental of facilities and donations from the general public • END

15. Current AffairsPLR 201204018 This was an adverse determination via a filed Form 1024 application for recognition of exempt status Found to only operate a restaurant Restaurant was operated by previous for profit owners Dues were unusually low END

16. Current AffairsPLR 201032045 Leading up to a large development in 2012 Dissolution of a club process ruling: continued exempt status issue Rising expenses and declining members resulted in members voting to liquidate club assets and dissolve the corporate entity QUESTION: liquidating sale of the club real estate will not cause loss of exempt status

17. Current AffairsPLR 201032045 Service referred to Rev. Rule 58-501, 1958-2 CB 262, holding where a social club found it impractical to conduct its operations and subsequently sales its assets and liquidates such sale was considered incidental to its exempt purposes Sale purpose was to facilitate the club’s dissolution, rather than to make a profit (very important fact) Exempt status up through the date of sale and distribution of the liquidated assets to its members. IRS allowed. End

18. Current AffairsPLR 201213034 • REVOKES AND SUPERCEDES PRIOR PLR 200451031 • Questions: • Sale and liquidation not result in loss of exempt status? • Sale proceeds subject unrelated business income tax? • Reason for dissolution: aging membership, new membership numbers dwindling, increasing operational costs

19. Current AffairsPLR 201213034 In the 2004 ruling, IRS stated no loss of exempt status on sale and liquidation and gain is not UBI. In this ruling, the SERVICE has done a 180 degree shift in this area!

20. Current AffairsPLR 201213034 - Rationale Investment income becomes taxable by virtue of IRC section 512(a)(3)(A) which taxes gross income that is NOT exempt function income IRC section 512(a)(3)(B) provides that exempt function income means dues, fees, charges, or similar amounts by members in consideration of use of property which forms the basis for a c7s tax exempt status

21. Current AffairsPLR 201213034 - Rationale Generally, gain generated from the sale of club property is not subject to tax and it is reinvested in club activity assets within one year previous to the date of sale, or three years from the date of sale. In order for this provision to apply, the assets must be used in accomplishing exempt purposes Gain is recognized for only the excess of proceeds from sale as compared to cost of the replacement property [IRC section 512(a)(3)(D)]

22. Current AffairsPLR 201213034 - Rationale There is a general gain exclusion from UBI in 512(b)(5), where such provision states that gains from exempt use assets are not UBI IRS cites Rev. Rule. 58-501 in addressing the exemption issue related to the sale of asset and liquidation of the club IRS referred to Rev. Proc. 2011-1 which provides that the Service may revoke a previously issued ruling found to be in error, or not in line with current thought processes of the Service

23. Current AffairsPLR 201213034 - Rationale Tamarisk Country Club, 84 TC 756 (1985) cited by IRS in the ruling where the court found that gain not reinvested in club replacement assets and distributed to members was taxable Atlanta Athletic Club, 980 F.2d 1409, (1993) gain was excluded from recognition even though the property sold was not continuously used or directly used just before the sale, but proceeds were reinvested in exempt purpose replacement assets

24. Current AffairsPLR 201213034 - Rationale Deer Park Country Club, v. Commr., 70 TCM 1445, (1995), sale of property never actually ever used in exempt activities was not protected under the general exclusion for gain recognition, notwithstanding its purchase at the time of acquisition the organization “intended” to use it in accomplishment of its exempt purposes

25. Current AffairsPLR 201213034 - Rationale • IRS then cites Legislative History…. • WHERE AN ORGANIZATION RECEIVES INCOME FROM ITS INVESTMENTS, THERE IS A BENEFIT TO THE MEMBERS NOT CONTEMPLATED BY THE EXEMPTION [PROVIDED TO SOCIAL CLUBS] • EXCEPTION PROVIDED WHERE PROCEEDS ARE REINVESTED AND GAINS ARE NOT WITHDRAWN BY MEMBERS….. • Senate Report 91-552 (1969), 1969-3 CB 423, at 471

26. Current AffairsPLR 201213034 - Rationale ISSUE: generally in order for an income flow to be subject to tax it must be generated by an unrelated trade or business regularly carried on However this rule does not apply for c7s, 9s, 17s or 20s The rule is exclude exempt function income and tax all other income for these entities Only modifications are provided for in 512b6, 10, 11 and 12, (b5 for gains is excluded from the provided for exceptions)

27. Current AffairsPLR 201213034 - Rationale Service states that Rev. Rule. 58-501, although it addresses the exemption issue, does not address the UBI issue Stating that it was issued before the 1969 ACT passage of the special UBIT rules of 512(a)(3)(D) [gain deferral rule for reinvestment] GAIN is UBI subject to tax PROBLEM: what to do if debt exchanged for property and no cash is received and debt is over tax basis thus resulting in a UBI liability?? END

28. Current AffairsPLR 200935041 Include this for those who may be in a situation where the clubhouse is a historic building Issue was can a c3 provide funds to a referenced c7 that was housed in a historic building After rehab general public access provided to the historic areas of the club RULING: Favorable to the c3 which accumulated public contributions for use in rehab (had a broad scope for the geographic area for historic rehab funding, referencing the club)

29. Automatic Revocation of Tax Exempt Status

30. Automatic Revocation of Tax Exempt Status Passed as a part of the Pension Protection Act of 2006 Basically what the law states is that failure to file a Form 990 series return for three consecutive years results in automatic revocation of tax exempt status (990, 990EZ or 990N) Revocation is by operation of law, therefore it occurs on the original due date (not including extensions) for the third consecutive year for filing failure, not when IRS may inform you or such revocation

31. Automatic Revocation of Tax Exempt Status Applies to all 501a tax exempt organizations required to file Form 990 Generally in the club and association world, we see charitable arms holding golf tournaments etc., losing exempt status (not good when a upcoming tournament is approaching) Also applies to small entities, those that have less than $50,000 of gross receipts No appeal process, once it is done, only way for reinstatement is via application process or via a letter if not required to file an application originally

32. Automatic Revocation of Tax Exempt Status May request retroactive reinstatement, but to date we are finding that IRS is reluctant to provide this relief as reasonable cause for failure to file must exist and it has only in very limited circumstances have accepted such an argument (ignorance or reliance on a tax professional generally does not work)

33. Automatic Revocation of Tax Exempt Status If a c3 running a golf tournament is revoked, during the interim it can not accept tax deductible contributions Penalties for late filings under the program to be reinstated will not be assessed according to the IRS website Any applications sent to the IRS can not receive “expedited treatment” There have been members of a group filing receive revocation notices

34. What to Expect When the IRS Comes Knocking The need for internal operational reviews

35. IRS Audit Posture: What to Expect When the IRS Comes Knocking Current administration has proposed doubling enforcement budget in next five years. Audits across the board going up, to include clubs and associations IRS Examiner Quote – “Tell your clients that we are coming………” IRS Manager Quote – “Go out and get assessments……” IRS posturing itself for a present round of 990-T audits

36. IRS Audit Posture: What to Expect When the IRS Comes Knocking • Compliance checks – whatever you do, DON’T IGNORE THESE! • Correspondence audits – taxpayer receives an inquiry related to certain activity disclosures • Field exams • These are mostly what we see in the club and association area

37. IRS Audit Posture: What to Expect When the IRS Comes Knocking Organizational requirements will be reviewed Focus is on social, pleasure, recreation purposes Activities are consistent with that purpose NO INUREMENT OF INCOME All UBI is reported properly and adequate expense allocations are used

38. IRS Audit Posture: What to Expect When the IRS Comes Knocking • Discrimination will be looked at but the following list are generally OK: • Limits on membership to a particular religion • Limits on membership to a particular national origin • Limits on political party or homeowners in a specific housing development

39. IRS Audit Posture: What to Expect When the IRS Comes Knocking • Membership requirements will be reviewed • Bylaws, club handbook, brochures and newsletters, applications, and materials given to prospective members will be reviewed • Corporation sponsored individuals who have the same rights and privileges as regular individual members are fine (Rev. Rule. 74-168)

40. IRS Audit Posture: What to Expect When the IRS Comes Knocking Focus on the 35%/15% test Tour of facilities will look for signs inviting general public usage or absence of signs which state “for members only” Member usage logs to show system restricting usage to members only (key cards or logs) All board minutes, looking at approved activities Liquor license review

41. IRS Audit Posture: What to Expect When the IRS Comes Knocking Contracts with taxable corporations Management contracts for relationships, more than general administrative responsibilities will be focused on (not good if management company can set dues amounts and select or expulsion of members) Dues structure - to make sure not too low to encourage transient use All advertising will be reviewed

42. IRS Audit Posture: What to Expect When the IRS Comes Knocking Website and all links on website Will go to chamber of commerce and visitor bureaus and review materials issued by these entities referring to your entity Nontraditional activities – sale of package liquor, long term facility rental of rooms, take out or catering services, commuter use of parking facilities, advertising income, personal services income (issue if 13%, or 4.28 to 6.07%, or 5% will be benchmark)

43. IRS Audit Posture: What to Expect When the IRS Comes Knocking • All records in line with substantiation requirements of Rev. Proc. 71-17 • Host/guest assumptions (8 or fewer and 1 member) • Unlimited number (where at least 75% are members) • Must have records that establish the above facts to use the assumptions

44. IRS Audit Posture: What to Expect When the IRS Comes Knocking Records related to nonmember use Cash sales – assumed to be nonmember unless records can trace to members! Credit card sales Reservation books, banquet books, party function sheets, member sponsorship of parties, dates club closed, reciprocal agreements, off premise sales of food and liquor

45. IRS Audit Posture: What to Expect When the IRS Comes Knocking • Party records (required by Rev. Proc. 71-17): • Numbers in the party • Total nonmembers in the party • Total charges to members and nonmembers • Charges paid by nonmembers • Member signed statement regarding reimbursement • Member signed statement related to employer reimbursements • Member signed statements related to gratuitous reimbursements

46. IRS Audit Posture: What to Expect When the IRS Comes Knocking Monthly member billing sheets All investment income sources Employment contracts for percentage of gross or net profit arrangements All distributions to members All member classifications (for disproportional benefits to what pay) Cash receipts journal Asset backup

47. IRS Audit Posture: What to Expect When the IRS Comes Knocking Financial statements with notes All tax return filings All work papers related to tax return filings showing trial balance tie back to amounts as reported on such returns Member employer payments Set asides and corresponding board resolution for the set aside

48. IRS Audit Posture: What to Expect When the IRS Comes Knocking Agent will make judgments related to your expertise in tax and your advisors expertise in tax Gross receipts allocation method is rarely considered reasonable by IRS to allocate fixed or variable expenses Nonmember use: not reasonable NM fees to M fees for golf, more reasonable, rounds by members vs. rounds by nonmembers

49. IRS Audit Posture: What to Expect When the IRS Comes Knocking IRS uses the “Big Divot Allocation Method” (referencing an example given in 1975 form 990 supplement) Direct COGS allocations based on NM sales to M sales, variable expense NM hours use to TOTAL hours facilities used Fixed expense allocations based on NM hours use to TOTAL hours in the year Service still uses above notwithstanding Rensselaer Polytechnic Institute case for taxpayer (only use actual use for fixed expenses)

50. IRS Audit Posture: What to Expect When the IRS Comes Knocking • Expenses reviewed for relationship to the generation of the UBI. • Proximate and primary relationships are audited • EX: Club manager devotes 35% of time to bar and restaurant activity, only 35% of his salary goes into the bucket to be allocated between member and nonmember use • EX: $40,000 of interest expense, 30k related to swimming pool, 5k related to purchase golf carts, 5k related to tennis court repairs, only $5K related to golf carts goes into bucket to determine member/nonmember allocable golf course expenses