IRS Launches Enforcement Initiative Targeting Compensation Practices of Exempt Organizations

The Internal Revenue Service (IRS) launched an aggressive enforcement initiative earlier this week, targeting the compensation practices of tax-exempt organizations.  This initiative is designed to target two specific types of organizations:  (a) those that have paid excessive compensation and benefits to directors, officers or other insiders, and (b) those that have engaged in questionable insider transactions such as loans, leases or other transfers of income or assets to directors, officers or other insiders.  The IRS intends to target both large and small charities, as it gathers data on the tax-exempt industry as a whole. 

At this point, the IRS has contacted at least 200 organizations to request information relating to these issues, and intends to contact at least 2000 by the Fall of 2005.  Organizations may be selected for review based upon an IRS concern with specific data it has reported on its Form 990 or 990-PF.  Alternatively, the IRS intends to select some organizations through a random process.  We believe it is very likely that the IRS will meet this aggressive schedule, because the United States Senate Finance Committee has very publicly and harshly criticized the IRS for its failure to increase its audit presence within the tax-exempt community.  In addition, Mark Everson, the IRS Commissioner, and Steven Miller, the Director of IRS Exempt Organizations, have both stated that this initiative represents a personal priority for them.

We believe that many of these contacts will originate with the IRS requesting specific information or documents, rather than initiating a full-blown audit.  If the IRS is satisfied with the level of information it receives during this process, the matter will likely be closed without further action.  Responses that are perceived to be incomplete or evasive will be much more likely to draw a broader examination or audit by the IRS.  This pattern of inquiry is very similar to the type of approach that the IRS has used with many other industries and concerns.

An organization's initial response to any request for information will be crucial in the resolution of the matter.  If you are contacted, you should take the inquiry very seriously.  A carefully considered and complete response will be critical. 

Even if you are not sent one of these initial inquiries, are there things you should be doing?  We suggest you take a look at your compensation arrangements and confirm that your organization relied upon appropriate data, approved the arrangement through independent (disinterested) directors, and documented the compensation deliberations and decisions in a thorough manner.  In addition, your organization should review any insider transactions (e.g., loans, leases, transfers of income or assets) and ensure that the transactions were fair and reasonable and did not violate any prohibitions against excess benefit transactions or self-dealing. 

Please feel free to call or e-mail any of the following individuals if you have questions regarding these issues or would like to discuss how they apply to your specific organization:

James D. Kemper
Direct Phone:  317.236.2293
james.kemper@icemiller.com
 
Gina M. Giacone
Direct Phone:  317.236.5829
gina.giacone@icemiller.com
 
Jeffrey Lozer
Direct Phone:  317.236.5839
jeffrey.lozer@icemiller.com
 
Marilee J. Springer
Direct Phone:  317.236.5947
marilee.springer@icemiller.com