Tax‐Exempt Organizations and E‐Filing

• DOI: http://doi.org/10.1002/npc.30687
• Published date: 01 February 2020
• Date: 01 February 2020

Bruce R. Hopkins’ NONPROFIT COUNSEL

6 February 2020 THE LAW OF TAX-EXEMP T ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonpr ofit Counsel DOI:10.10 02/n pc

exempt function income in any year, with the result

being that the limit applies to the total amount of invest-

ment income earned during the year (T.D. 9886).

Law

In the definition of unrelated business taxable income

(IRC § 512(a)), special rules apply to exempt social clubs,

VEBAs, and SUBs. As to these types of exempt organi-

zations, UBTI is defined as gross unrelated income, less

directly connected expenses, other than exempt function

income (IRC § 512(a)(3)(A)).

Exempt function income is gross income from two

sources (IRC § 512(a)(3)(B)). One type of exempt function

income is amounts paid by members as consideration for

providing members or their dependents or guests with

goods, facilities, or services in furtherance of the orga-

nizations’ exempt purposes. The second type of exempt

function income is all income (other than income from

unrelated business that is regularly carried on) that is set

aside for a charitable purpose; in the case of a VEBA or

SUB, to provide for payment of life, sick, accident, or

other benefits; or for reasonable costs of administration

directly connected with an exempt purpose.

The law imposes a limit on the amount a VEBA or

SUB — termed covered entities in the regulation — may

set aside as exempt function income to an amount that

does not result in an amount of total assets in the cov-

ered entity at the end of the tax year that exceeds the §

419A account limit for the years (IRC § 512(a)(3)(E)). This

account limit does not take into account any reserve for

post-retirement medical benefits (IRC § 419A(c)(2)(A)).

The limit involved caps the amount of investment

income a covered entity may treat as nontaxable exempt

function income in a year to the extent such income

“result[s] in” a year-end account balance “in excess of”

the § 419A account limit (IRC § 512(a)(3)(E)(i)). The pre-

amble to the regulation states that an account overage

“can be considered the result of, or essentially caused

by, investment income only by considering all investment

income earned during the year.” Thus, the principal

import of this regulation: to give “appropriate meaning”

to the words result in, the total amount of investment

income earned during a year must be considered when

calculating whether an excess exists at the end of the

year.

Regulations to interpret these rules were published in

2014. These final regulations are essentially the same as

the proposed regulations. The final regulations apply to

certain title-holding companies, includes a nonrecogni-

tion-of-gain provision, and alters its effective date.

Controversy

The interpretation of this limitation was not unani-

mous. Some taxpayers asserted that investment income

may be set aside and used separately before the end

of a tax year for current benefit payments and related

administrative costs and thereby avoid the limit. This

argument was accepted by the US Court of Appeals for

the Sixth Circuit (Sherwin-Williams Co. Employee Health

Plan Trust v. Commissioner (summarized in the August

2003 issue)). The Federal Circuit Court of Appeals

rejected this argument (CNG Transmission Management

VEBA v. United States (summarized in the January 2009

issue); Northrop Corp. Employee Insurance Benefit Plans

Master Trust v. United States (referenced in the February

2013 issue)).

Needless to say, Treasury and the IRS are of the view

that the decision in Sherwin-Williams is contrary to the

statute and its legislative history, and that it is “appropri-

ate” to issue this final regulation “clarifying the proper

calculation method.” The preamble states that the “fun-

gible nature of money means that there is necessarily a

connection between investment income that a [c]overed

[e]ntity earns during the year and the total amount of

funds in the entity at year-end, even if the [c]overed

[e]ntity purports to apply all of that income to benefit

expenditures.” [25.3] ◆

OTHER RECENT IRS PRIVATE

LETTER RULING

An organization identified as an automobile owner-

ship club attempted to obtain recognition of tax exemp-

tion as a social club. Its principal activity is an annual car

show, open to the public. Its other activities include an

annual appreciation dinner for members, vehicle displays,

and educational activities. The IRS declined to recognize

exemption, finding the annual show to be a business

and concluding that the amount of income derived from

nonmembers “greatly exceeds” the permissible percent-

age limitations (Priv. Ltr. Rul. 201948009). The member-

ship dinner was seen as conferring unwarranted private

benefit. [13.3, 20.13(a)] ◆

TAX-EXEMPT ORGANIZATIONS

AND E-FILING

The IRS, on December 13, reminded tax-exempt

organizations that new law — created by the Taxpayer

First Act (summarized in the September 2019 issue) —

requires them to electronically file information returns

and related forms (IR-2019-206). This law affects exempt

organizations in tax years beginning after July 1, 2019.

Forms 990 and 990-PF

Most e-filings will not be due before December 15,

2020, from charitable organizations and other exempt

organizations that generally file Form 990 or 990-PF by