Exempt organizations and the Coordinated Examination: a rude awakening.

It seems like just yesterday that an exempt organization's biggest concern about the IRS was having an agent spend 100 to 200 hours examining it. The advent of the Exempt Organizations Coordinated Examination Program (CEP), at least for exempt organizations with assets over $50 million, has significantly changed that. A CEP examination brings together personnel from various offices within the Service, such as Exempt Organizations managers and agents, computer audit specialists, income tax, excise tax, international and Employee Plans agents, engineers and economists. The CEP, in conjunction with Exempt Organizations taking jurisdiction of employment tax issues affecting exempt organizations and tax-exempt bonds, has opened a new era in tax compliance. It is not uncommon for four to eight agents to spend 1,000 to 3,000 hours on a CEP examination. In addition to the additional time involved, the IRS is looking at issues that were routinely ignored in the past.

In the employment tax area, the Service has expanded its focus from strictly independent contractor-employee classification issues to include the student nurse and full-time student exemptions from FICA. In another area that had not received widespread attention, reporting requirements for nonresident aliens, IRS International Examiners will open up a major compliance initiative and begin with examinations of colleges and universities. This program is expected to expand in the future to include hospitals and other not-for-profit organizations. In raising these "new" issues, it is not unusual for a large institution, such as a university, to be assessed tax, interest and penalties into the millions of dollars.

The exhaustive nature of CEP examinations has brought Sec. 403(b) tax-sheltered annuity plans under scrutiny. According to the IRS National Office reviewers, they have not seen even one plan that complies with the statutory requirements. The primary areas of noncompliance are the contribution limits, distributions and discrimination in favor of the highly compensated. This area has raised such a concern that the Service has developed exhaustive examination guidelines for use by its examiners. In response to the limited guidance it has issued on Sec. 403(b), the IRS is establishing a Voluntary Compliance Resolution (VCR) program to allow exempt organizations with compliance defects to voluntarily approach the Service and resolve the defects.

The IRS has begun reviewing compensation arrangements as a whole. A new priority has become See. 457 nonqualified deferred compensation arrangements. Participation in these plans for employees of exempt organizations is limited to a select group of individuals or management. As such, the arrangement inherently creates inurement concerns. Thus, issues that will emerge include the limitations applicable to an eligible plan; when the plan is aggregated with a Sec. 403(b) tax-sheltered annuity; and distributions from the plan. As part of the review of compensation arrangements, the Service is also looking at cafeteria plans and fringe benefits.

The IRS Exempt Organizations group now has jurisdiction over all tax-exempt bond audits. It is working closely with the Securities and Exchange Commission to ensure compliance with the appropriate laws. Exempt Organizations examiners are also focusing on the use of bond proceeds, arbitrage and any use by outside parties of the facilities built with the bonds.

The Service also continues its pursuit of unrelated business taxable income (UBTI), in particular, corporate sponsorship, advertising and affinity credit cards. While many organizations search for guidance as to what is a valid corporate contribution (and therefore not advertising), the regulations remain mired in the Treasury Department. The IRS continues to litigate the position that the sale of mailing lists and use of logos by taxable corporations is UBTI. The Tax Court decided in Sierra Club, 103 TC No. 17 (1994), that a payment for the use of a logo and a transfer of a mailing list to a financial institution was payment for the use of intangibles and, therefore, a royalty excludible from tax. The Service has appealed this case.

While many organizations are unaware of the consequences of not paying the proper amount of tax on their UBTI, they should note that, as reported in the press, the IRS entered into an agreement with a large exempt organization for a payment of over $100 million. The settlement was reportedly based on insurance, travel tour and mail order activities.

In view of the Service's emphasis on its CEP, it is apparent that its Exempt Organizations "sleeping giant" has awakened.