Internal revenue service an overview with a focus on charity oversight

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Marcus S. Owens

Caplin & Drysdale

Washington, DC

  1. Congressional Authorization

The existing federal tax structure is authorized by the 16th Amendment to the United States Constitution which allowed Congress to enact an income tax without regard to apportionment among the states or census data. The current iteration of that tax structure is the Internal Revenue Code of 1986, although many of the provisions relevant to tax exempt organizations, and charities in particular, have their antecedents in prior revenue acts and Internal Revenue Codes, particularly the Internal Revenue Code of 1954.

The core of the IRS authority to enforce the Internal Revenue Code is found in section 7601(a) which directs the Secretary of the Treasury to “cause officers or employees of the Treasury Department to proceed, from time to time, through each internal revenue district and inquire after and concerning all persons therein who may be liable to pay any internal revenue tax…” To facilitate the process, section 7805(b) gives the Treasury and the IRS the authority to issue “all needful rules and regulations” for the enforcement of the tax law. Section 6033(a) mandates the filing of returns and the maintenance of records, including the authority to design returns to collect information for the “purpose of carrying out the internal revenue laws.” Finally, section 7602(a) authorizes the examination of such books and records as may be “relevant or material” to tax administration for the purpose of “ascertaining the correctness of any return.”
Tax exempt status for charities is authorized by section 501(c)(3) which provides for the tax-exempt status of organizations:
[O]rganized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
Organizations determined to be tax-exempt under section 501(c)(3) are further divided by section 509 into either what are generally called “publicly-supported charities” or private foundations. The distinction between a publicly-supported charity and private foundation is based on the pattern of income of the organization, with organizations that receive contributions from the general public considered “publicly-supported” and organizations that subsist on investment income or contributions from a small group of persons or taxable entities considered private foundations. Exceptions to the preceding general rule are made for churches, schools (including colleges/universities), hospitals/medical research organizations and “supporting organizations” (entities that are structurally required to support the activities of particular publicly-supported charities), all of which are deemed to be “publicly-supported.”
In addition to the preceding exempting provisions, the Internal Revenue Code includes a number of regulatory provisions including:

  • the imposition of an income tax on income received by a charity or other tax-exempt organization from activities that are not substantially-related to the exempt purposes of the charity other than as a source of funds

  • an excise tax on excessive lobbying or political campaign activity (in lieu of or in addition to loss of tax-exempt status)

  • an excise tax on organization managers who authorize acts of campaign intervention

  • an excise tax on organization managers who are the beneficiaries of “excess benefit transactions”

  • an excise tax on organization managers who authorize excess benefit transactions

  • a series of excise taxes on private foundations that apply to self-dealing, excess business holdings (concentrated business ownership), investments that jeopardize the ability of the foundation to carryout its purposes, and taxable expenditures (grants for non-charitable purposes, lobbying or political campaign intervention)

The excise taxes on private foundations and on publicly-supported charities (on excess benefit transactions, political campaign activities but not excessive lobbying) include a requirement that the improper expenditure giving rise to the excise tax be corrected, e.g. the charity made whole, in order to avoid the imposition of a second-tier excise tax and, in the case of private foundations, a third-tier excise tax under section 507 calculated as the lesser of the aggregate tax benefit that accrued to the foundation as a result of its tax-exempt status or the value of its net assets – essentially forced dissolution of the foundation and confiscation of its assets by the IRS.

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