The IRS Tax Exempt & Government Entities (TE/GE) division has issued its Fiscal Year 2019 Accomplishments Letter (the Letter), which reviews exempt organization-related compliance and administrative activities completed by the agency in fiscal year 2018.

TE/GE Commissioners' message

The Letter's opening message from the TE/GE Commissioners highlights several changes that TE/GE implemented during 2018 with an aim to enhancing exempt organization customer service and improving efficiency.

These highlighted changes include revising various forms, including:

 — Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code

 — Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code

 — Form 1024, Application for Recognition of Exemption Under Section 501(a) or for Determination Under Section 120.

The Letter states these forms were revised to make it easier for organizations to select the correct form when applying for tax-exempt status and to help the IRS make the correct determinations on tax-exempt status. In particular, the Letter notes the addition to Form 1023-EZ of a 250-character text box in which the organization must describe its exempt purpose. It also notes the addition of a specific question as to whether an applicant seeks recognition as a church, hospital or school (because organizations seeking such recognition may not use Form 1023-EZ).

The Letter further highlights the release of Form 1024-A, Application for Recognition of Exemption Under Section 501(c)(4) of the Internal Revenue Code, which organizations seeking 501(c)(4) status may use to seek an official determination of their tax-exempt status from the IRS.

In addition, the Letter highlights the launch in 2018 of the Tax Exempt Organizations Search (TEOS), which helps users find information about a tax-exempt organization's federal tax status and filings.

Compliance platform

The Letter explains that TE/GE employs a compliance platform that is divided into six programs: (1) compliance strategies; (2) data-driven approaches; (3) referrals, claims and other casework; (4) compliance contacts; (5) determinations; and (6) voluntary compliance and other technical programs. For each program, the Letter includes statistics on the number of "new starts" or "receipts" for the year, as well as the number of closures.

Compliance strategies

Compliance strategies focus on certain issues identified and approved by TE/GE as compliance priorities. Compliance strategies in FY 2018 included:

1. Non-Exempt Charitable Trusts (NECTs) — examining organizations that under-report income or over-report charitable contributions
2. Forms W-2/1099 matches — comparing payments reported on Form 1099, Miscellaneous Income, with wages reported on Form W-2, Wage and Tax Statement, and subject to Federal Insurance Contribution Act (FICA) tax and income tax withholding
3. Early retirement incentive plans — examining entities that provide cash (and other) options to employees as an incentive for early retirement to determine if the proper tax treatment was applied to these benefits
4. Notice CP 2100 (backup withholding) — examining entities that failed to comply with backup withholding requirements due to mismatched and/or missing taxpayer identification numbers on Form 1099

For exempt organization compliance strategies for the year, the Letter reports 307 new starts and 165 closures.

Additional compliance strategies related to tax-exempt bonds included:

1. Notice of defeasance — examining whether bond issuers may have taken remedial actions under Reg. Sections 1.141-12 or 1.142-2 without meeting all requirements under the applicable regulations
2. Arbitrage — examining tax-advantaged bonds with guaranteed investment contracts and/or qualified hedges as well as bonds with investments beyond a temporary period
3. Acquisition financing — examining private activity bonds to determine whether the rehabilitation requirement was satisfied
4. Non-qualified use — examining dispositions of financed facilities and/or excessive private business use
5. Other — examining bonds issued with a deep discount and private activity bonds with excessive weighted average maturities

Data-driven approaches

With the data-driven approaches program, TE/GE uses models and quantitative criteria to examine return data and historical information to identify high-risk areas of noncompliance.

In FY 2018, TE/GE continued to work on improving its compliance models for Form 990-series returns. It also identified returns of exempt organizations and government entities containing the highest risk of employment tax noncompliance.

In collaboration with Research, Applied Analytics & Statistics (RAAS), TE/GE also continued to examine various items and activities, including private benefit/inurement, officer business partnerships, underreported credit card income, and related employees and for-profit partnerships.

For private foundations, TE/GE used data-driven approaches to examine potential anomalies found on private foundations' Form 990­PF filings. This included examining organizations that show indicators of potential private benefit or inurement to individuals or private entities.

For exempt organization data-driven approaches for the year, the Letter reports 3,902 new starts and 3,501 closures.

Referrals, claims and other casework

In FY 2018, TE/GE continued to pursue referrals alleging noncompliance by exempt organizations from both internal and external sources. It also continued to address claims (i.e., requests for refunds or credits of overpayments of amounts already assessed and paid).

Other casework included (1) continuing to examine entities that filed and received exemption using Form 1023-EZ, and (2) continuing to review hospitals for compliance with Section 501(r).

For exempt organization referrals, claims and other casework for the year, the Letter reports 2,374 new starts and 2,933 closures.

Compliance contacts

TE/GE used compliance contacts, known as "compliance checks" and "soft letters," to determine whether exempt organizations are adhering to recordkeeping and information reporting requirements, including for:

1. Combined Annual Wage Reporting (CAWR) employment tax — tax-exempt employers that had discrepancies between Form W-2 and Form 941, Employer's Quarterly Federal Tax Return / 944, Employer's Annual Federal Tax Return
2. CAWR and Federal Unemployment Tax Act (FUTA) — exempt organizations that were required to, but failed to file, Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return
3. Form 990-T non-filer — Section 501(c)(7) organizations that reported investment income on Form 990/990-EZ but did not file Form 990-T
4. Financial Assistance Policy (FAP) — tax-exempt hospital organizations that did not comply with Section 501(r)(4)
5. Employment tax returns of small federal, state and local governments and tax-exempt organizations

For exempt organization compliance contacts for the year, the Letter reports 1,357 new starts and 1,317 closures.

Determinations

TE/GE issues determination letters to exempt organizations on exempt status, private foundation classification and other determinations relating to exempt organizations. The Letter includes some statistics on applications received and closed in FY 2018, with levels broadly consistent with previous years.

For exempt organization determinations for the year, the Letter reports 95,529 receipts and 91,981 closures.

Voluntary compliance and other technical programs

TE/GE uses the tax-exempt bond (TEB) Voluntary Closing Agreement Program (VCAP) to assist governmental issuers in resolving violations of federal tax laws applicable to their tax-exempt bonds, tax credit bonds or direct pay bonds (tax-advantaged bonds) through the execution of closing agreements with the IRS. The Letter notes that FY 2018 receipts in the TEB VCAP were lower than anticipated.

For TEB voluntary compliance and other technical programs for the year, the Letter reports 27 receipts and 27 closures.

Implications

The FY 2019 Accomplishments Letter offers a summary of the priorities undertaken by TE/GE during FY 2018 and supplements the 2019 Program Letter that was issued in October 2018. See Tax Alert 2018-2005. The 2019 Program Letter builds upon the TE/GE accomplishments of FY 2018 by identifying high priority issues and emerging risks going forward. Organizations should take careful account of all compliance strategies accomplished during FY 2018 and identified for FY 2019, including the following takeaways within each program:

Compliance strategies: Priority issues for FY 2018 show TE/GE's increasing trend to focus on employment-related tax issues such as W-2/1099 reporting, backup withholding and retirement plans. Organizations should continue to monitor compliance with these strategies as well as those areas of focus identified in the FY 2019 Program Letter, including: worker misclassification; investment income earned by Section 501(c)(7) social clubs; self-dealing by private foundations; for-profit entities that converted to Section 501(c)(3) tax-exempt organizations; and the cost of issuance limitations applicable to private activity bonds.

Data-driven approaches: TE/GE's improvements to its data-driven exam selection approach have increased its success in identifying anomalies and flagging those organizations with the highest risk of non-compliance. Through the use of this approach, TE/GE opened nearly 4,000 new cases, demonstrating the effectiveness of this method. Furthermore, in its FY 2019 Program Letter, TE/GE announced future developments in this process, including data-driven exam selection models for Forms 8038 and 5227, as well as continued collaboration with RAAS to identify issues not directly reported on Form 990. Organizations should remain mindful of TE/GE's ability to review the data provided on an increasing number of forms submitted to the IRS.

Referrals, claims and other casework: As evidenced by over 2,300 new starts and 2,000 closures, referrals, claims and other casework continues to be a successful identifier of noncompliance for TE/GE.

Compliance contacts: The accomplishments achieved by TE/GE in FY2018 indicate an increasing trend by TE/GE to focus on employment-related issues as well as compliance with Section 501(r) by tax-exempt hospital facilities. TE/GE will continue to review hospital websites for compliance with the Section 501(r) regulations.

Determinations: In FY 2018, TE/GE revised Forms 1023, 1023-EZ, and 1024, and created Form 1024-A. Focus on these forms signify TE/GE's determination to streamline the filing process and reduce the number of errors that occur when seeking exemption. Organizations should understand the new qualifications for each determination form when filing for tax-exempt status.

Voluntary compliance and other technical programs: Issuers (and/or the conduit borrowers) of tax-exempt bonds should use the TEB VCAP program to resolve violations of the federal tax laws applicable to tax-exempt bonds. Use of the voluntary compliance programs should allow tax-exempt organizations to minimize the risk of potential penalties and interest and preempt issues that may arise on examination.

Please contact your EY professional for further information.

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