People often form non-profit entities with the intent that they will get traction and take off. Not all entities do that.
The entity may not be able to raise funds or secure donations, funding may dry up, or the entity may not find the support of those who need to operate or service it. There are scores of other reasons why non-profit entities fail.
The board members may not want to bear the cost or put the time in to terminate the non-profit in these situations. However, it is imperative that they do just that. The IRS has a number of tools at its disposal to not only force compliance but to impose penalties.
IRS Release Number 200720027 provides an example and opportunity to consider these questions.
Facts & Procedural History
The facts for the entity involved in this ruling are straightforward. The entity was abandoned in 2002. It qualified as a non-profit by filing Form 1023 with the IRS.
A Form 990 annual return was not filed for the entity. The IRS assigned an auditor with the Tax Exempt/Government Entity (“TE/GE”) division to secure and audit the return.
The entity was administratively dissolved with the state. The IRS agent made numerous attempts to contact the former president and board members who were identified in the state filings.
The IRS agent was able to make phone contact with the former president of the organization and was promised information about the dissolution of the entity; however, no information was provided.
The IRS eventually issued this decision which revokes the tax-exempt status and requires the entity to file Forms 1120 for each year.
The Non-Profit Filing Requirements
Non-profit organizations are quired to file Form 990 each year. This is equivalent to Form 1040 filed by individual taxpayers.
Taxpayers are also required to keep books and records for the non-profit. The failure to file and produce records when requested by the IRS is a sufficient basis for revoking the entity’s non-profit status. That is what the IRS did in this case.
Those who control the organization may think that this ends the matter. It usually does not end the matter. This is just the first step for the IRS in proposing penalties and issuing summons to force the parties to turn over the books and records.
The Initial Penalties & Tax
Section 6652(c) provides what can be a hefty penalty for non-profits. It provides for a $20 per day fine for non-profits for each day that any tax return is not filed, with a $10,000 maximum fine. The section goes on to specify that the $20 fine is $100 per day and the cap is $50,000 for non-profits that have gross receipts of $1,000,000 or more.
Once the non-profit status is revoked, the entity has to file Form 1120. Any income received by the entity is treated as income and taxable. The IRS will often issue summons for known bank accounts. Absent a response from the entity officers, the IRS will count the deposits into the bank account as income subject to tax and not allow any offsetting deductions. The tax will be assessed against the entity and apply the accuracy-related penalty and standard failure to file penalty.
The IRS may also try to impose penalties on the board members.
Section 4958 provides rules and penalties for “Intermediate Sanctions,” which are imposed on tax-exempt organizations that engage in certain transactions with disqualified persons, such as excessive executive compensation, loans to insiders, or other financial transactions that benefit insiders at the expense of the organization’s tax-exempt purposes.
The term “disqualified person” generally includes officers, directors, and other insiders who have significant influence over the organization, as well as their family members and related entities.
Under Section 4958, the IRS has the authority to impose excise taxes on the disqualified person who receives an excess benefit and on the organization’s managers who approved the transaction. The excise tax is equal to 25% of the excess benefit for the disqualified person and can be up to 200% of the excess benefit for the organization’s managers who knowingly participated in the transaction.
The purpose of these Intermediate Sanctions is to deter transactions that are not in the best interest of the organization and to ensure that tax-exempt organizations do not provide undue benefits to insiders at the expense of their charitable mission. In situations where the entity is dissolved with the state and the IRS is not provided records, it will typically get records from banks. These records may indicate that there were transactions with or for the board members. This can provide the basis for intermediate sanction penalties.
Compliance with non-profit filing requirements is critical. The IRS has a number of penalties and other tools to deal with non-compliant entities. Those who serve on the board of entities should consider these rules when dissolving an entity. Suffice it to say that the entity should not be abandoned, it should be properly dissolved under state law and a final return filed with the IRS. If the IRS shows up on audit, the board members should take steps to work with the IRS to close the entity.
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