Tax‐Exempt Organizations and E‐Filing

Published date01 February 2020
Date01 February 2020
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).
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
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.
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]
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)]
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

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