Accountability and Oversight

INDEPENDENT SECTOR Comments in Response to Announcement 2002-92
Internal Revenue Service Proposed Revisions to Form 1023, Application for Recognition of Exemption Under Section 501(c)(3)

America’s “independent sector” is a diverse collection of more than 1 million charitable, educational, religious, health, and social welfare organizations. It is these groups that create, nurture, and sustain the values that frame American life and strengthen democracy. In 1980, a group of visionary leaders, chaired by the Honorable John W. Gardner, became convinced that if the independent sector were to continue to serve society well, it had to be mobilized for greater cooperation and influence. Thus a new organization, named to celebrate the independent sector’s unique role apart from government and business, was formed to preserve and enhance and protect a healthy, vibrant independent sector.

Today, INDEPENDENT SECTOR is a coalition of more than 700 national organizations and companies representing the vast diversity of the nonprofit sector and the field of philanthropy. Its members include many of the nation’s most prominent nonprofit organizations, leading foundations, and Fortune 500 corporations with strong commitments to community involvement. This network
represents millions of volunteers, donors, and people served in communities around the world. IS members work globally and locally in human services, education, religion, the arts, research, youth development, health care, advocacy, democracy, and many other areas. No other organization represents such a broad range of charitable organizations and activities.

INDEPENDENT SECTOR very much appreciates the opportunity to submit comments in response to IRS Announcement 2002-92. IRS Form 1023 serves an important “gatekeeping” function for the charitable sector. Therefore, IS takes a keen interest in seeing that the Form 1023 appropriately balances the need to provide the least burdensome administrative process possible for new organizations seeking to do charitable work with the need to prevent organizations that, for whatever reasons, do not meet the requirements for exemption under section 501(c)(3) of the Internal Revenue Code from incorrectly receiving that status.

I. General Comments
In general, INDEPENDENT SECTOR believes the proposed changes strike an appropriate balance between minimizing administrative burdens and obtaining sufficient information. We particularly appreciate the deletion of a number of overbroad and confusing questions and the refocusing of a number of questions on the information most relevant to tax-exempt status, including in the areas of officers, directors and trustees, fundraising, and membership benefits. We also applaud the inclusion of more general information about operating a section 501(c)(3) organization in the instructions, since for many charitable organizations the application may be the best opportunity they have to learn about the federal tax rules that govern such organizations.

II. Specific Comments
We do, however, have the following specific comments with respect to the various changes.

A. Location Address (Part I, Question 4)
We generally support requesting the address where an organization will be keeping its books and records. We are concerned, however, that for certain organizations, such as shelters for battered women and health clinics performing abortions, having to reveal a physical address in the publicly available Form 1023 could create significant dangers for their staff and clients. We therefore
recommend that the form be modified to provide a checkbox for “Location address not disclosed because of risk to staff and clients” and that the instructions be modified to state that this box should be checked if public disclosure of the organization’s physical address could place the organization’s staff or clients at risk.

B. Officers, Directors, and Trustees (Part III)
We agree that focusing on financial relationships with officers, directors and trustees is appropriate, while at the same time eliminating some of the questions about financial transactions, such as leases, with other parties. We believe, however, that certain modifications are needed to the questions in this part.

1. Addition of Key Employees (All Questions)
We recommend that all the questions in this part be expanded to also include “key employees,” as that term is defined in the instructions to Form 990. This modification will make the Form 1023 consistent with the Form 990 and at the same time ensure that financial transactions with all senior staff are captured regardless of what titles they may or may not hold.

2. Related Officers, Directors, and Trustees (Question 2)
We also recommend that the term “related” in Question 2 be clarified. The proposed instructions simply state that “related” refers to “both family and business relationships.” The lack of definitions for “family relationship” and “business relationship” is unnecessary and will only result in confusion among applicants and a huge variation in responses. 

For “family relationship,” we recommend that the instructions provide that an individual has a family relationship with his or her spouse, ancestors, children, grandchildren, great grandchildren, and siblings (whether by whole or half blood), and the spouses of children, grandchildren, great grandchildren and siblings. This definition follows the intermediate sanctions definition of “family members” found in section 4958(f)(4).

For “business relationship,” we recommend that the instructions provide a definition that encompasses both “direct” business relationships and “indirect” business relationships. An officer, director, trustee or key employee would have a direct business relationship with another officer, director, trustee, or key employee if they have an employer-employee, independent contractor,
lessor-lessee, or other direct contractual relationship.

An indirect business relationship would exist through a “35-percent controlled entity.” The term “35-percent controlled entity” should be defined as in section 4958(f)(3), except that for these purposes the definition should be based only on ownership by officers, directors, trustees, key employees and their family members, thereby avoiding the need for applicants to determine if anyone else exercises “substantial influence” over the applying organization. Particularly for new organizations, the only persons with such influence are almost always going to be officers, directors, trustees, or key employees.

An officer, director, trustee or key employee would then have an indirect business relationship with another officer, director, trustee, or key employee if:

• The individuals are both owners of a 35-percent controlled entity;
• One individual is an employee, independent contractor or otherwise has a contractual relationship with a 35-percent controlled entity owned in part or in whole by the other individual; or
• One individual is the owner, in part or whole, of a 35-percent controlled entity that is an independent contractor or otherwise has a contractual relationship with another 35-percent controlled entity owned in part or in whole by the other individual.

While this definition would require the applicant to identify all 35-percent controlled entities, almost all applicants will have no more than a few such entities.

3. Substantial Influence (Question 5)
We recommend that this question be rephrased so that it applies to transactions and agreements with 35-percent controlled entities, as defined above. This change would be consistent with section 4958.

C. Requirements for Copies of Organizational Documents (Part V)
Questions 1 through 3 of Part V require an applicant to submit either signed copies of its governing documents or, in the case of articles of incorporation, a copy that shows proof of filing with the appropriate state agency. While these are the copies that applicants normally will have available, Revenue Procedure 68-14, 1968-1 C.B. 768, provides that other kinds of copies may be provided. For example, the Revenue Procedure provides that copies of organizational documents do not need to be signed if an officer provides a declaration that the copies are complete and correct. The Revenue Procedure also provides that if a copy of an original governing document is not available, then a complete and correct copy of a document stating the applicant’s powers, principles and other governing rules will be sufficient. These other options should be listed in the instructions for Part V, and the heading for Part V should state: “If the copies required by the following questions are not available, see the instructions for these questions.”

D. Information About Your Specific Activities (Part VIII)

1. Questions About Certain Activities (Questions 14, 16, 19, 20)
We agree that the addition of questions about activities that the IRS tends to ask about on a routine basis is a useful change that should speed the application process. We are puzzled, however, by the addition of questions about certain common and, to our knowledge, generally innocuous activities. 

More specifically, we do not understand what purpose is served by asking about ownership of intellectual property and Internet activity. Almost all charitable organizations own intellectual property (if only their name) and almost all charitable organizations, particularly new ones, have or plan to have an Internet presence which may involve fundraising, instruction or the sale of products or
services. Form 1023 already asks for the applicant’s current assets and its website address, as well as asking in Part IX for a general description of the applicant’s activities. We therefore recommend deleting Questions 14 and 16 as redundant and unnecessary. Alternatively, the first sentence of Question 14 should have added to it “, other than your organization’s name , logo and slogan, if any” and Question 16 should have added to it,“ other than maintaining a website that describes your exempt functions.”

We also do not understand what purpose is served by asking about operations in foreign countries and contributions to foreign organizations. It is well established that section 501(c)(3) organizations may conduct some or all of their activities in foreign countries, including by making grants to foreign organizations for charitable purposes. Rev. Rul. 71-460, 1971-1 C.B. 231 (activities in a foreign country permitted); Rev. Rul. 66-79, 1966-1 C.B. 48 (grants to foreign organizations permitted). These activities should also be covered by the request in Part IX for a general description of the applicant’s activities, particularly since Questions 19 and 20 only ask for an “explanation” of these activities. If these questions are an attempt to prevent applicants that support foreign terrorist
organizations from receiving tax-exempt status, it is unlikely that these questions would cause an applicant to reveal such plans. We therefore recommend deleting questions 19 and 20.

2. Lobbying (Question 2b)
We strongly support the addition of this question about Form 5768, as INDEPENDENT SECTOR has long supported encouraging section 501(c)(3) organizations to make the section 501(h) election by filing this form. We are concerned, however, that the current wording of this question suggests that the applicant has to be planning to engage in lobbying to file Form 5768. This is simply incorrect; an organization can file Form 5768 even if it does not have any current plans to engage in lobbying. In fact many organizations file Form 5768 when they complete their Form 1023 simply in order to complete all of the IRS forms at one time and to provide for the possibility that perhaps, sometime in the future, they may decide to engage in lobbying. Also, if an organization has already filed Form 5768 there should be no need for the organization to file it again with its Form 1023.

We therefore recommend changing this question to read as follows: “Whether or not you have attempted to or plan to attempt to influence legislation, do you want to elect to be subject to the expenditure limits on such activities instead of the requirement that such activities be an insubstantial part of your total activities? If ‘Yes,’ attach a completed copy of Form 5768 unless you have already filed this form.”

E. Financial Data (Part X)

1. Net Unrelated Business Income (Lines 4 and 5)
The splitting of the net unrelated business income line into income from businesses acquired after 6/30/75 and all other net unrelated business income is confusing and unnecessary. We assume the significance of this date relates to when the IRS adopted the position that a business acquired from a taxable entity has to be treated as an unrelated trade or business, even if it would otherwise be related. There is no hint in the instructions, however, to explain the significance of this date, which makes its use confusing. The instructions to these questions are also confusing because they appear to assume that all net unrelated business income is from businesses acquired either before 6/30/75 or after that date, when most if not virtually all applicants that have or plan to have unrelated
trade or businesses did not “acquire” them but develop them in-house. We therefore recommend recombining Lines 4 and 5 into one line for all net unrelated business income.

2. Professional Fees (Line 23)
The addition of the requirement for an itemized list and attachment of all contracts is unnecessary. The application already requires information about contracts with insiders (Part III) and with paid fundraisers (Part VIII, Question 3b). Whatever information may be gained by having details of contracts with accountants, attorneys and similar professionals does not appear to justify requiring both an itemized list showing the identity of these professionals and copies of the contracts. More importantly, requiring applicants to describe the purpose for hiring outside attorneys and to submit copies of their engagement letters with such attorneys, which often include a description of the legal services to be provided, could threaten the attorney-client privilege that normally applies to
communications between clients and their attorneys. We therefore recommend that this line only require information comparable to that currently required on the Form 990, which would be a brief description of the services to be provided (“legal,” “accounting”) and the amounts that have been paid or are expected to be paid.

F. Form 990 Filing Requirement
The draft revised Form 1023 no longer contains the question about whether the applicant will be required to file Form 990 (or Form 990-EZ) found in Part I of the current Form 1023. We disagree with the deletion of this question because it prevents an applicant that is exempt from having to file Form 990, such as a church, from having that exemption confirmed. We therefore recommend restoring
this question.

III. Conclusion
We appreciate the efforts of the IRS in revising Form 1023 and its invitation to comment on the proposed changes. We are available to discuss any of our comments if desired.