22 tips to attain tax tranquility. (Tax Tranquility).

Is your association waving red flags at IRS auditors? To keep from becoming a tax target, plan and document.

TAXATION. You CAN'T LIVE WITH IT.

You can't live without it. You can, however, minimize it. How? Through planning and documentation. This article offers a survey (once over lightly, no in-depth analysis) of 22 areas that need attention, in alphabetical order. Perhaps not all of them need attention at your organization. Find and prioritize those that do. Then, follow up.

1. Affinity programs

Trend: More nondues revenue pressure leads to more affinity programs. Many affinity programs are unsolicited proposals, long on sales puffery and short on program and vendor facts.

Trap: Too often, sales talk prevails. Unsupported promises sound too good to pass up when they could help plug budget shortfalls. Unfortunately, those proposals often remain silent on tax and legal liability issues. Why sign up for a program--unless members are clamoring for it--that may produce very little income and leave you with financial exposure from third parties?

Tip: Be wary of unsolicited proposals. When you solicit others for a new program, use a request for information (RFI) instead of a request for proposal (RFP). That is not just a language difference. RFPs generate sales-oriented proposals, heavy on boilerplate and short on critical facts. RFIs generate answers to important questions and copies of important documents. Get help to develop a checklist to evaluate unsolicited proposals and to prepare a good RFI.

2. Contemporaneous documentation

Trend: Year after year, dispute after dispute, insufficient day-to-day documentation proves fatal in IRS controversies. Your tax position is only as strong as your contemporaneous documentation.

Trap: Some association executives believe, or hope, they can document their positions if and when an IRS controversy arises. Or, they think documentation can be limited to a memo in the CFO's files. Wrong twice.

Tip: The best documentation is contemporaneous. If it is a contract, it is executed before the transaction occurs or the activity begins. It cuts across all departments and types of documents. It includes board minutes, member brochures, contracts, correspondence, and, certainly, tax returns. All departments should present consistent, organization-wide documentation.

3. Convenience rule

Trend: Section 501(c) (3 ) organizations can exclude income from unrelated business income tax (UBIT) computations if it is generated by an activity conducted primarily for the convenience of members, students, patients, officers, or employees. For example, this rule was intended to cover income from a college-operated laundry cleaning dormitory linens. Executives have tried to use the rule to exclude other types of income, such as income from general merchandise sales at college bookstores.

Trap: Too many organizations, faced with unplanned UBIT, claim at the 11th hour that an income-generating activity is conducted for the convenience of members. This rule's original purpose was very narrow. It will not help you unplanned at the 11th hour.

Tip: The flipside of the trap is that association executives may be underusing this rule due to lack of familiarity and planning. As you plan new activities, or revise old ones, think about how to structure or restructure them to fall within this rule. However, executives with membership organizations who want to claim "convenience of members" should remember the "services to individuals and inurement" traps noted later in this article.

4. Debt-financed income

Trend: Many association executives have never dealt with this rule, which taxes income from debt-financed activities. The rule receives less and less publicity, so executives who were not active when it was enacted just miss it.

Trap: This rule overrides specific exclusions from the UBIT. For example, most association executives know dividends and interest are excluded from the tax. But, that holds true only if there is no debt in the picture, such as a line of credit connected to the income-generating investment.

Tip: Review all your organization's existing debt and any plans to incur new debt. Analyze relationships, direct and indirect, between debt and income. The closer the relationship, the greater the chance of tax exposure.

5. Inurement

Trend: With greater emphasis in the past decade on UBIT, association executives pay less attention to issues like inurement. Inurement means the flow of benefits or earnings to individuals, rather than to the organization's target public or industry. It can be excessive executive compensation--or excessive vendor compensation.

Trap: IRS officials pay close attention to inurement because they got beat up in congressional hearings for not revoking exemptions for real or perceived abuses. They are now very interested in exempt-status issues. You should be equally interested.

Tip: Review each significant activity. When planning a new program, include an inurement analysis. Ask yourself, does this activity benefit primarily the public or the industry, or primarily those members or individuals who participate? If you pay compensation to an executive or to a vendor, do you have contemporaneous documentation indicating the amount is reasonable?

6. IRS examinations

Trend: Many years ago, the IRS audited more exempt organizations than they do now. The low audit rate makes association executives complacent.

Trap: When the audit rate was higher, audit results were not impressive. Many audits resulted in no change, with no tax assessed and no exemption revocation. Not so now. The IRS has greatly improved its audit effectiveness. Audits have become more intensive, extensive, and productive.

IRS officials know the importance of showing Congress results, which means more tax and more exemption revocations. They also seek assessments for their ripple effect, so that assessments become known and persuade others to comply.

Tip: Tax complacency can make you lose in an audit, resulting in taxation and possibly exemption revocation. In addition, if the examining agent perceives that you took certain positions without a reasonable basis that shows up in contemporaneous documentation, penalties could follow. The first exempt-organization tax expert to see your tax return and tax documentation should not be the IRS agent. Instead, consider hiring an expert to do an internal, confidential tax audit every three years. In between, implement audit findings and recommendations.

7. Joint ventures with for-profit companies

Trend: Association executives have increased joint venture activities to generate more revenue. At the same time, the IRS has increased its audit activity in that area, especially for 501(c)(3) organizations. The IRS is concerned when money or other benefits flow from an exempt organization to a for-profit, especially if the exempt organization is a charity.

Trap: Like affinity programs, joint ventures are often unsolicited. When solicited, they tend to be big on sales talk and short on key business, financial, and legal details, which can trigger major tax and legal issues.

Tip: Beware of for-profit requests for you to provide anything free or for a reduced rate. For example, some organizations provide free mailing lists, trade show booths, and advertising. Also, look out for ventures where the for-profit group pays your organization "X" dollars a year and keeps the rest of the income generated from the joint venture. How much is the rest? Is it reasonable?

Structure your joint venture planning as a rigorous business process, avoiding sales talk, proposals, and unsupported promises. Ask how much money the association will receive, as well as how much money the for-profit group will keep.

8. Mailing lists and databases

Trend: More organizations, especially individual member societies, have valuable mailing lists and databases. Commercial companies recognize this opportunity and want to exploit those assets for profit.

Trap: Those assets do not appear on traditional financial balance sheets. As a result, executives have no basis for properly valuing them. Yet, those assets may be worth as much or more than many assets listed on the balance sheet.

Tip: Do not let anyone use your database for free. Giving away assets can trigger exemption revocation. Determine through outside sources or through marketplace competition the real market value of a database before agreeing on a price. Then, start your tax planning so that database income can be tax-free. In the process, avoid exclusive arrangements and maximize income through multiple database licensees.

9. Private foundation taxation

Trend: Executives of 501(c)(3) organizations ignore private foundation rules at their peril. Other organizations, such as 501(c)(6) groups that set up affiliated foundations exempt under 501(c)(3), also can be hurt by these rules.

Trap: As the number of 501(c)(3) organizations has grown and memories of the severity of the private foundation rules have faded, the risk of incurring financial penalties increases. The IRS imposes those penalties, by way of excise taxes, not only on the foundation but also on staff and volunteers.

Tip: Use the public support tests that differentiate public charities from private foundations to ensure that your 501(c)(3) organization is not an "accidental" private foundation.

10. Royalties

Trend: Many organizations have tried to use this exclusion from UBIT. Unfortunately for them, an increasingly vigilant IRS has monitored and successfully attacked their efforts.

Trap: Too many organizations labeled as royalties various items of income that did not qualify. The IRS figured this out and now normally views just about anything that is labeled "royalty" as a red flag.

Tip: Maximize the benefit of the royalty tax exclusion by thorough planning, negotiating, and documenting. Be prepared to pass audit scrutiny, which can be accomplished by understanding the many cases and rulings interpreting the royalty exclusion.

11. Services for individuals

Trend: Associations and other membership organizations emphasize member service. That's fine. Sometimes, though, they lose track of one key fact: Except for groups such as social clubs, the federal tax-exempt status of organizations is not based on member service.

Trap: Your organization may not be exempt based on member benefits. The exemption of 501(c)(3) organizations is probably based on public service, and the exemption of 501(c)(6) organizations is based on industry service. The penalty for falling into this trap is exemption revocation, meaning your organization loses its tax-exempt status and becomes a taxable organization, perhaps retroactively.

Tip: Keep individual benefits incidental, not primary. Be sure that is reflected in member benefit brochures, board minutes, tax returns, and elsewhere.

12. Tax litigation 

Trend: Some executives play the tax lottery. Ever mindful of tight budgets, they find that the lottery is cheaper than serious tax planning. It also takes no staff time. So, it saves those two most precious commodities: time and money.

Trap: IRS auditors can spot lottery players. Those executives fail to report unrelated business income without good documentation. They file tax returns prepared clerically, not professionally. They do not intentionally flout the law; they just do not spend much time and money complying with it. IRS auditors are much less settlement-oriented with lottery players and will force them into litigation when amounts assessed are too high to pay without a fight.

Tip: Tax litigation can be called the ultimate lottery because of the huge uncertainty of outcome. The only certainty is that it will cost substantial time and money--many multiples larger than what you tried to save by not planning in the first place. To make your activities unattractive to IRS litigators, plan and document. That way, when the IRS auditor presents your case to IRS litigators for a proposed court fight, the litigators will recommend that the auditor find an easier target.

13. Tax management process

Trend: Tax management is needed more as exempt organizations become larger, more sophisticated and complex, more in need of nondues revenue, and more involved with other organizations, both exempt and taxable.

Trap: Many executives downplay tax management because they run tax-exempt organizations. In truth, tax-exempts are subject to many regular corporate income-tax rules, plus the special UBIT rules and the unique tax-exempt status-preservation rules. That's a lot to downplay.

Tip: Implement a coordinated tax management process. Assign responsibility, plan thoroughly, maximize your negotiating power, document your results, and annually update your analysis factually and legally.

14. Tax opinion letters

Trend: Many years ago, executives routinely requested written tax opinions from outside professionals on important tax issues. In recent years, with tighter budgets, executives tend to rely on off-the-cuff professional impressions, rather than formal, researched opinions.

Trap: Off-the-cuff impressions have their place, but they will not help when disputes arise. They are much less reliable than an opinion based on legal research, combined with factual analysis.

Tip: Increase your budget to allow for one or two written tax opinions annually on the most important issues that arise. In addition to greatly increased reliability, these opinions can protect you against an extended statute of limitations caused by tax return omissions and against severe penalties for non-compliance caused by non-disclosure. Another advantage: The points your adviser discovers and ideas he or she develops while analyzing the published rules and precedents can help you identify and prioritize choices in structuring activities.

15. Tax penalties

Trend: Before making decisions, association executives usually do not evaluate tax penalties they could incur.

Trap: The Internal Revenue Code has many more tax penalties than 20 or 30 years ago. In an audit, IRS officials are more likely to impose multiple penalties if they perceive intentional or negligent non-compliance.

Tip: Before taking action that could cause tax liability, investigate which penalties could be added to your hill and how you can avoid them.

16. Tax return planning

Trend: Tax return preparation is usually the last step in financial statement audit work, performed as a clerical task by the most junior audit staff.

Trap: Form 990 (subject to public inspection) and Form 990-T set the stage for an adversary proceeding.

How you prepare them can cause, or avoid, an IRS audit. How you prepare them can also help determine tax litigation victory or defeat.

Tip: Use an experienced exempt organization tax professional to prepare returns and to advocate your organization's positions.

17. Taxation of advertising

Trend: When reporting tax on advertising, executives of associations with advertising income tend to copy last year's tax return without further analysis. With that, they copy whatever mistakes occurred last year and ignore opportunities to capitalize on new developments or new ideas.

Trap: Nobody likes to spend time doing boring work. Many executives give little or no attention to cost allocations and dues allocations. Unfortunately, they are the keys to minimizing taxation of advertising.

Tip: Strategies for improving cost allocations and dues allocations do not appear in the law or U.S. Treasury regulations, but an experienced exempt-organization tax professional can provide them. All major cost categories, such as paper, printing, salaries, and postage, can be allocated in more than one reasonable way. Figure out which works best for you. Indirect costs, sometimes called general and administrative (G&A) costs, can also be handled in more than one way. However, the best way to handle G&A is to minimize it by very thorough direct cost allocations. The dues allocation rules will probably hurt your position unless you study them and come up with a way to avoid, or minimize, the damage.

18. Taxation of staff and volunteers

Trend: Surprisingly, most staff and volunteers of 50l(c)(3) and (c)(4) organizations who can be personally taxed under the intermediate sanctions rules just ignore them. This tax can total more than the amount initially at stake in the transaction in question because the tax is imposed annually until the perceived problem is corrected. The tax could easily exceed an association executive's annual salary.

Trap: The IRS needs examples to take back to Congress, where t lobbied hard to get this tax enacted. IRS auditors will not hesitate to tax staff and volunteers.

Tip: Figure out which existing and proposed activities could trigger this tax. CEO compensation and vendor compensation are two examples. Implement the steps required to come within the safe harbor rule for reasonable compensation.

19. Taxation of subsidiaries

Trend: Organizations often create subsidiaries without considering tax planning.

Trap: Subsidiaries can be taxable entities if association executives don't take tax planning into account. The subsidiary could end up owing more tax than the association would owe if the subsidiary's activity were conducted within the association.

Tip: First, tax justify the subsidiary. Get a written analysis confirming that the subsidiary--not the association--must conduct the activity for tax reasons. Then, plan the subsidiary, creating it as a tax-exempt organization. If you cannot obtain a tax exemption for the subsidiary but can still justify its creation, figure out in advance how to manage its finances to minimize the annual tax.

20. Trade shows

Trend: Most associations stopped tax planning for trade shows when Congress changed the law several years ago.

Trap: Congress did not say all trade shows are tax-exempt. The law just sets up rules to satisfy if you want your organization's exhibit income and other trade show income to avoid the UBIT. You must meet the rules. Some shows will need changes to do so, such as those that are not sufficiently educational or do not display a comprehensive cross-section of industry products. Other shows that qualified last year or the year before may not qualify this year or next year if they change.

Tip: Study the rules as they pertain to your trade show, and review them each time you change your show. Disclose in Form 990 the show's qualification by referring to each of the qualifying rules.

21. Volunteer rule

Trend: Section 501(c)(3) Organizations' income from activities run mostly by volunteers is excluded from the UBIT. However, association executives tend to ignore this when planning activities.

Trap: Organizations get taxed on income that could have been generated by volunteers.

Tip: Evaluate which income-generating activities that could be run mostly by volunteers. Make that change to avoid tax on future income. For example, advertising sold by volunteers could create tax-exempt income even though it would be unrelated business income if sold by staff.

22. Web site income

Trend: As organizations rely on larger and more sophisticated Web sites, they also seek ways to obtain income through those sites.

Trap: Association executives, particularly those with an "Internet as Wild West" mentality, put new income-producing activities on the Web without tax planning. However, the IRS is studying taxation of Internet activities and already has announced there is no blanket UBIT exemption for Web income.

Tip: All Web-based income generators require the same tax planning as non-Internet activities. For example, advertising that would be taxable in a paper publication will also be taxable on the Web. Extra care will be required, however, in applying the U.S. Treasury regulation rules for periodicals in an Internet setting.

Analyze your specific facts

This article, which covers the tip of the iceberg on each trend, is intended to present general, non-technical information, not legal advice. Before taking action or making business decisions, retain a tax professional to analyze your specific facts and apply the law to them.

It's your organization's income. Try to keep it.

RELATED ARTICLE: IMPLEMENT AN EFFECTIVE TAX MANAGEMENT PROCESS

To minimize your organization's taxes, implement a tax management process with these five steps:

1. Assign. Ask a top executive to make minimizing taxes an ongoing priority. Put the responsibility in his or her job description.

2. Plan. Minimizing taxes does not happen by accident. The opposite does.

3. Negotiate. Many activities require negotiation. Decide who is your best negotiator. It may not be a staff person, due to lack of time, lack of skills, or an overabundance of emotional involvement. In those cases, your lawyer may be more productive.

4. Document. Contemporaneous documentation is paramount. Strong, consistent documentation, across the whole organization, is often the single biggest factor in determining the outcome of a tax controversy.

5. Update. Lack of annual updates is a common weakness in the tax management process. Last year's solution, last year's contract, and last year's research are all suspect. A two-or-three-year-old plan has depreciated to a point approaching obsolescence.

Each year, look back at your prior year plans and documents, ask your lawyer about new legal and tax developments, and ask your colleagues about factual and operational changes. Any one of those could require an update to your plan and documents.

IS INTERDEPARTMENTAL COOPERATION AN OXYMORON?

If I could have a dollar for each time a staff member has told me that tax planning or documentation must wait because a person in another department is holding up the process, I could retire right now.

Maybe the meetings department is denying documentation changes to confirm the trade show's compliance with UBIT exclusion rules. Perhaps the membership department is shying away from limits on affinity program promotion to preserve tax-free royalty status for affinity income. Possibly the publications department is balking at filling out detailed time sheets that support cost allocations to minimize tax on advertising income.

Can you imagine your chief financial officer telling an IRS audit agent that your documentation would be stronger but a person in another department would not cooperate? Neither can I.

Interdepartmental cooperation is critical. Tax reduction is not the CFO's problem. It's the whole organization's responsibility. If you sense this is an environmental issue in your organization, consider bringing in an environmental consultant...such as your CEO.

Joseph Greif, an attorney and certified public accountant, is the founder of Greif Legal Economics Services. He has served associations for more than 30 years. E-mail: attycpa @eolaw.com.