The IRS Tax Exempt Government Entities division (TE/GE) announced on April 5, 2021, that it has updated its Compliance Program and Priorities webpage to add eight new compliance initiatives. These eight new initiatives fall under two components of the TE/GE compliance program: seven of the initiatives are "compliance strategies" that will be handled through examinations pertaining to employee plans, tax-exempt organizations and tax-exempt bonds, and the other initiative is described as a "compliance contact" for employee plans.

New compliance strategies

Three of the new compliance strategies are geared toward employee plans.

• Small exempt organizations that sponsor retirement plans. TE/GE will review the retirement plans of small tax-exempt organizations to determine whether (1) plan investments have been properly administered; (2) any party-in-interest transactions exist in the plan trust; or (3) any participant loans have been made that violate IRC Section 72(p). The IRS notes that improper transactions between a plan and its participants can be considered prohibited transactions under IRC Section 4975, making the distributions taxable, or can result in early distribution penalties under IRC Section 72(t).
• One-participant 401(k) plans. The IRS plans to review IRC Section 401(k) plans that have only one participant to determine whether (1) operational or qualification failures exist; (2) income tax and excise tax adjustments need to be made; or (3) plan document violations have occurred.
• Worker classification. The IRS will examine retirement plans of employers that have misclassified employees as independent contractors to determine whether IRC coverage requirements are satisfied.

Two of the new compliance strategies focus on tax-exempt organizations.

• Officers treating EO as a Schedule C business. TE/GE will focus on whether officers and insiders are claiming their tax-exempt organization's expenses as Schedule C business deductions. Claiming an exempt organization's expenses as business deductions on an individual return indicates private benefit and inurement, in addition to an inaccurate Form 1040.
• Form 990-N filers/gross receipts model. The IRS will examine whether an exempt organization was eligible to file a Form 990-N (i.e., whether the organization meets the $50,000-or-less-gross-receipts test).

Two of the new compliance strategies are directed at tax-exempt bonds.

• Student loan bonds market segment. These examinations will focus on determining whether requirements under IRC Section 144(b) were met, allowing the bond at issue to be considered a student loan bond. If the requirements are not met, interest on the bonds could be taxable to the bond holders.
• Form 8038-G yield restriction. On exam, the IRS will review yield restrictions on bond proceeds after the temporary period to determine whether the proceeds came only from the bond issue. If the issuer fails to yield restrict the investments after the temporary period, the IRS points out, the bonds are considered taxable arbitrage bonds.

New compliance contact

The new compliance contacts initiative addresses employee plan liabilities and unrelated business income (UBI). Specifically, the IRS will perform compliance checks on employee plans to determine if plan sponsors that reported plan liabilities on Form 5500-series returns engaged in activities that generated taxable UBI.

Implications

In updating its Compliance Programs and Priorities webpage to announce eight new initiatives, TE/GE has signaled its intent to expand the subject matter of its examinations and compliance checks for newly identified issues. The Compliance Programs and Priorities webpage supplements the FY 2021 Program letter and is updated as new priorities arise. (For more on the 2021 Program Letter, see Tax Alert 2020-2656.)

Although the IRS already had compliance strategies in place for employee plans, exempt organizations, and tax-exempt bonds, the inclusion of additional strategies, especially in the employee plan and tax-exempt bond space, underscore TE/GE's resource commitment to these areas. Taxpayers operating employee plans or issuing tax-exempt bonds should be prepared for increased scrutiny.

The decision to add compliance strategies for small exempt organizations sponsoring retirement plans, one-participant 401(k) plans, and Form 990-N eligibility also indicates a willingness by TE/GE to examine smaller organizations that might otherwise have considered themselves outside the Service's scrutiny. As noted previously, each compliance strategy includes specific inquiries for examiners to make. Organizations should continue to focus on compliance within these areas.

TE/GE updated its compliance contacts initiative to include compliance checks for plan sponsors that reported plan liabilities on their Form 5500 to determine if they are engaging in activities that generate UBI. Organizations that file Form 5500 should review their plan investments to identify possible UBI-generating activities.

As TE/GE seeks to improve operational efficiencies and leverage technology and data analytics, organizations should expect a greater digital presence from the IRS. TE/GE's efforts to expand e-filing of the Form 990-series and unveil electronic determination letter applications will improve their access to information provided by filing organizations. Organizations can expect new online tools and resources as well as expanded digital communications from TE/GE in the coming months. Tax-exempt organizations' management should review the Compliance Programs and Priorities webpage from time to time as TE/GE will continue to update the site with new compliance strategies.

Please contact your EY professional for further information.

———————————————