Greenberg Traurig Alert

IRS Reorganization to Focus on Exempt Organizations;
Updates: Intermediate Sanctions; Physician Recruitment

June 1999
By Harry J. Friedman, Greenberg Traurig, Miami Office

  View or download the PDF version of this Alert here.

IRS Reorganization to Focus on Exempt Organizations

In several presentations before tax exempt organization practitioners, Marcus Owens, Director of the Internal Revenue Service Exempt Organization Division, has stressed his belief that because of recent changes in the law, tax exempt organizations will be subject to much greater scrutiny in the future. The IRS has observed that exempt organization revenues represented 12.4% of the U.S. gross domestic product in 1995. Revenues of exempt organizations tripled between 1975 and 1995. The size of the exempt community is a driving force behind the interest in exempt organizations. The importance of tax exempt organizations is evidenced by its position in the reorganization plan soon to be implemented by the IRS. The IRS will create four new operating divisions: wage and investment income earners, small business and self-employed persons, large and big-sized businesses, and tax exempt and government agencies.

Under the current structure of the IRS only one of 21 IRS assistant commissioners is linked to exempt organization activities. Under the new plan, activities of exempt organizations and government entities will be one of only four operating divisions. Owens has stated that the single operating division is a recognition of the tax exempt sector’s growth in the economy and the complexities associated with the regulation of exempt organizations. The new operating division for exempt organizations should begin functioning by the end of this year.

Increased scrutiny in the future will not be limited to IRS auditors. The IRS issued Announcement 99-62 reminding exempt organizations to comply with the new rules for disclosure of tax returns and exempt organizations. New Treasury Regulations became effective on June 8, 1999, requiring that exempt organizations, other than private foundations, provide copies of tax returns and exemption applications upon the request of members of the public. (See, GT Alert, May 1999 for a discussion of the Regulations.) Exempt organizations must make available their exempt application, Form 1023 or 1024, as well as all supporting documentation and letters submitted with the application. While the rules require disclosure of the organization’s Form 990, an exempt organization is not required to disclose Form 990-T that is filed if the organization has unrelated trade or business income.

The statutory change that prompted the new disclosure rules also applies to private foundations. However, the new disclosure rules do not apply to private foundations. Private foundations continue to be subject to prior law that requires that private foundations make their returns available for inspection at specified periods, pending promulgation of Treasury Regulations addressing the disclosure of private foundation returns. The IRS anticipates that proposed regulations applying similar rules to private foundations should be promulgated by the end of the year.

As a result of the ease of obtaining tax returns, reporters, donors and other members of the public will have the opportunity to review tax returns, scrutinizing the entries on the return. Each exempt organization should take advantage of the wider audience for its returns to publicize the benefits it provides to the public. Owens has urged exempt organizations to use their tax returns as a public relations vehicle to provide information about their activities.

Intermediate Sanctions Update

IRS officials have indicated that the IRS is actively reviewing circumstances that may constitute excess benefit transactions subject to Intermediate Sanction penalties. (See, GT Alert, August 1998, for a discussion of Proposed Regulations.) The IRS National Office has issued a series of memoranda to insure that standards with respect to the imposition of Intermediate Sanctions are coordinated nationally. Before a field agent may impose Intermediate Sanctions, a submission to the National Office for technical advice is required. (Technical advice is guidance from the IRS National Office requested by auditors in the field on the application of the tax laws to a specific taxpayer’s circumstances.)

The memoranda require that technical advice be requested in fact patterns involving proposed Intermediate Sanctions or private inurement and excess benefit transactions or private inurement findings must be considered for resolution by a closing agreement. The memoranda advise that the parties to any technical advice request should include not only the exempt organization, but also any involved individual or entity who is a "disqualified person" for purposes of Intermediate Sanctions. If there is more than one disqualified person, technical advice with respect to one person will not be shared with other disqualified persons. Because the penalties under Intermediate Sanctions are imposed on the disqualified person and organization managers, not the exempt organization itself, the procedures are complex to insure appropriate confidentiality.

Intermediate Sanctions may be applied to agreements entered into or substantially modified after September 1995. An exempt organization that has participated in an excess benefit transaction subject to Intermediate Sanctions is required to disclose this fact on its tax return. Disclosure of such problems may even trigger interest from state attorneys general who may also be concerned with the misappropriations of charitable assets. The IRS has indicated that it is receptive to discussing informally "gray areas" involving Intermediate Sanction issues. Exempt organizations subject to Intermediate Sanctions should scrutinize transactions to insure compliance with Intermediate Sanctions.

Physician Recruitment Update

Recently, the publication of a previously unreleased Private Letter Ruling involving a physician recruitment plan has provided some additional insight into the IRS’ position on recruitment incentives for physicians. In 1997, the IRS issued a Revenue Ruling, Revenue Ruling 97-21, that addressed permissible physician recruitment incentives for tax exempt hospitals. The Revenue Ruling analyzed five situations involving physician recruitment incentives. The Revenue Ruling indicated that the establishment of a community need for a particular physician service either for the service area of the hospital or for the staff of the hospital is a favorable criteria for permissible incentives. The Revenue Ruling permits financial incentives such as a signing bonus, providing professional liability insurance, office space, and income guarantees, with the stipulation that the physician practice full-time in its service area.

In the Private Letter Ruling, the hospital had made a community assessment of staffing needs and concluded that its medical staff needed between 202 and 257 additional primary care physicians and other under-represented physician specialists to serve its patient population. The exempt hospital wished to recruit physicians who were practicing in the community, but had been engaged in practice for less than four years and had not established a meaningful practice at their current site. In the Revenue Ruling 97-21, the IRS approved recruiting practicing physician at a hospital’s locale in the case of a radiologist. Commentators suggested that the approval of recruitment of radiologists already in the community was acceptable because the physicians would not be referring to the hospital.

The Private Letter Ruling expands this concept to include physicians who lack a significant patient base, young physicians who have recently started practicing in the community. Like the radiologists, young physicians would likely not have substantial referral potential to the exempt hospital. The ability of a physician to provide immediate referrals to the hospital appears to be an important issue.

The Private Letter Ruling also goes beyond a closing agreement involving a hospital in Texas that was made public in 1994 with respect to paying recruitment expenses to a group of practicing physicians to attract new physicians. In the closing agreement, the hospital could only pay 50% of the recruitment incentives incurred by a group of practicing physicians to recruit new physicians. The Private Letter Ruling approved the payment by the exempt hospital of all of the costs associated with offering incentives to new doctors who have not yet started practice. This confirms what many practitioners believe that the guidelines set out in the released closing agreement are not always controlling in similar fact patterns.

© 1999 Greenberg Traurig