Does Your Organization Meet The Criteria For An Educational 501(c)(3)?

Section 501(c)(3) is a part of the United States Internal Revenue Code that allows nonprofit organizations to apply for tax exemption if they meet certain requirements. The organization must meet one of the exempt purposes designated by the Internal Revenue Code, including educational purposes. Educational purposes can be defined broadly and may apply to organizations other than traditional schools. In addition, not all educational organizations necessarily qualify for tax-exempt status. For an organization to apply for tax-exempt status based on educational purposes, its leaders should make sure that it meets the criteria for an educational 501(c)(3). While obtaining tax-exempt status for your nonprofit can be complex, an experienced nonprofit lawyer can provide useful guidance throughout the process. If you want to learn more about educational 501(c)(3)s or are ready to file for your nonprofit to receive this status, consider contacting the Jennifer V. Abelaj Law Firm by calling 212-328-9568 to schedule a consultation.

What Qualifies as an Educational Organization?

The term “educational purposes” is not specifically defined in the Internal Revenue Code. Rather, the Internal Revenue Service (IRS) refers to Section 1.501 (3)-1(d)(3)(i) of the Code of Federal Regulations for their definition, according to the United States Government Publishing Office, which states that an organization must meet one of the following two requirements to qualify:

• Provide instruction and training of individuals to improve or develop their capabilities or
• Instruct the public regarding subjects useful to the individual that benefit the community

This idea is further elaborated in the same statute’s definition of “charitable,” which includes advancing education as one qualifier. These broadly defined terms allow some organizations that do not directly work in education to claim tax-exempt status based on educational purposes, such as providing a support service to educational organizations. However, educational organizations and other 501(c)(3) organizations will not qualify for exemption if a substantial part of their activities is related to non-exempt purposes.

IRS Restrictions for All 501(c)(3) Organizations

In addition to meeting the criteria for “educational purposes,” educational 501(c)(3) organizations are required to meet the same requirements, according to the Internal Revenue Service (IRS), as all other types of tax-exempt non-profits, including that:

• The nonprofit may not be organized or operated for the benefit of private interests
• None of the organization’s earnings may be distributed to private shareholders or individuals
• The organization may not dedicate a substantial amount of its activities toward influencing legislation, nor participate in any political campaign activities

In addition to meeting these requirements when applying for tax-exempt status, nonprofit organizations must maintain these standards at all times in order to maintain their status. Those who violate the IRS requirements may have their tax-exempt status revoked and could face serious financial penalties. If you have questions about meeting the criteria for an educational 501(c)(3) organization, an experienced nonprofit lawyer at the Jennifer V. Abelaj Law Firm may be able to help.

Is the Organization a Public Charity or Private Foundation?

The IRS classifies each Section 501(c)(3) organization as either a public charity or a private foundation. Educational organizations should be aware of the distinction between these two categories, as each carries its own rules and regulations. The central distinction is the organization’s source of funding. Private foundations are typically under the control of an individual, family, or corporation, and most of their funding comes from a handful of donors and investments. Conversely, public charities generally receive their financial support from a large network of public donators and fundraising.

The vast majority of educational and other Section 501(c)(3) organizations are public charities. Schools automatically qualify as public charities, while certain other types of educational organizations may need to prove that they are publicly supported. In most cases, demonstrating this proof involves showing that at least one third of the organization’s support comes from donations, membership fees, or gross receipts from activities directly related to educational purposes. Those who provide this proof and meet all other criteria may qualify as tax-exempt public charities.

 

What Types of Educational Organizations Qualify?

Schools are the most obvious example of an educational organization, but there are several types of educational activities that could qualify an organization for tax-exempt status under Section 501(c)(3). To qualify, the organization must serve the public good by providing educational activities related to instruction and training. For example, a coding boot camp would be obligated to help its students acquire new skills and become more proficient at coding. If the camp is operated to educate the community without any focus on private interests and meets all other requirements, it could qualify as an educational 501(c)(3) organization.

There are just a few common examples of nonprofit educational organizations. IRS evaluations of exempt purposes are subjective, but several types of organizations could qualify as long as they are dedicated to providing instruction and training without seeking profits. Some of the other types of nonprofit businesses that could qualify for tax-exempt status under Section 501(c)(3) include:

• Trade schools
• Kindergartens and daycares
• Public and private universities
• Museums
• Planetariums
• Public libraries
• Science centers

Applying for 501(c)(3) Classification as an Educational Nonprofit

Those who are in the beginning stages of forming an educational nonprofit will need to meet several requirements before applying for 501(c)(3) tax-exempt status. Extensive paperwork must be filed to incorporate the organization with federal and state governments, and regulations may vary from state to state. Once incorporated, the organization must meet all requirements for 501(c)(3) and provide thorough documentation proving that it meets these requirements. These documents must be submitted along with the IRS Form 1023-series application.

Contact an Experienced Nonprofit Lawyer To Learn More

Applying for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code is a complicated and lengthy process that requires strict adherence to all guidelines. Filing this application is critical to the formation of nonprofits. While organizations may be able to handle the steps internally, many seek help from experienced nonprofit attorneys who understand what is required to successfully obtain tax-exempt status for their clients. If you have questions regarding the criteria for an educational 501(c)(3) or another nonprofit matter, consider contacting a knowledgeable nonprofit lawyer at the Jennifer V. Abelaj Law Firm by calling 212-328-9568 to schedule a consultation today.

Inherited Property: What is Step Up in Basis? Discussion with Cherie Williams, CPA of The Little CPA

Jennifer collaborated with Cherie Williams, CPA, founder of The Little CPA, on the topic of inheriting assets. Cherie created The Little CPA to empower purpose-driven professionals to make wise financial decisions that build diligent wealth.

Inherited Property: What is Step-Up in Basis? – The Little CPA

(The Little CPA empowers purpose-driven professionals to make wise financial decisions that build diligent wealth.)

Creating A Business Succession Plan

Starting and building a business is a work of a lifetime that requires making unsaid compromises and facing unknown hardships. Yet, when it comes to planning a future for their businesses, most business owners do not have a legal plan in place. The United States Small Business Administration reports that around 70 percent of privately owned businesses, with an estimated worth of $70 trillion, will change hands in the next 10–15 years. Yet, as reported by the National Association of Corporate Directors, only one in four private companies opt to have a formal succession plan in place. If you want to know more about creating a business succession plan for your business and about the legal process involved, consider contacting the experienced New York estate planning attorneys of Jennifer V. Abelaj Law Firm today by calling 212-328-9568.

What Is Business Succession Planning?

In simple words, business succession planning means preparing in advance for a change in the ownership of the business. This involves identifying the events that may cause the ownership change, establishing certain timelines and standard operating procedures, and identifying potential successors or key employees.

Unforeseen and unfortunate events, such as a family feud, death, severe illness, or disability, may require a sudden change in business ownership and management. Having a proper succession plan for a business is like having a will for a person. When a person prepares a will, that person decides what will happen to his or her wealth and property after he or she dies. Similarly, having a business succession plan in place ensures that the business has an exit or a transfer per the owner’s wishes.

Benefits of Having a Business Succession Plan

Creating a succession plan for one’s business has many benefits. Some of these benefits include:

• Smoothing the transition
• Maximizing value and minimizing loss
• Training future leaders or employees
• Identifying weaknesses
• Retaining key employees or creating roles

Smoothing the Transition

If the business is to be transferred to a family member, a succession plan enables a smooth and clear transition and avoids a potential family feud. Rather than leaving it to the court to decide what happens to the business, the decision is made by the business owner in advance when a plan is in place.

Maximizing Value and Minimizing Loss

If the business is to be sold or transferred to a third party, a pre-determined plan about how that transition will be handled helps to maximize the value of the business. Having a succession plan in place also helps to avoid a last minute or sudden sale below the market or fair value.

Training Future Leaders or Employees

Whether the business is to be transferred among family members or to a key employee, identifying the potential successor or successors allows time for sufficient training.

Identifying Weaknesses

While planning in advance, the owner may identify loopholes or inefficiencies in the business and will be able to make a plan to address those weaknesses.

Retaining Key Employees or Creating Roles

Certain employees are important to the success of the business. Further, a business owner may want to involve certain family members in the business. With succession planning, the business owner has the opportunity to retain those employees and create roles as needed for family members.

If you have been thinking about creating a business succession plan but are not sure about the best options for your business, a skilled estate planning attorney at Jennifer V. Abelaj Law Firm can help you better understand the steps involved in creating a sound business succession plan.

Steps To Create a Business Succession Plan

Creating a business succession plan involves considering multiple factors. Some of the most important steps involved in creating a business plan include the following:

• Identifying future goals
• Identifying potential successors
• Conducting a business valuation
• Completing estate and tax planning
• Making necessary changes to governing documents
• Selecting an exit option
• Selecting a team of professionals

Identifying Future Goals

While creating a business succession plan, the business owner needs to identify personal goals are and desires for the business. This includes retirement planning and, if the business is a family business, choosing whether to transfer the business to family members or opt for an exit strategy.

Identifying Potential Successors

A business owner must initiate an honest conversation with family members and identify who is most capable of running the business. Additionally, determine whether the family member is actually interested in running the family business in the future. Sometimes, however, a key employee may be best suited to run the business through an Employee Stock Ownership Plan. If there are no potential candidates, the business owner may consider selling the business.

Conducting a Business Valuation

Conducting a business valuation through an appraiser is important to the process of creating an appropriate business succession plan. A business valuation is done on the basis of revenues, potential incomes, debt, assets, pending litigation, and current market value.

Completing Estate and Tax Planning

Estate and tax planning is one of the most important steps in a business succession plan. Failing to plan these well can lead to unnecessary expenses. However, proper planning can minimize taxes.

Making Necessary Changes to Governing Documents

Making corresponding changes in the organization’s governing documents will ensure that those documents align with the succession plan. Any contrary terms or clauses in the company’s partnership agreement or shareholder agreement may later create a hurdle if not changed accordingly.

Selecting an Exit Option

Typically, business owners select one of four modes of exiting their own business:

• Transferring to a family member
• Making a sale deal with a key employee or a business partner
• Selling the company to a third party
• Closing and liquidating the company

Selecting a Team of Professionals

A good business succession plan addresses the multiple factors that impact the value and longevity of the business. Therefore, it is important to select a team that can handle the many aspects of succession planning.

Contacting a Business Succession Planning Attorney

Creating a business succession plan is a challenging and multidisciplinary task. One needs to consider family relationships, personal future goals, taxes, and other legal matters involved while making a solid succession plan. To learn more about your legal options and how you can create a succession plan for your business, consider contacting an experienced New York estate planning attorney at Jennifer V. Abelaj Law Firm today by calling 212-328-9568 to schedule a consultation.

Valuation Of Hard To Value Assets

It is difficult to determine the value of hard to value assets, hence their name. Hard to value assets, also referred to as HTVAs, can make appraisals in estate planning and business valuation more complicated and time-consuming. There are different methods for valuing hard to value assets, but the appropriate methodology depends on the type of asset and the circumstances surrounding the valuation. A consultation with a knowledgeable estate planning attorney may be beneficial for a proper and accurate valuation of hard to value assets. At the Jennifer V. Abelaj Law Firm, we assist clients in New York with a wide range of estate planning needs. You can request more information by calling 212-328-9568 and scheduling a consultation.

Methods for Valuing Hard to Value Assets

The methods for valuing HTVAs differ from one case to another. Choosing the appropriate methodology requires a thorough understanding of appraisal regulations and available valuation approaches. When selecting the method for a valuation of hard to value assets, it is vital to consider the purpose of the valuation, the asset’s competitive properties, and the nature of the local market. When valuing HTVAs, appraisals need to apply a comprehensive framework, follow the accepted guidelines, use professional judgment, and consider all factors to ensure an accurate valuation.

A Guide to Valuation of Hard to Value Assets

As mentioned, the appropriate method for valuing hard to value assets depends on the type of asset and reason for the valuation. For example, is the valuation necessary as part of a sale, gift or death.  What follows are general guidelines for valuing these HTVAs:

• Real estate and automobiles
• Stocks
• Bonds
• Life insurance
• Annuities
• Business
• Personal property
• Debts

Real Estate and Automobiles

Often, people seek the help of an experienced real estate agent to estimate the value of their real property. An agent who knows the local market will be able to provide a rough estimate. However, this approach may not work with hard to value real estate. Similarly, certain automobiles, such a collectibles or rare versions, may have a value which depends on whether it is part of a collection.  If the asset requires a more thorough analysis, the owner of the property will most likely have to hire an appraiser and collect all available information about real estate and any automobiles in order to obtain an accurate valuation.

Stocks

Valuing closely-held stocks often involves computing the company’s price-to-earnings ratio. However, an amateur may not be able to determine the value of stocks accurately. If the owner of stocks dies, the personal representative of the decedent’s estate may choose to get in touch with the company that managed the decedent’s stocks or consult with a financial expert well-versed in stock valuation. Title 26 of the Code of Federal Regulations (CFR) § 20.2031-2 provides guidelines for the valuation of stocks and bonds based on selling, bid, and asked prices.

Bonds

The approach to valuing bonds is similar to the method for valuing stocks. Determining the value of a bond usually involves calculating the bond’s cash flow and face value. The individual or firm performing a valuation of a bond may also need to add accrued interest that has not been paid after the decedent’s death.

Life Insurance

When determining the value, the appraiser may calculate the policy’s face value and cash value. The policy’s face value is the amount of money beneficiaries of the policy receive upon the owner’s death. The cash value, on the other hand, is the accrued amount that can be accessed outside of the death benefit.  For life insurance that is part of a gifting transaction, sometimes the value is based on the interpolated terminate reserve (ITR).  The ITR is similar to the cash value, but the calculation is based on various other factors.

Annuities

A valuation of hard to value assets may also include valuing annuities if the decedent owned any. In order to determine the value of annuities, the personal representative of the decedent’s estate may need to contact the company that sold the annuities to valuate them as of the date of the owner’s death.

Business

Often, determining the value of a business is the most challenging part of valuing hard to value assets because businesses may include both tangible and intangible assets and liabilities. A business is also difficult to value if the deceased person was not the only owner of the business. In this case, the personal representative of the estate may need to contact a certified public accountant to estimate the value of the deceased person’s interest. However, business and other valuations may be easier if planned in advance. At the Jennifer V. Abelaj Law Firm, we offer estate planning and business succession planning services tailored to each client’s needs.

Personal Property

Certain types of personal property may be considered hard to value assets. Common examples of HTVAs among personal property include cryptocurrency, digital assets, works of art, jewelry, and antiques. While many people choose to visit eBay and similar platforms for estimating how much personal property is worth, it may be necessary to reach out to an auction house, art museum, gemologist, or other expert who specializes in valuing antiques, artworks, and jewelry.

Debts

According to the Federal Trade Commission, the personal representative of the estate is responsible for settling the deceased person’s debts. Once the valuation of hard to value assets is complete, it is essential to identify all debts that the debtor owes and determine their value. Common types of debt include mortgages, credit cards, loans, and debts associated with the deceased person’s medical treatment prior to the death.

Is an Appraisal Necessary for a Valuation of Hard to Value Assets?

An appraisal may be necessary for some of the hard to value assets mentioned above. Usually, people choose to hire a professional appraiser for an accurate appraisal. It is recommended to request the appraisal as soon as possible after the decedent’s death. A valuation of hard to value assets can become even more difficult if a significant amount of time has passed after the owner’s death. The Date of Death Appraisal is necessary for several purposes, including taxes. The appraisal will be used to establish whether an estate tax should be paid to the Internal Revenue Service (IRS) and to determine the amount of estate tax if any.

Contacting an Estate Planning Attorney

For assistance with the valuation of hard to value assets, consider seeking legal guidance from an estate planning attorney at the Jennifer V. Abelaj Law Firm. We help executors and personal representatives of estates in the efficient settling of the decedent’s affairs, including valuation of the assets. We also assist people with creating a comprehensive estate plan that takes into account the hard to value assets in order to protect them and minimize taxes. To schedule a case review, call 212-328-9568.

The IRS Now Mandates Electronic Filing For All Non-Profits

Even though the Internal Revenue Service (IRS) has long accepted electronic tax filings, tax-exempt organizations have been able to rely exclusively on paper returns and filings until recently. The IRS now mandates electronic filing for all non-profits. The new mandate is designed to streamline the filing process, modernize technology, and improve tax compliance in the tax-exempt sector. To help your non-profit organization comply with the new mandate, consider contacting the Jennifer V. Abelaj Law Firm at 212-328-9568 before the next tax deadline.

New Requirements for Non-Profit Electronic Filing

In the years prior to 2019, exempt organizations were only required to electronically file returns if they had at least 245 employees or reported assets of $10 million or more. However, on July 1, 2019, President Donald J. Trump signed the Taxpayer First Act into law, requiring all tax-exempt organizations to e-file their returns.

Smaller exempt organizations were initially provided some relief by being allowed to file paper returns if they filed Form 990-EZ, Short Form Return of Organization Exempt for Income Tax. However, the IRS has stopped accepting paper returns even for this purpose as of July 31, 2021. Due to the new IRS update, all exempt organizations, including those that filed Form 990-EZ, must file their returns electronically.

Forms to Be Electronically Filed

Since the IRS now mandates electronic filing for all non-profits, the following Form 990 series must be electronically filed:

• Form 990, Return of Organization Exempt from Income Tax
• Form 990-EZ, Return of Organization Exempt from Income Tax (Short Form)
• Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation
• Form 990-N, Electronic Notice
• Form 990-T, Exempt Organization Business Income Tax Return

Additionally, tax-exempt organizations that file any of the following forms must now file them electronically:

• Form 8872, Political Organization Report of Contributions and Expenditures
• Form 1120-POL, United States Income Tax Return for Certain Political Organizations
• Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code
• Form 1065, United States Return of Partnership Income

About Form 990

The IRS Form 990 series provides transparency and accountability for the non-profit sector. These forms can generally be viewed and inspected by the public and are the primary source for basic information about the non-profit organization. However, the filing of paper returns often created a lag between the time when the non-profit organization submitted its required forms and when the public had access to view the contents. That made it difficult for the public to have accurate and timely information about many organizations in the non-profit sector. The new mandate is expected to provide more timely data for donors, regulators, and other stakeholders.

The IRS does not require certain non-profit organizations to file Form 990 or even Form 990-EZ. These include:

• Certain religious organizations
• Certain government organizations
• Certain political organizations
• Organizations with gross receipts less than $50,000 (although they must file Form 990-N)
• Certain organizations that file different kinds of annual information returns, such as private charitable entities exempt under section 501(c)(3) and described in section 509(a), private charitable entities terminating their status by becoming a public charity, religious or apostolic organizations described in section 501(d), and stock bonus, pension, or profit-sharing trusts that qualify under section 401.

E-Filing Deadline

The electronic filing deadline for non-profit organizations is July 31. Although smaller exempt organizations were provided with transitional relief to give them more time to switch over from filing paper returns to electronic filing, all tax-exempt organizations except those with a specific exemption must now prepare electronic filings. All entities, including the ones that previously used Form 990-EZ, were required to electronically file forms 990 and 990-EZ with tax years ending July 31, 2021, and later.

How to Comply with the New Mandate

Organizations that previously filed paper tax forms were sent a letter from the IRS notifying them that the IRS now mandates electronic filing for all non-profits. If organizations filed a paper return after the applicable deadline, the IRS might have responded by saying that they needed to redo the return electronically. The IRS might have flagged the return as late when providing this notification. To abide by the new tax law, exempt organizations can engage the services of an outside tax professional or use one of the IRS’s pre-approved software providers to prepare their electronic return.

Because tax-exempt organizations may have complex reporting requirements that are substantially different than for regular taxpayers, they may wish to work with a tax consultant or legal professional who has more experience with the system. The Jennifer V. Abelaj Law Firm works closely with non-profit organizations and is well-versed in the laws and regulations that affect them. Consider contacting the office for help with tax filings and answers to any questions you have.

Contact a Non-Profit Lawyer for Help

If you are uncertain about how to comply with the current requirements for tax filings since the IRS now mandates electronic filings for all non-profits, you might consider reaching out to a lawyer who focuses in this area of the law. The Jennifer V. Abelaj Law Firm has years of experience working with various non-profit organizations, including public charities, private foundations, social welfare organizations, business associations, and more. We also assist with estate planning so that your non-profit organization can benefit from legacy gifts. Numerous charities and non-profit organizations depend on us for help with their creation, governance, transaction assistance, advocacy, tax compliance, and dissolution. We are also prepared to handle any potential legal issues that arise during tax filing season. Because we know all about the new mandate, we can help to ensure compliance and help you achieve your non-profit’s objectives by explaining whether the new mandate applies to your organization, how to transition from paper returns to electronic returns, and how to electronically file a return. Consider contacting the Jennifer V. Abelaj Law Firm at 212-328-9568 to discuss your non-profit organization’s current challenges, tax filing status, and goals.

Non-Profits and Automatic Revocation of Tax-Exempt Status for Failure to File Tax Return

Non-profit organizations must comply with many tax laws to maintain their tax-exempt status.  One of the easiest compliance requirements which is sometimes overlooked is filing annual tax returns.  If a non-profit fails to file a tax return for three consecutive years, the IRS automatically revokes its tax-exempt status.

Filing Requirement

All non-profit organizations are required to file annual income tax returns.  The type of return required depends on the organization’s tax classification.  Non-profits with annual gross receipts of less than $50,000 must file a Form 990-N on the IRS’s website (sometimes called a “postcard 990”).  This is an online filing and can easily be done by the organization without the assistance of an attorney or accountant.

An organization with annual gross receipts greater than $50,000 must file a full Form 990.  This is best prepared by a Certified Public Accountant. 

All private foundations must file Form 990-PF.

Small Organizations Must Remain Vigilant to File Timely

An organization may request an extension of time to file their income tax returns.  This allows an additional 6 months to prepare and file the appropriate tax return. 

If an organization forgets or fails to file a return in one year, it can “catch up” in the following year by filing both years. 

This is particularly the case for small organizations that must annually file the postcard Form 990-N.  The due date for a 990-N is 4 months and 15 days after the organization’s year-end.  If it fails to file by the due date, the IRS closes the system for that particular year and the organization must wait until the portal re-opens for filing in the following tax year.  At that time, the organization can file the current 990-N, as well as up to 2 prior years that were not filed without losing tax-exempt status.

Failure to File for 3 Years Results in Automatic Revocation of Tax-Exempt Status

If any organization fails to file or request extension of time to file for 3 consecutive years, the IRS automatically revokes the organization’s tax-exempt status.

The result is that the organization will be taxed as a corporation (or as a trust if applicable) and be required to file a Form 1120 and pay tax at the corporate rate.

The organization will also appear on the IRS’s website as having lost its tax-exempt status.

In addition, donations to the organization are no longer tax-deductible to the donor.  This can have a significant impact on fundraising efforts.

What to Do if Your Non-Profit’s Tax-Exempt Status is Automatically Revoked

The IRS provides information on how to reinstate tax-exempt status due to automatic revocation.  The date of the organization’s reinstatement as tax-exempt may be retroactive to the creation date OR to the date of revocation notice.  This is critical to note because reinstatement to the date of creation provides tax-exempt status, including tax-deductible donations, for the non-compliant three years.  By comparison, reinstatement to the date of the revocation notice will result in the organization loses tax-exempt status for the non-compliant three years and any donations made in that time will not be tax-deductible to the donor.

The IRS provides a “Streamlined” reinstatement process for organizations that were eligible to file a Form 990-EZ or 990-N for the three years that they failed to file a return (and which caused the revocation).  Organizations that were required to file a Form 990 or 990-PF are not eligible for a streamlined process and must provide additional information.

Don’t Delay in Taking Action if your Non-Profit Organization Loses its Tax-Exempt Status

It is very important for a non-profit organization to timely file its tax returns.  If its tax-exempt status is automatically revoked due to failure to file for three years, it must act promptly to obtain reinstatement.

Depending on the complexity of your non-profit organization, it may require representation by an attorney and tax preparation by an accountant.

If your organization has received notice of automatic revocation of tax-exempt status, do not hesitate to contact our Firm.  We have years of experience assisting non-profits in tax and corporate governance and compliance.

Time is of the Essence for High-Net Worth Estates

Potential Changes in Estate Tax Laws

You may have heard about the most recent House proposal in September, 2021 that addresses changes to the tax law, which will cover the costs of a massive ($3.5 trillion) proposed spending package.  There have been various proposals since President Biden was elected that target an increase in various taxes.  Until now, none of the prior proposals have successfully passed.  This might be a different scenario.

Brief Summary of Recent Estate Tax History

Most of the current popular tax concerns, such as income, estate, gift, and corporate taxes, are governed by the Tax Cuts and Jobs Act (TCJA).  The TCJA was effective as of January 1, 2018 and is set to sunset on December 31, 2025.  The sunset provision means that the tax laws that were in effect on December 31, 2017 will again govern beginning in 2026.

The current (i.e., 2021) estate tax exemption is a whopping $11,700,000 per person, which can be doubled for married spouses with intentional planning for a total of nearly $24,000,000.  The estate tax exemption generally increases each year for inflation.  Under the TCJA, the increased exemption will revert back to 2017 exemption of $5,490,000, adjusted for inflation, or approximately $6,000,000, beginning on January 1, 2026.

What is important in the House Proposal for Estate Tax Planning?

I.  Capital Gains Taxes Increase

The rate of capital gains will increase to 25%, which is 5% higher than the current 20%.  The 25% is closer in line to what it was prior to the TCJA.  Capital gains taxes are an important consideration when transferring or selling assets during life.  The 5% increase may be substantial for assets that have significant built-in capital gains.  Two common scenarios are real estate and small businesses. 

For example, if someone purchased real estate 30 years ago with an adjusted cost basis of $150,000, and the property is now worth $2,000,000 (i.e., built-in gains of $1,850,000), the 5% increase in capital gains results in $92,000 more in capital gains tax, for a total capital gains tax of $462,500.  This is only FEDERAL capital gains tax.  If you live in an area such as New York City, you can add up to 25% to the capital gains tax without taking advantage of other estate planning tools (i.e., Delaware Asset Protection Trusts, 1031 Exchange, Charitable Trusts, etc.).

What to do:  Discuss with your attorney or accountant whether certain assets might benefit from being sold this year while the capital gains tax is still at the lower rate.

II. Federal Estate Tax Exemption Reduced Sooner than 2026

As summarized above, the current estate tax exemption is set to expire December 31, 2025 and reduced to 2017 levels of approximately $6,000,000.  The Proposal would accelerate the effective date to January 1, 2022.

For estates that are greater than $6,000,000, they will essentially lose an equivalent amount that can be given away estate tax-free during life or at death.

What to do:  Discuss with your attorney how to reduce your estate by making gifts or otherwise transferring portions of your estate while the exemption is still $11.7 million.

III.  Grantor Trust Rules for Income Tax Purposes will be Eliminated

Trusts which are treated as owned by the Grantor for income tax purposes (i.e., Grantor Trusts) will be deemed as owned by the Grantor for estate tax purposes as well.  This means that most common trusts used for estate tax planning purposes will be included in the Grantor’s taxable estate.  This includes Grantor Retained Annuity Trusts (GRAT), Irrevocable Life Insurance Trusts (ILIT) or Spousal Lifetime Access Trusts (SLAT), just to name a few.

Explanation of Grantor Trusts

Grantor Trusts are a great tool for estate planning in that it allows the Trust assets to grow without the Trust assets being utilized to pay the Trust’s annual income tax.  In addition, as the Grantor pays the Trust’s income tax annually, the Grantor’s estate continues to be reduced.  Any assets in the Trust are excludible from the Grantor’s estate as it is considered a completed lifetime gift.

Under the Proposed rules, any Grantor Trusts created after the effective will be included in the Grantor’s estate for estate tax purposes.  In addition, existing Grantor Trusts that receive additional contributions will also be included in the Grantor’s estate.  The timing is for any trust that is created after the EFFECTIVE DATE, which is the date the proposal is approved (could be in 2021).

What to do:  Discuss with your attorney whether you should URGENTLY CREATE AND FUND certain trusts before the EFFECTIVE DATE.  Remember, under the current rules, the effective date might be earlier than January 1, 2022.  Any delay can create a significant impact in the amount of estate taxes that your estate might have to pay when you die.

IV.  Other Proposals that Might Impact Estate Planning

Valuation Discounts May be Eliminated

Many individuals have an interest in a corporation or limited liability company for purposes of liability protection and not for running an operating business.  Under the current rules, discounting for these types of assets may be eliminated.

What to do:  Make an inventory of your current holdings and determine with your attorney or accountant which ones are operating a business and which are being held for non-operating purposes.  Determine if any changes can and must be made.

Back-Door IRA Conversions May be Limited

Current law does not allow individuals to make contributions to a Roth IRA if their income exceeds a certain level.  However, these same individuals can get around the limitation rule by first contributing to a non-deductible traditional IRA and then converting to a Roth IRA.  The primary benefit of a Roth IRA is that any increase in value over time is not includible in the annuitant’s income taxes when withdrawals are made during retirement.  The Proposal would disallow Roth conversions for taxpayers whose taxable income exceeds $450,000 for married taxpayers filing jointly or $400,000 for single taxpayers or married taxpayers filing separately.

What to do:  Discuss with your financial advisor your options in converting certain traditional IRA account to Roth IRA accounts and with your accountant the tax impact of the conversion.

Take Action Now

There are many other proposals that impact various areas of the tax law.  Some have more chance of being adopted than others.  However, it is very likely that a change will affect and limit estate tax planning options.

If you have any questions on the areas of the tax law that impact your estate and asset planning, please do not hesitate to contact me.

Ongoing Tax and Governance Compliance for Tax-Exempt Organizations

Existing not-for-profit organizations (“NPO”) must ensure that they annually comply with corporate and tax laws.  The failure to do so may impact the NPO is minor ways or in significant ways.

Tax Compliance

Annual Tax Return Filing (Form 990)

An existing NPO must file a Return of Organization Exempt from Income Tax (Form 990) as soon as it completes its first fiscal year of existence. Occasionally, the NPO may still be awaiting a determination letter from the IRS approving its tax-exempt status.  However, the NPO must file the appropriate Form 990 based on the activities and gross receipts within the first year.

An amended return can be filed if the IRS determines that the NPO is tax-exempt under a tax section which differs from the application request.  For example, an NPO may apply for exemption as a public charity.  However, the IRS may approve the application as a private foundation.  In such a case, the organization would be able to file an amended Form 990-PF for the year in question.

Following receipt of the determination letter, and assuming the NPO agrees with the IRS’s determination, the NPO must file an annual Form 990.  In some cases, it may be as simple as the online filing of Form 990-N for organizations with gross receipts of less than $50,000 in the taxable year (and less than $250,000 in assets).   An NPO that requires a full Form 990 must ensure that they provide their CPA with annual financials necessary for timely and complete preparation.

Failure to file a Form 990 for three consecutive years automatically revokes the organization’s tax-exempt status.  The process to reinstate tax-exempt status requires the assistance of your attorney and accountant.

Estimated Tax Payments on Unrelated Business Income

If an NPO has unrelated business income in excess of $500 a year, it is required to pay quarterly taxes on Form 990-W.  Unrelated business income is a complex area and beyond the scope of this article, but it is generally an investment by the NPO that is not related to its charitable activities in which it expects to receive an income.  The IRS allows an NPO to receive UBI without losing its tax-exempt status if the UBI is not significant.  The challenge is that there is no formula to determine the amount is not significant.

Failure to monitor UBI could place the organization in jeopardy of losing its tax-exempt status.

Tax Payments on Net Investment Income for Private Foundations

A private foundation must pay taxes on its annual net investment income.  The payment may be done at the time of filing the tax return (Form 990-PF) or in quarterly estimated payments.

Governance Compliance

Registration and Filing with the Office of Attorney General

NPOs that fundraise within New York State must register with the Charities Bureau of the New York State Office of Attorney General (“Charities Bureau”).  The initial registration is completed contemporaneously with filing of the Application for Tax-Exempt status or shortly following receipt of the IRS determination letter.

An NPO must file an annual report with the Charities Bureau, along with a copy of their Form 990.  A filing fee may be required as determined by the NPO’s annual gross receipts.  The annual filing, including the Form 990, is publicly available on the Charities Bureau’s website.  Religious organizations are not required to register or to submit an annual filing.

Annual Meetings

New York State requires that an NPO hold a membership meeting at least once each year.  NPC-L 603(b). The membership meeting generally includes voting of directors or officers, discussion of the Board’s annual activities and financial reports, and ratification of certain actions, such as changes in the Bylaws.

Although the NPO does not require an annual meeting of directors, it is likely that the NPO’s Bylaws mandate an annual Board meeting.    Discussions include long-term strategy for the NPO, goals on how to effectuate the NPO’s charitable purposes, financial and tax considerations, and building a team of advisors and support for the Board.

Annual Compliance Makes NPO Management Easier in the Long Run

Taking small steps each year to maintain compliance with the tax and governance laws applicable to your NPO has a big impact for the success of the organization.  Regular communication with your Board, members and advisors ensures that the NPO is proactively managing its activities to avoid potential troubles.

If you have questions about ongoing governance or tax compliance, please contact us to discuss how we can assist your organization.

Substantial Contributors to Public Charities: With Reward comes Some Risk

Charitable organizations are created and operated for a public good and not for purposes of making a profit for investors.  But there is a cost to operating and carrying out a charity’s goals.  The cost is covered by a portion of the contributions received by the charity. 

It’s great when a charity is the potential recipient of an unusually large contribution.  It will help the charity carry out its objectives and pay the expenses necessary to do so.  But such a large gift may place the organization in jeopardy of losing its tax-exempt status, as described in this article.

Impact of Substantial Contributor on Governance and Taxation

If a donor makes a large contribution to an organization, the donor may be classified as a “substantial contributor” to the charity.  A substantial contributor impacts the charity in two important ways: (i) determining whether the substantial contributor is a disqualified person, and (ii) determining whether the charity meets the public support test for IRS purposes.  The tentacles of a substantial contributor classification reach very long lengths.

Identifying a Substantial Contributor

A substantial contributor is any person or entity (other than a 501(c)(3) pubic charity or government entity) who contributes or bequeaths a total amount of more than $5,000 to the charity if the amount is more than 2% of the total contributions and bequests received prior to the end of the year.  Substantial Contributor Private Foundation | Internal Revenue Service (irs.gov). 

If an officer or director’s family member makes a substantial contribution, that officer or director is considered to be a disqualified person.

A corporation or partnership is a disqualified person if a substantial contributor has a 35% interest in the corporation (i.e., total voting power) or partnership (i.e., ownership of profit interest in partnership).  In addition, if a corporation/partnership is a substantial contributor, then any person who has an interest of 20% or more therein is also a disqualified person.  This includes employees of the substantial contributor.

Once a person meets substantial contributor status, she remains a substantial contributor for 10 years, even if she does not meet substantial contributor status in subsequent years.

(i) Disqualified Person

Most charities understand that a director of officer has a special relationship with the organization and are aware to avoid any conflicts of interest.  In the IRS’s view, these persons are considered “disqualified persons,” such that they must recuse themselves from certain actions or decisions that may create a conflict of interest.

The IRS also considers a substantial contributor to be a disqualified person. 

A substantial contributor may be on a charity’s Board, but too many substantial contributors may place the charity’s tax-exempt status in jeopardy.  The voting power of a disqualified person (whether as a substantial contributor, director, officer or key person) must be a MINORITY (i.e., specifically 49% or less, of the board’s total voting power).  Further, the combination of the voting power of multiple disqualified persons must be 49% or less. 

Any disqualified person is deemed to have control over the Board if her voting power, in combination with the voting power of another disqualified person, exceeds the 49% rule. 

This is a big deal when you combine it with the 10-year rule mentioned above.

(ii) Public Support Test

A charitable organization, unlike a private foundation, must be publicly supported.  Although there are various formulas to satisfy the public support test, a commonly used formula is that at least 1/3 of annual contributions received are received from the general public. 

In determining the contributions that are counted toward the 1/3 calculation, contributions received from disqualified persons is excluded.  This may impact the organization’s ability to satisfy the public support test and be treated as a private foundation for tax purposes.

Consider the following simple examples for a charity that has annual contributions of $100,000.

Example 1. Satisfies Public Support Test.  Of the $100,000 received, a contribution of $10,000 was from one disqualified person (i.e., a director, officer, or family member), which is 10% of the total contributions received.  A portion of the contribution must be excluded from the total support test because it is greater than $5,000 and the amount is more than 2% of the total support received (i.e., $2,000).  The amount excluded from the total support test is $8,000, which is the contribution in excess of 2% of total contributions ($2,000) (i.e., $10,000 minus $2,000).  Total support for the 1/3 test is $92,000 (i.e., $100,000 minus $8,000).  The charity satisfies the public support test because 92% of its contributions are from the general public.

Example 2. Fails Public Support Test.    Of the $100,000 received, a contribution of $10,000 was from one disqualified person (i.e., a director, officer, or family member), $15,000 was from a partnership in which an officer’s family member has at least 35% income interest, and various $50,000 substantial contributions carried over from the prior 5-year period.  A portion of all these contributions must be excluded from the total support test because they are more than 2% of the total support received for the year ($2,000).  The amount excluded is approximately $69,000 ($10,000 minus $2,000 = $8,000; $15,000 minus $2000 = $13,000; $50,000 minus $2000 = $48,000).  Total support for the 1/3 test is $31,000 (i.e, $100,000 minus $69,000).  The charity fails the public support test because 31% of its contributions are from the general public.

2-Year Rule for Failure to Satisfy Test

Although it is beyond the scope of this article, the IRS provides that a public charity fails to meet the public support test for 2 consecutive years loses its public charity status and must file as a private foundation.  This is important to note in order to forecast when and what amount of substantial contributors a charity can receive to safeguard its charitable tax status. 26 CFR § 1.509(a)-3(c)(1)(i).

Final Thoughts

An excise tax may be imposed for a charity that fails the public support test after two consecutive years.  It is advisable for a charity to take note of who is a disqualified person and whether any substantial contributor rules may impact the charity’s fundraising effort.

A charity should work closely with their CPA to monitor the organization’s finances and charitable tax calculations.

Tax-Exempt Organizations and Political Activity

As the 2024 election nears, now is a good time for your tax-exempt organization to review the rules and regulations regarding political activity. 

A 501(c)(3) tax-exempt organization can engage in limited amounts of political activity so long as it remains nonpartisan, and it may also engage in legislative lobbying provided it is not a substantial amount of activity. These limitations also extend to grantee organizations that receive grant money from a 501(c)(3) organization, including 501(c)(4) organizations and fiscal sponsors. 

501(c)(3) Grants and Fiscal Sponsors

When a 501(c)(3) makes grants or fiscally sponsors another organization, the funds dispersed are restricted for use to exclusively engage in the specific charitable, education, or other permissible activities under Section 501(c)(3) of the Internal Revenue Code (the “Code”.) Once the 501(c)(3) disburses any funds, it must receive reports or other documentation showing that this requirement has been honored so it does not jeopardize its tax-exempt status. 

Political Activity

Under section 501(c)(3) of the Code, a tax-exempt organization must NOT participate in or intervene in any political campaign on behalf of (or in opposition to) a candidate for public office, nor publishing or distributing statements of the kind. A 501(c)(3) organization may, however, take positions on public policy issues, which include issues that divide candidates, so long as the organization avoids any advocacy issues that function as a political campaign intervention. Any “political” agitation either director or indirect is enough to revoke an organization’s tax-exempt status because that would cause the organization’s activity to fall outside it’s exclusively charitable purposes.

It is important that a 501(c)(3) organization take extra caution in their communication because even if a statement does not expressly tell an audience to vote for or against a specific candidate, a tax-exempt organization delivering the statement is at risk of violating political campaign intervention prohibited activity if there is any message factoring a candidate. 

A 501(c)(3) organization can participate in specific voter education political activity so long as it remains neutral and nonpartisan. 

If an organization posts something on its website that favors or opposes a candid for public office, the organization will be treated the same as if it is distributing printed materials or oral statements. A tax-exempt organization is responsible for the links that are on its website. When an organization establishes a link to another website, the organization is responsible for the consequences of establishing and maintaining that link, even if that organization does not have control over the content of the linked site. Be mindful of any links on your website that may may lead to prohibited political activity. 

Lobbying Activity

A 501(c)(3) may engage in lobbying, which includes carrying out propaganda or otherwise attempting to influence legislation, so long as it does not constitute a substantial amount of the organization’s activity. Despite this limitation, the following activities are allowed and not counted toward the organization’s lobbying limits:

• making available the results of a nonpartisan analysis, 
• providing technical advice or assistance to a governmental body, appearances before, or communication to a legislative body with respect to a possible decision which might affect the existence of the organization, 
• communication between tax-exempt organization and its bona fide members with respect to legislation or proposed legislation, and 
• any communication with a government official or employees other than the attempt to influence legislation. 

There are two types of lobbying recognized by the law: direct lobbying and grassroots lobbying. Direct lobbying is an attempt to influence legislation by communicating directly with government officials, and grassroots lobbying is an attempt to influence legislation by communicating with the general public. If an organization engages in grassroots lobbying, it is limited to twenty-five percent (25%) of the organization’s total lobbying allowance. 

 

Learn How an Experienced Attorney Can Assist with Any Questions Regarding Political Activity or Lobbying for a Tax-Exempt Organization

 

Ensuring that your organization is complying with the rules and regulations regarding political activity or lobbying is essential to maintaining its tax-exempt status. Even if it’s not an election year, a tax-exempt organization must still adhere to the rules and restrictions. At Abelaj Law, PC, we are committed to assisting tax-exempt organizations with all of their legal needs so they can focus on achieving their mission and purpose. Contact our experienced legal team today at 212-328-9568 to learn more.