Joint Committee on Taxation: Options to Improve Tax Compliance and Reform Tax Expenditures
by David M. Flynn, Duane Morris LLP, Philadelphia, PA
On January 27, 2005 the Staff of the Joint Committee on Taxation released a report entitled “ Option to Improve Tax Compliance and Reform Tax Expenditures ” in response to a request made last February by Senators Charles Grassley and Max Baucus, the chair and ranking minority member of the Finance Committee. The Senators, noting an estimated gap of $311 billion in the year 2001 between the amount of tax voluntarily and timely paid and the amount of actual tax liability, and a projected fiscal year 2004 Federal budget deficit of $477 billion, asked the Staff of the Joint Committee on Taxation to provide periodic reports setting forth proposals to reduce the size of the tax gap by, among other things, addressing areas of noncompliance in present law and recommending appropriate legislative changes. Many of the recommended changes would impact tax-exempt charitable organizations, and many of those would affect tax-exempt hospitals.
It needs to be emphasized that the options presented by the Joint Committee Staff do not represent pending legislation that has been introduced or is being considered by Congress. Nevertheless, it is a high profile list of legislative options, all of which are expected to raise revenue at a time when Federal budget deficits are reaching historic levels. For this reason, and because they are not likely to be as politically unpalatable as other forms of tax increases, any of the options could be included in a legislative package without much notice or opportunity for comment.
Options of Interest to Tax-Exempt Hospitals
Set forth below are summaries of the options that are most likely to be of interest to tax-exempt hospitals:
- Exempt Status Reviews Every Five Years – Under this option, every section 501(c)(3) organization (except churches) would be required every five years to file with the IRS sufficient information to enable the IRS to determine whether the organization continues to be organized and operated exclusively for exempt purposes (and whether its original section 501(c)(3) determination letter should remain in effect, or be modified or revoked). The 5-year review filing with the IRS would be done electronically, and would be available to the public. Failure to satisfy the 5-year review filing requirement would result in loss of tax-exempt status. This requirement would be in addition to the annual Form 990 filing requirement (which is itself expected to be expanded significantly by promulgation of a revised Form 990, probably some time later this year, and likely seeking considerably more detailed information concerning compensation determinations for highly-compensated executives and physicians, and the material terms of any transactions between exempt organizations and their board members or senior staff). It is impossible to predict how onerous the 5-year review filing requirement might be if such a provision is ever enacted, but it would seem likely that annual Form 990 filings by well-advised exempt organizations would be expanded to include each year the kind of information that will have to be included with the 5-year review filing.
- Impose Termination Tax on Conversions of Charitable Assets – This proposal would expand application of the termination tax that currently applies only to private foundations so that it would apply to all charitable organizations (this is intended to improve the Federal Government’s ability to enforce the requirement that a charitable organization’s assets remain dedicated to charitable purposes by imposing a termination tax on the liquidation or “conversion” of a charitable organization). A “conversion” generally includes any transaction in which there is a change in ownership or control of charitable assets representing one-third or more of the organization’s gross assets, including sales, acquisitions by merger, leases, or contributions of assets to a joint venture or partnership with others. The amount of the termination tax would be equal to the value of the organization’s assets that are no longer dedicated to charitable purposes after a liquidation or conversion transaction. There would be no termination tax due if the entire pre-transaction value of the charitable organization’s net assets remains dedicated to charitable purposes. If a tax is imposed, it would not be collected from the assets of the charitable organization that continue to be dedicated to charitable purposes. It would attach to an acquirer of the charitable organization’s assets in a conversion or liquidation transaction (essentially by extension of the intermediate sanctions or excess benefits transaction tax rules).
- Reform Intermediate Sanctions Regime – Under this option the so-called “rebuttable presumption of reasonableness” currently provided in the regulations under the intermediate sanctions provisions would be eliminated, and the procedures that currently apply under the rebuttable presumption (regarding advance approval by an authorized body, reliance upon data as to comparability, and adequate and concurrent documentation of all decisions) would instead be established as minimum due diligence standards of performance with respect to any compensation arrangement or transaction involving a disqualified person. Thus, satisfaction of these minimum standards would not result in the creation of any presumption in favor of the exempt organization, but instead would essentially be minimum requirements. In addition, all section 501(c)(3) organizations (including both public charities and private foundations) and section 501(c)(4) organizations would be required to disclose whether the minimum due diligence standards have been satisfied with respect to any transactions that could be subject to the intermediate sanctions (or the “self-dealing”) rules. If the minimum standards were not applied, the organization would be required to disclose what procedures, if any, were adopted and followed in order to insure that no excess benefit was provided to a disqualified person. Although a failure to satisfy the minimum due diligence standards would not necessarily establish a presumption of unreasonableness, that failure would place an additional burden on the organization to explain the procedures used and the data relied upon in approving a transaction. In addition, under this option if an initial tax is imposed on a disqualified person under the intermediate sanctions rules, the organization would itself be subject to an excise tax in the amount of 10 percent of the excess benefit provided to the disqualified person. This tax would not apply if the organization establishes that it operated in a manner consistent with application of the minimum due diligence standards with respect to the transaction that resulted in imposition of the intermediate sanctions tax on the disqualified person. This 10 percent tax on the organization would not be subject to abatement, even if the excess benefit transaction is ultimately corrected. In addition, under this option the current law protection for organization managers who approve an excess benefit transaction on the basis of the opinion of an expert advisor (to demonstrate that their approval was not “knowing”) would be unavailable, and the initial contract exception currently available under the intermediate sanctions regulations would be significantly limited.
- Require Public Disclosure of Form 990-T and Create a Related Certification Requirement – Under this option, the current law public inspection and disclosure requirements and penalties that apply to an organization’s Form 990 would be extended so that they would also apply to the organization’s Form 990-T (if any). Certain information could be withheld by the organization from public disclosure and inspection (e.g., information relating to a trade secret, patent, process, style of work or apparatus, of the exempt organization) if the IRS determines that public disclosure of the information would adversely affect the organization. In addition, organizations with total gross revenues or gross assets of at least $10 million would be required to include with their Forms 990 and Forms 990-T filings a certification by an independent auditor or by independent counsel that the organization’s filings accurately reflect the unrelated business income tax liability of the organization for the taxable year involved. The certification would require attestation that the independent auditor or counsel: (1) has reviewed the trades and businesses of the organization, and sources of investment income, program service revenues, and other items, and determined that the reporting and descriptions of all such items are complete and accurate; (2) has determined that the organization’s expense allocations between UBIT activities and other activities comply with tax law requirements; (3) has or has not reviewed or provided a tax opinion relating to the organization’s treatment of income or an activity under the UBIT rules; and (4) has or does not have knowledge that the organization participated in a tax shelter or other type of listed transaction.
- Eliminate Advance Funding of Qualified 501(c)(3) Bonds – Currently, the Internal Revenue Code does not limit the number of times the tax-exempt bonds may be currently refunded. Generally, however, qualified 501(c)(3) bonds may be advance refunded only one time (that is, generally, a refunding issue the proceeds of which are not used to redeem or repay the refunded bonds within 90 days of the date of issue of the refunding issue). This proposal would eliminate all advance refundings of qualified 501(c)(3) bonds.
- Modify FICA Tax Exemption for Students – Under this option, the recently issued final regulations that have the effect of substantially limiting the treatment of medical residents as students eligible for an exception from FICA tax essentially would be codified. Thus, in most cases, payments to medical residents would be subject to FICA tax.