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In the "Tax Exempt and Government Entities FY 2017 Work Plan" (Work Plan), the IRS Tax Exempt and Government Entities division (TE/GE) details several methods used in the past year for selecting taxpayers and issues for examination and highlights TE/GE's priorities for the coming year.

TE/GE priorities

In an introduction to the Work Plan, TE/GE Commissioner Sunita Lough and Deputy Commissioner Donna Hansberry explain that recent changes within TE/GE are evaluated with three goals in mind — transparency, efficiency and effectiveness. In an effort to increase transparency, TE/GE launched Knowledge Network teams (K-Nets) and has "been diligently working on creating issue snapshots that provide short analyses on specific issues commonly encountered by the field," the commissioners explain. (The IRS publishes TE/GE issue snapshots here.) Since introducing a short-form exemption application (Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3)) to increase efficiency in processing exemption applications, TE/GE has implemented pre-determination and post-determination review processes to ascertain whether use of the Form 1023-EZ has been effective.

Other initiatives begun in the last two years that will continue in FY 2017 include:

— Reviewing how issues of non-compliance are identified "based on robust filters and modeling"

— Honing TE/GE's information document request process

— Developing resources, answering questions, conducting discussion forums and facilitating collaboration through K-Nets

— Cross-training TE/GE personnel, having "successfully combined [TE/GE's] three case-closing functions (Exempt Organizations, Employee Plans and Government Entities) into a single entity"

— Creating "an innovative, interactive form" for the tax-exempt bond community to eliminate "many costly filing errors" (Form 8038-CP, Return for Credit Payments to Issuers of Qualified Bonds)

Exempt Organizations (EO) Examinations

In FY 2016, EO Examinations implemented a data-driven case selection process to identify and address "existing and emerging high-risk areas of noncompliance" and focused compliance efforts on educational programs, compliance reviews, compliance checks, and correspondence and field examinations. The five issue areas of primary focus for EO Examinations have been: 1) exemption, 2) protection of assets, 3) tax gap, 4) international, and 5) emerging issues involving non-exempt charitable trusts and hospitals' compliance with Section 501(r).

EO Examinations completed 4,984 examinations in FY 2016. The largest number (2,109) of these examinations involved filing, organizational, or operational issues; the next largest number (1,323) involved employment tax issues. The other primary issue areas were: unrelated business income (611); discontinued operations modifications/revocation (195); inurement/private benefit (192); political, legislative, governance (59); and other (495).

ACA and Section 501(r) oversight

As of June 30, 2016, TE/GE had completed 692 reviews of hospitals for compliance with Section 501(r), and referred 166 hospitals for field examinations based on three issues: lack of a community health needs assessment (CHNA), as required under Section 501(r)(3); absence of financial assistance and/or emergency medical care policies, as required under Section 501(r)(4); and failure to comply with billing and collection requirements under Section 501(r)(6). In FY 2017, TE/GE will continue to review hospitals for compliance with Section 501(r).

Post-determination compliance program

In FY 2016, TE/GE "continued post determination compliance examinations" of 1,400 exempt organizations that had applied for exemption by filing Forms 1023 or 1024 under a streamlined process. TE/GE selected these organizations for compliance examinations using a statistically valid sampling process; 61% of 1,051 closed returns resulted in "no change," and TE/GE revoked the exempt status of five entities through this post-determination program.

TE/GE also conducted post-determination compliance examinations of entities that had been granted exempt status after filing Form 1023-EZ, choosing 1,182 organizations through a statistically valid, random sample. As of June 30, 2016, 34 of the 36 examinations that had closed resulted in no change; the other two required amendments to the entities' organizing documents.

Finally, in FY 2016, TE/GE began selecting Forms 990, 990-EZ and 990-PF for review based on a case selection modelling technique that uses data from Form 990 search queries. Of the 62 returns that had been selected through this process and closed in FY 2016, 90% required a change. The overall change rate for all cases closed by June 30, 2016 is 82%. TE/GE interprets these high change rates as meaning that its case selection modelling technique is effective.

FY 2017

In the coming year, the EO Examinations function intends to continue making data-driven decisions for case selection and leveraging feedback from IRS field agents to improve how information returns are selected for examination. Focus will continue on the same five strategic issue areas and on hospitals' compliance with Section 501(r). Other goals for FY 2017 include:

— Utilizing data sources to identify: 1) entities at risk for private inurement and private benefit; and 2) anomalies on private foundations' returns, including 400 returns in the work plan identified for high risk of private inurement and private benefit and 100 private foundation returns with detected anomalies

— Implementing a statistical sampling methodology to assess general compliance in the exempt organizations community and developing a plan for an "ongoing rolling statistical sample" of Section 501(c)(3) organizations and other Section 501(c) entities

EO rulings and agreements

The Work Plan highlights the recent successful methods of EO Determinations in expediting application processing.

FY 2016 accomplishments

Erroneous revocation prevention: In May of 2016, EO Rulings and Agreements formalized procedures to early identify and prevent erroneous automatic revocations, and has succeeded since March 2015 in preventing 3,202 erroneous revocations out of 13,933 potential auto revocations.

Rejection of incomplete applications: In November 2015, EO Rulings and Agreements began rejecting incomplete exemption applications in order to allow revenue agents to focus on complete applications and to educate applicants about application requirements.

PATH Act implementation: The Protecting Americans from Tax Hike (PATH) Act was signed in December 2015 and requires social welfare and civic organizations to submit a notice to the IRS of intent to operate as a Section 501(c)(4) organization. EO Rulings and Agreements has processed over 400 notifications since the enactment of the PATH Act.

Form 1023-EZ: Decreased user fees for the streamlined Form 1023 resulted in an increase in the number of applicants using Form 1023-EZ, which accounted for 58% of total Form 1023 cases through the third quarter of FY16. 1023-EZ cases are also closing at a faster rate. Through the third quarter of FY16, EO Determinations received a total of 33,549 Form 1023-EZ cases and closed 33,909.

Closing applications: EO Determinations closed more applications than it received through the third quarter of FY2016. The average application took 73 days to process, and less than 1% of the closed cases were denied. The most common reasons for denial were private benefit and inurement, substantial non-exempt purposes and commerciality issues.

FY 2017 goals

Expecting an increase in exemption applications, EO Determinations will focus on improving case processing despite reduced resources. The IRS expects to see a slight decrease in the number of Form 1023 applications in favor of an increase in Form 1023-EZ applications and a slight increase in Form 1024 applications and Form 8940 determination requests. The IRS expects to deal with this through continuous improvements made in case processing. Further, to mitigate reduced resources amongst increased applications, EO Determinations will continue to reposition staff resources as needed. The IRS will also focus on the Form 1023-EZ data-driven pre-determination application reviews and consider adjustments to the application, instructions and pre-determination program.

EO Determinations also plans to continue to improve the new electronic Form 8976, Notice of Intent to Operate Under 501(c)(4). Form 8976 works as the notification process for the newly enacted Section 506, which requires organizations intending to operate under Section 501(c)(4) to notify the IRS within 60 days of formation.

Other initiatives for FY 2017 include the Knowledge Management (KM) Issue Snapshot initiative. Each Issue Snapshot is based on certain issues raised to KM and is typically supplemented with a short, 15- to 20-minute training video. With five Snapshots completed, KM has 20 more in development. Forthcoming Snapshots include: private foundation qualifying distributions, conservation easements, limited liability companies, trusts and Section 508(a), requirements for community health needs assessment (CHNA), Section 501(c)(4) and determining primary activity, and a VEBA non-discrimination overview. Each Snapshot is posted to the Electronic Reading Room on IRS.gov.

Tax-exempt bonds

Examinations

The Tax-Exempt Bonds division of TE/GE (TEB) reports that its highest priority examination cases are claims and returns that have been identified because of evidence of noncompliance (e.g., returns selected based on referral information), with 22 referral examinations completed in FY 2016. The next priority is tax returns with issues that the IRS knows, based on experience (e.g., past examinations, the Voluntary Compliance Agreement Program (VCAP), etc.), "indicate a higher risk of noncompliance." For FY 2017, this category will include small issue bonds.

In FY 2017, TEB Examinations will be looking for new areas of noncompliance calling for examination by using data analytics "to identify returns with multiple or especially significant indicators of potential noncompliance" and market scans "to identify new issues or fact patterns that have a higher risk of noncompliance."

VCAP

In its Work Plan, TE/GE explains that, although VCAP cases will continue to be a priority in FY 2017, the TEB function "expects that VCAP will require fewer resources than in the past" because the closing agreement process is more efficient, transparent, consistent and enforceable, and because fewer VCAP requests are being submitted. For FY 2017, a "streamlined VCAP" will focus on "certain arbitrage violations."

Implications

TE/GE's Work Plan describes its compliance focus areas for its 2017 fiscal year and the actions it intends to take within those focus areas. The Work Plan provides exempt organizations with valuable insight into issues on the IRS's radar and affords some specifics regarding the nature of initiatives the IRS plans to undertake in the coming year. Many of the 2017 topics are continuations of previously identified areas of focus and were included in prior IRS Work Plans. There are also many new areas of focus.

Some highlights of the Work Plan that tax-exempt organizations should heed include:

— TE/GE offered some insight into and the results of its Form 990 data-driven case selection process to identify noncompliance, which resulted in a change rate of 90% for organizations selected for exam using this process. While TE/GE maintains its focus on five areas, it is especially focused on exemption issues (e.g., filing, operational, organizational and revocation issues) and tax gap problems (e.g., unrelated business income and employment tax issues).

— Tax-exempt hospitals should continue to implement policies and procedures required by Section 501(r) and the final Section 501(r) regulations, as this is a continued focus of TE/GE in FY 2017. As of June 30, 2016, the IRS was conducting Section 501(r) field examinations of 166 hospitals. The most common issues that resulted in field examinations were lack of a CHNA, no financial assistance or emergency medical care policies, and failure to comply with Section 501(c)(6) billing and collections requirements.

— Based on its post-determination compliance program, TE/GE concluded that its streamlined exemption determination process is working well. Therefore, the IRS will continue its streamlined processing of applications for tax exemption, and applicants submitting Forms 1023 and 1023-EZ should continue to experience efficient processing of their applications.

— Tax-exempt organizations and private foundations should expect increased monitoring of private inurement and private benefit issues in fiscal year 2017, as TE/GE will utilize data sources to identify potential private inurement and prohibited private benefit.

— EO Rulings and Agreements expects to continue to improve its exempt application determination time despite decreased resources. One expectation is that decreased user fees for Form 1023-EZ will increase the number of those applications over the number of standard Form 1023 applications, thereby improving processing time. Organizations should expect continued improvement in exemption application processing time, including developments to the Form 1023-EZ and Form 8976 processes.

— TEB is focused on effective identification of noncompliance and will continue using previous examinations, VCAP and new data-driven approaches to monitor new trends in and high-risk areas for noncompliance, such as private use of bond-financed property, arbitrage compliance failures, and advance refunding issues with variable interest rates or escrows funded with open market escrow securities. With a new focus on data analysis, TEB examinations of Section 501(c)(3) conduit borrowers are likely to increase as well.

Organizations should evaluate the potential implications that each of the areas identified by the IRS in the Work Plan may have on the organization.

Please contact your EY professional for further information.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg

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