Classification Conversion of A Tax-Exempt Organization: 501(c)(6) and 501(c)(3) Organizations

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In a previous article, I already discussed some of the major differences between 501(c)(3) and 501(c)(6) organizations. However, this discussion was limited to characteristics of these organizations as opposed to dynamic developments that these organizations may experience during their existence. While most of these organizations tend to be stable once a particular type of tax-exempt organization is formed, this is not always the case. Sometimes, after a number of years in existence, an organization may modify its goals or its founders suddenly realize that they are limited in their practical options. For example, one large limitation of a 501(c)(6) organization is the inability of donors to deduct donations as charitable contributions on their tax returns. Conversely, members of a 501(c)(3) organization may desire to convert into another type of tax-exempt organization because of the substantial limitations on lobbying placed on such organizations.

At that point, a Board of Directors of such an organization may start to wonder about whether it is possible to convert the status of an organization, how to do it and whether there are any viable alternatives.  In this article, I will examine the possibility of converting a non-profit organization’s tax-exempt classification, focusing on 501(c)(3) and 501(c)(6) classifications.

General Conversion Process

First, in order to attempt the conversion from one classification to another, a tax-exempt organization will need to change its organizational documents (such as the Articles of Incorporation and the corporation’s Bylaws) to reflect the primary purpose of the new type of tax-exempt organization being sought and to comply with the requirements of such organizations. Usually, the Bylaws or the Articles of Incorporation govern the exact process of approval of the amendment of these important organizational documents. Frequently, these documents will say that a Board of Directors’ resolution is sufficient, but, often, an approval of the majority of members maybe required. If the organizational documents are silent on the amendment process, your state’s statute would need to be consulted on the amendment process.

Amending the documents is usually not enough. Changing the primary purpose of an organization may also entail eliminating, or at least substantially reducing, any prohibited or limited activities under the new desired classification. For instance, if you seek to convert a 501(c)(6) organization into a new 501(c)(3) organization, then, after changing the original organizational documents (and following any necessary rules in doing so) to comply with applicable 501(c)(3) requirements, will also need to limit substantial lobbying activities and any other activities that are prohibited or limited under 501(c)(3) rules. Usually, these activities require a wholesale overview of the organization’s activities by an attorney in order to determine what types of practices need to be modified and how.

Finally, in order to convert, a new form will need to filed with the IRS requesting the grant of the new tax-exempt status, demonstrating compliance with the relevant regulations. For example, in case of conversion to 501(c)(3), Form 1023 will need to filed, demonstrating compliance with IRS 501(c)(3) rules. This, in turn, will require paying an application fee as well as providing any applicable required verification documents. There is no guarantee that the IRS will recognize the new tax-exempt status being sought. This is why it is important for the application to be well drafted, demonstrating adherence to the relevant law and regulations.

Alternatives to Conversion

The motivations for seeking alternatives to full conversion from one classification to another are numerous. Nevertheless, the most popular reason for avoiding such conversion and seeking an alternative is the fact that an outright change in classification of an entity may significantly limit the ability of such organization to achieve their goals.

It is not easy to discuss alternatives to conversion, because the particular circumstances of an organization will determine what alternatives are available and whether they are more desirable than the process of conversion.

Yet, one can identify two general trends (which may or may not apply to a particular organization), which I will state here in their ideal form. First, some organizations attempt to create a hybrid organization which contains completely separate components – one that strictly follows the rules of a 501(c)(3) and another that adheres to the 501(c)(6) rules. This alternative will require separate application forms and fees, but it may give the most flexibility to the Board of Directors (assuming the IRS grants the requested status).

On the other hand, as a second alternative, a lot of organizations opt to create a new organization altogether in order to avoid legal complications. The idea here is that the members of the Board of the old corporation will form the majority of the members of the Board of the new corporation. Beware, while this alternative may solve one type of legal complications, it may actually bring a host of others.

Conclusion

Conversion from one tax-exempt classification to another can be very complex and usually requires an in-depth knowledge of the Internal Revenue Code, IRS regulations and case law. Therefore, you will need to consult an experienced attorney familiar with both business and tax aspects of these issue.

If you have any questions concerning tax-exempt classifications of non-profit corporations, contact Sherayzen Law Office for legal help. Our experienced tax firm can assist you in resolving any problems in this area of law.

Offshore Voluntary Disclosure Program 2012: Impact of Form 8938

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The announcement by the IRS of the opening of the new Offshore Voluntary Disclosure Program (OVDP) on January 9, 2012 (now closed) came as a surprise to most tax practitioners, especially since the 2011 OVDI just ended on September 9, 2011. Yet, if one analyzes the number of new developments in international tax compliance over the past several years, then the surprise of the announcement of a new offshore voluntary disclosure program is greatly reduced.

One of these latest developments is the new Form 8938, which was born out of the passage of FATCA (Foreign Account Tax Compliance Act). In this article, I will analyze some of the key aspects of the interaction between Form 8938 and OVDP 2012.

Link between OVDP 2012 and Form 8938

In an earlier article, I already described the main features of the OVDP 2012. In announcing the OVDP 2012, IRS cited several reasons for announcing the new voluntary disclosure program for U.S. taxpayers with offshore assets, particularly the success of the previous programs and the mountain of information gathered by the IRS which would allow it to investigate (and ultimately penalize and/or prosecute) additional non-compliant U.S. taxpayers as well as Swiss bankers. Some international tax attorneys elaborated on the IRS motivation as well as added some of their own reasoning.

Yet, among all of these reasons, most international tax attorneys completely omitted even mentioning the new Form 8938. Yet, in my opinion, Form 8938 is likely to play a very important role in driving additional U.S. taxpayers toward OVDP 2012.

Form 8938’s Impact on Foreign Asset Disclosure Structure

The main reason for Form 8938‘s potentially profound impact on OVDP 2012 participation lies in the nature of Form 8938.

As I explained in an earlier article, Form 8938 is a fundamental tool for the IRS to identify the scope of international tax non-compliance of a given U.S. taxpayer. It is very important to understand the reason why Form 8938 is so useful for the IRS. It is not only because Form 8938 now requires a taxpayer to disclose more information, but, rather, because Form 8938 connects various parts of a taxpayer’s international tax compliance including the information that escaped disclosure on other forms earlier. This summary, in turn, allows the IRS to identify the overall scope of a taxpayer’s noncompliance in an efficient manner. Moreover, compliance with Form 8938 may lay the foundation for an IRS investigation of whether the taxpayer has been in compliance previously.

Compliance With Form 8938 May Force Taxpayers to Enter a Voluntary Disclosure Program

This ability by the IRS to discern whether the areas of actual or potential non-compliance in current as well as prior years puts previously non-compliant taxpayers in a highly uncomfortable position.

For example, suppose that taxpayer T was previously non-compliant with respect to reporting his foreign bank accounts because he did not know anything about the FBAR. Since Form 8938 is filed together with the tax return, T will have to go through a voluntary disclosure of some type because failure to file Form 8938 at this point is likely to turn his previous non-willful non-compliance into a willful one.

Similarly, suppose T was did not report his ownership of a business entity because he classified the entity as a partnership (assuming at this point that it is not a “controlled partnership”) instead of as a corporation. Prior to Form 8938, it was unlikely that the IRS would challenge this classification because the partnership ownership was never disclosed. However, with Form 8938, T will have to disclose his partnership ownership drawing IRS attention to the classification issue. T will have to consult Sherayzen Law Office in order to figure out what is the best course of action to deal with this dilemma.

Thus, as the examples above demonstrate, Form 8938 is likely to have a profound impact on the number and depth of voluntary disclosures as taxpayers are forced to re-evaluate their tax compliance strategies.

It is important to emphasize that the impact of Form 8938 on your particular situation should be analyzed separately by an international tax attorney. This article can only provide a very general background, because the exact strategies, including the optional enrollment into OVDP 2012, will differ from situation to situation.

Contact Sherayzen Law Office for Legal Help With U.S. Tax Compliance Issues

If you have any questions with respect to Form 8938, OVDP 2012, and any other international tax compliance issues, contact Sherayzen Law Office. Our experienced international tax firm will guide you through the complex web of international tax requirements, identify potential problem areas, create a plan of action to deal with these problems, and implement a plan while providing zealous ethical IRS representation.

Impact of Form 8938 on the International Tax Compliance Structure

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The new IRS Form 8938 is not just another tax form that a taxpayer needs to file. Its reach and impact on taxpayer compliance and IRS ability to verify it are far more profound.

Yet, while the addition of Form 8938 to the long list of international tax compliance forms has created a burst of interest among various international tax attorneys (as evidenced in their writings), a very important assessment of the impact of Form 8938 on the rest of the IRS international tax compliance structure appears to be missing in these writings. It is this crucial strategic aspect of the new Form that I wish to address in this article.

Pre-8938 Structure of the IRS International Tax Compliance Requirements

In order to assess the impact of the IRS Form 8938 on the rest of the international tax compliance requirements, it is necessary to briefly explore the pre-8938 (or pre-FATCA (Foreign Account Tax Compliance Act) international tax compliance structure.

Prior to Form 8938, the IRS has already imposed a tremendous variety of reporting requirements on U.S. taxpayers with economic ties to the overseas. First and foremost, the FBAR (the Report on Foreign Bank and Financial Accounts) already forced the disclosure of the foreign bank and financial accounts which are either owned by the U.S. taxpayers or over which these taxpayers have signatory or other authority. Moreover, the FBAR disclosure is tied to the taxpayers’ tax returns through Section III of Schedule B.

From the business side, the IRS required the taxpayers to file a relevant tax form if to report partial or full ownership of a business entity (or if the taxpayer were a director or officer of such entity), including a disregarded business entity. The most prominent examples are Forms 5471, 8865, and 8858. On top of that, Form 3520 and 3520-A address foreign trust ownership and income issues.

Then, there are numerous other reporting requirements addressing such diverse issues as foreign gifts and inheritances, PFIC (Passive Foreign Investment Company) income, Controlled Foreign Corporations, and so on.

In essence, the IRS managed to cover huge areas of international economic activity with various forms and regulations. Moreover, in the past decade, all of these forms were supported by a radical, almost atrocious, increase in penalties in case of non-compliance.

Main Enforcement Problem With Pre-8938 Structure

If the IRS had all of these tools before FATCA, why did the IRS then need any additional forms?

A careful analysis reveals that, despite the presence of the multitude of various forms, it is still not easy to spot a taxpayer’s non-compliance or address all of the non-compliance issues in a given situation for one important reasons – these forms are not connected. Prior to FATCA, there was no form that would allow the IRS to immediately assess the extent of a taxpayer’s non-compliance.

Moreover, despite the number of various tax compliance forms, a lot of information still escaped the IRS. For example, suppose that T (a U.S. taxpayer) owns 15 percent of a business entity B in a country X; other owners are not U.S. taxpayers under any definition. Let us further suppose that business entity B possesses characteristics of a corporation and of a partnership. Assuming all other conditions are met, if B is a foreign corporation, then T would have to file Form 5471. However, if B is a partnership (and assuming all other conditions are met), T would not have to file Form 8865. T was able to classify it as a partnership for U.S. tax purposes, therefore, he needs to file neither Form 5471 nor 8865, leaving the IRS with no information (again, assuming this information would not fall under any other reporting requirement) of T’s foreign business ownership.

Form 8938 is a “Catch-All” Form That Fixes Enforcement Problem for the IRS

This is where Form 8938 comes in. In an example above, the Form 8938 may potentially force T to disclose the ownership information that did not need to be disclosed on Form 8865. If T is particularly unlucky, the IRS may decide to challenge his classification of the business entity, require him to file Form 5471 and impose non-compliance penalties under Form 5471.

This is just one possible scenario. In fact, Form 8938‘s reach is far more ambitious – it is the catch-all form that the IRS desired so much. The Form is directly tied to Forms 3520, 3520-A, 5471, 8621, 8865 and 8891. Moreover, it forces the taxpayers to re-state their foreign bank and financial accounts that should be reported on the FBAR, thereby allowing the IRS to identify with ease if a taxpayer has not complied with the FBAR requirements. Then, it imposes additional reporting requirements that may potentially expose any other taxpayer non-compliance (as in example above).

If that were not enough, failure to file Form 8938 will render the filing of a tax return incomplete, keeping the Statute of Limitations open until the Form is actually filed.

Impact of Form 8938: Breeding Ground for IRS Audits

Thus, Form 8938 is not just another tax compliance form. Rather, it is a fundamental, crucially-important tool which the IRS needs in order to effectively identify potential taxpayer non-compliance.

Hence, the most likely consequence of Form 8938 will the commencement of numerous IRS audits and investigations (which will also feed on the mountain of information obtained by the IRS through various voluntary disclosure programs) of the potentially non-compliant taxpayers. I also expect that the IRS ability to identify and challenge problematic classifications will be increased manifold.

Contact Sherayzen Law Office for Help With Form 8938

If you need help with Form 8938 or you are worried about your tax compliance exposure in light of Form 8938 or any other form, contact Sherayzen Law Office. Our experienced international tax firm will guide you through the complex web of international tax requirements, identify potential problem areas, create a plan of action to deal with these problems, and implement the plan while providing zealous ethical IRS representation.

Form 5472: Basic Information

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The focus of this article is to provide some basic information on the IRS Form 5472, an Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.

The purpose of Form 5472 is to provide information required by the IRS when “reportable transactions” occur during the tax year of a “reporting corporation”, with a foreign or domestic related party. In general, “reportable transactions” are defined to mean certain types of transactions listed in part IV of the form (such as sales, rents, royalties, interest), for which either monetary consideration was the sole consideration paid or received during the reporting corporation’s tax year, or if any part of the consideration paid or received was either not monetary consideration, or was less than full consideration.

“Reporting companies” that generally are required to file Form 5472 include both: 25% foreign-owned U.S. corporations and foreign corporations engaged in a trade or business within the United States.  Broadly speaking, the 25% ownership requirement is meant to apply to a foreign person who owns either directly or indirectly 25% of a US corporation, but not to multiple foreign persons owning only 25% in the aggregate.  However, the related party rules apply to determining ownership.  In certain situations, filing of Form 5472 may not be necessary if applicable exceptions are met.

For those required to file, Form 5472 must be filed with the reporting corporation’s tax return.  The IRS may consider a substantially incomplete Form 5472 to constitute a failure to file the Form.  For each foreign or domestic related party with which a reporting corporation had a reportable transaction during its tax year, a separate Form 5472 must be filed.  The IRS recently issued temporary and proposed regulations with the intent to remove a requirement under existing regulations mandating duplicate filing of the form.

Contact Sherayzen Law Office for Legal Help With Form 5472

If you have any legal or tax questions about Form 5472, contact Sherayzen Law Office for professional help.  Our experienced international tax firm will help you determine your 5472 filing requirements as well as assist you in properly completing the form.