Welcome to the NYSSCPA’s “frequently asked questions” section of its web site. These questions and the answers are of a general nature and intended to be of use to members and others visiting our site.

The staff updates this section to reflect the best information it has to share with users in a multitude of disciplines twice a year.

The information contained herein comes from a variety of sources: telephone inquiries to the Society’s technical hotline, the standing committees of the Society’s volunteer structure, the staff, members, and other interested parties.

We strive to provide FAQs that are helpful to you, assist you in your work and enhance your membership experience.

FAQs are designed to provide general information and serve as a quick reference. They neither substitute for one’s own research and judgment nor constitute an opinion of the Society, of any of its committees or of its staff. References to appropriate standards-setting bodies and to authoritative literature is made whenever possible.

Members having a technical inquiry may call the NYSSCPA’s technical hotline at 212-719-8309.

Please contact the Society if you have suggestions or improvements regarding FAQs by e-mailing klazarus@nysscpa.org.

The following are composites of some recent inquiries, as an educational tool for members who may have encountered similar situations.

• investment advisors and financial consultants;
• foreign broker-dealers who cannot rely on Rule 15a-6 under the law;
• persons who operate or control electronic or other platforms to trade securities;
• persons who market real-estate investment interests, such as tenancy-in-common interests, that are securities;
• persons who act as placement agents for private placements of securities;
• persons who market or effect transactions in insurance products that are securities, such as variable annuities, or other investment products that are securities; 
• persons who effect securities transactions for the account of others for a fee, even when those other people are friends or family members; 
• persons who provide support services to registered broker-dealers; and 
• persons who act as independent contractors, but are not “associated persons” of a broker-dealer.

• finding investors or customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies (or mutual funds, including hedge funds) or other securities intermediaries;
• finding investors for issuers (entities issuing securities), even in a consultant capacity;
• engaging in, or finding investors for, venture capital or “angel” financings, including private placements;
• finding buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions where securities are involved).

• a person who holds himself out as being willing to buy and sell a particular security on a continuous basis; 
• a person who runs a matched book of repurchase agreements; or 
• a person who issues or originates securities that he also buys and sells.

• advertises or otherwise lets others know he is in the business of buying and selling securities; 
• does business with the public ( retail or institutional); 
• makes a market in, or quotes prices for purchases and sales of, one or more securities;
• participates in a “selling group” or otherwise underwrites securities;
• provides services to investors, such as handling money and securities, extending credit or giving investment advice;
• writes derivatives contracts that are securities.

Closely Held and S Corporations Committee

Q: What constitutes basis in an S corporation?

A: A shareholder’s basis in an S corporation is the purchase price paid for the stock or the fair market value of the property given in exchange for the stock. Stock acquired by gift of the shareholder’s basis in the stock is the basis of the donor.

Stock acquired from a decedent will have a fair market value basis measured by either the date of death value or the alternative valuation date if elected.

The basis in the stock is increased as follows:

1. All items of income, including tax exempt income that are separately computed and passed through to the shareholder.
2. The income from the corporation that is not separately stated.
3. The excess of the corporation’s deductions for depletion over the basis of the property subject to depletion.
4. No increase in basis may be made for any “pass-through” items that are required to be included in the shareholder’s taxable income unless the amounts are included in gross income on the shareholder’s income tax return.
5. Loans made by the shareholder to the company. Shareholder’s guarantee of a loan to a financial institution or to any other creditor does not increase basis.

The basis in stock is decreased as follows:

1. All loss and deduction items of the corporation that are separately stated and passed through to the shareholder.
2. The non-separately computed loss of the company.
3. Any expense of the corporation not deductible in computing its taxable income and not properly charged to a capital account. This includes nondeductible expenses such as tax penalties and fines, officers’ life insurance premiums in which the company is the beneficiary and the 50 percent disallowance for meals and incidental expenses.
4. The amount of the shareholder’s deduction for depletion of any oil and gas property held by the S corporation to the extent such a deduction does not exceed the shareholder’s proportionate share of the adjusted basis of the property.
5. Cash and property distributions. Distributions can only be charged against stock basis.

If a shareholder’s basis is reduced to zero, any decrease due to losses and deductions are then applied against a shareholder’s debt basis which is the amount owed to the shareholder by the corporation. Restoration of basis in future years applies first to debt basis and then to stock basis.

Q: My client is considering forming a new entity. What are the differences between an S corporation and a limited liability company (LLC)?

A: An S corporation can only have a citizen or resident of the United States as a shareholder, whereas an LLC can have a foreign member.

A corporation or partnership can be a member of an LLC, as opposed to an S corporation, which cannot have these entities as shareholders.

S corporations have a limitation of 100 shareholders. LLCs, on the other hand, do not have this restriction.

S corporations require an election to be filed with the Internal Revenue Service (IRS) and New York State (NYS), and LLCs do not need to do this.

LLC members are responsible for payroll taxes on all LLC earnings for which they materially participate. S corporation shareholders are responsible for payroll taxes for the salary that is taken from the S corporation and not for the income on the S corporation K-1.

LLCs must take a publication ad in a newspaper for six weeks. S corporations are not bound by this requirement.

S corporation shareholders are not responsible for uncollected sales tax if the corporation defaults. Members of LLCs would be liable.

Appreciated property can be distributed to members without recognition of gain (see Code Section 731(b)), while shareholders of S corporations must recognize the gain.

LLCs can make disproportionate allocations and distributions to its members (see Code Section 704). S corporation shareholder must allocate and distribute everything proportionately.

And finally, LLC members can exchange appreciated property for membership interests without the recognition of gain or loss (see Code Section 721). S corporation shareholders do not have this option.

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Relations with the Internal Revenue Service Committee

Q: When should I contact the Taxpayer Advocate Service (TAS)?

A: You should contact TAS if you have an ongoing issue that has not been resolved through normal channels or processes. You should also contact TAS if your client is about to suffer, or has suffered, a significant hardship as the result of an action the IRS is about to take or has taken. An extreme example is a taxpayer in need of a quick tax refund in order to pay for a medical procedure.

In addition, TAS can help resolve problems if you have experienced a delay of more than 30 days in resolving an issue or if you have not received a response to correspondence by the date promised.

Before you contact TAS on behalf of a client, be certain to have a fully executed Power of Attorney form either on file or ready to be faxed to TAS. Without a Power of Attorney, TAS will not be able to discuss any aspect of your client’s problem with you. 

It is also important to note that TAS cannot usually stop a lien from being filed or a levy against your client’s funds in the absence of demonstrating hardship. An argument that a lien or a levy is in error can be made after the fact, and the funds will be returned if you prove your case. A mere error by itself, however, is not classified as a hardship.

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Taxation of Individuals Committee

The Taxation of Individuals Committee often receives questions that the IRS has issued guidance on. The following responses to the first two FAQs were derived from the IRS.

Q: How does direct deposit work?

A: Direct deposit can reduce the possibility you won’t receive your check and prevents your refund from being stolen. When preparing a tax return, simply follow the instructions for “refund” on the return. Verify that you entered the correct bank account and bank routing numbers on your tax form and you will receive a refund more quickly than before. Clients can electronically direct your refund to multiple accounts by using the "split refund" option. Taxpayers can divide their refunds in up to three checking or savings accounts and three different U.S. financial institutions, although some financial institutions do not allow a joint refund to be deposited into an individual account. Check with your bank or other financial institution to verify that a client’s direct deposit will be accepted.

Q: What is available on the IRS Web site?

A:IRS.gov is accessible all day, every day for individuals, businesses and tax-exempt organizations. Tax preparers can get tax forms and publications and view, download or order tax forms and publications any hour of the day or night. CPAs may use IRS.gov to request a payment agreement using the IRS’s online payment agreement application, make payments electronically, check a refund status, or find if a client qualifies for the earned income tax credit (EITC). Tax preparers may also find useful Publication 78, Cumulative List of Organizations, which lists organizations that are exempt from federal taxation. The publication also provides information on how much of a client’s contributions to that organization is tax deductible.

Q: I am planning to sell the house that I have owned and lived in for the past two years. Can I take the exclusion of gain on the sale of the residence which was previously a rental property and acquired in a like-kind exchange?

A: You must own the principal residence for at least five years prior to its sale in order for the exclusion of gain rule to apply. However, you only need to use the property as a principal residence for at least two years. The required five years of ownership and two years of use need not be continuous.

You also have to recapture the depreciation taken over the years when the property was a rental property. In other words, you must report the amount of depreciation taken on the property as income subject to 25 percent capital gain tax rate.

If you meet the ownership and use tests, you might be able to exclude up to $250,000 on a single return or $500,000 gain on a joint return.

For further details and reference, see Code Sec. 121(d)(10), as added by the American Jobs Creation Act of 2004 (P.L.108-357).

Q: Can I make a nondeductible contribution to a traditional IRA (Individual Retirement Account) or to a Roth IRA if I have no taxable compensation?

A: No. It doesn’t matter that no deduction will be claimed for the IRA contribution because, in order to be permitted to make a contribution to an IRA, whether it is a traditional, deductible or nondeductible IRA, or to a Roth IRA, you must have taxable compensation.

Compensation includes wages, salaries, tips, professional fees, commissions, self-employment income and taxable alimony (IRS Publication 590).

Q: Can I take a Section 179 deduction on my individual income tax return in connection with my Schedule C business if my Schedule C is showing a loss?

A: If you or your spouse has earned income from other sources such as wages or income from another active trade or business, such as another Schedule C on a jointly filed return, they are combined to determine the business limitation for purposes of Section 179.

If the combined amount equals or exceeds the potential Section 179 deduction, you may take the deduction even though the Schedule C that the fixed asset is connected with shows a loss (Form 4562 Instructions).

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Trust and Estate Administration Committee

Q: How are capital gain dividends received by a trust from a mutual fund to be treated?

A: Under Article 11-A Uniform Principal and Income Act of New York’s Estates, Powers and Trusts Law, the presumptive characterization for fiduciary accounting purposes of capital gain distributions received from a mutual fund are as receipts of principal. Per Article 11-A, “A trustee shall allocate the following receipts from an entity as principal: … money received from an entity that is a regulated investment company or a real estate investment trust if the money distributed is a capital gain dividend for federal income tax purposes” [(EPTL 11-A-4.1(c)(4)]. Note that for federal income tax purposes, short-term capital gain dividends, unlike long-term capital gain dividends, are ordinary income.

However, this article may not always apply. The trust agreement might provide an exception. Per EPTL 11-A-1.3, when allocating receipts and disbursements between principal and income the fiduciary:

When capital gain dividend receipts are to be categorized as principal, the fiduciary is left with the perennial issues of addressing the difference between accounting and tax income and in determining distributable net income. Private Letter Rulings 9811036 and 9811037 issued by the IRS provide guidance.

The parameters for the rulings say that in accordance with applicable state law, the trustee allocates the portion of cash distributions received from a regulated investment Corporation (RIC) that are short-term and long-term capital gains to principal. Remaining amounts received from the RIC are designated as ordinary dividend income. In New York state, only long-term capital gain dividends would be allocated to principal.

The two rulings provide the following identical example: The trust receives $10,000 in interest income and $15,000 from the RIC, $10,000 of which is ordinary dividends per the form 1099-DIV and $5,000 of which is capital gain distributions per the 1099-DIV. The trustee determines that 60 percent of the ordinary dividends reported to him are short-term capital gains. Trustee commissions are $6,000, one-third chargeable to income and two-thirds chargeable to principal. The conclusions are modified here to satisfy conditions in New York state: Fiduciary accounting income equals $18,000 ($20,000, comprised of $10,000 of interest plus $10,000 of ordinary dividends, including the short-term capital gain dividends minus $2,000) one-third of the commissions. Distributed net income (DNI) is $14,000 (gross income of $25,000 minus commissions of $6,000, minus the capital gain dividend of $5,000). Under IRC section 643(a)(3), short-term capital gains are not capital gain dividends and are included in DNI.

Under IRC section 651, the trust distribution deduction is limited to the lesser of the amount required to be distributed ($18,000) or DNI ($14,000). Therefore, ignoring the personal exemption, income taxable to the trust is $5,000 ($25,000 minus the deduction of $6,000, minus the distribution deduction of $14,000). The beneficiary is taxable on the $14,000 DNI.

Q: The sole beneficiary of a trust established in New York moves to California. The sole trustee remains in New York. Is there a California filing requirement?

A: Yes. California law (CA Revenue & Tax Code sections 17742-17745) provides that the taxation of a trust depends on the residency of the noncontingent beneficiaries and the trustees. The instructions to the California Fiduciary Income Tax Return, Form 541, illustrate the application of the law as follows:

For the case in question, both New York and California will have filing requirements.

Q: Can a trustee distribute capital gains to a beneficiary with the beneficiary being taxed on those gains instead of the trust?

A: Normally capital gains are not treated as distributable to beneficiaries except in the final year of the trust. The capital gains and losses remain in the trust as part of trust principal and the trust is taxed on the net capital gain. However, Treasury Regulation 1.643(a)-3 allows exceptions to this general rule, and provides examples. If the trust instrument and state law (or pursuant to a reasonable and impartial exercise of discretion by the fiduciary consistent with the trust instrument and state law) allow, the regulation permits the trustee to distribute capital gains to a beneficiary under three circumstances:

Q: Can a New York resident trust be changed so that no New York Fiduciary Form IT-205 would be required?

A: Yes. The New York resident trustee(s) would have to resign as trustee(s) and nonresident trustee(s) would have to be appointed. Also, tangible property in New York would have to be removed, and any real property in the state, divested. Per filing instructions for Form IT-205:

“If a decedent was domiciled in New York state at the time of his or her death, his or her estate is a resident estate and any trust created by his or her will is a resident trust. If an irrevocable trust consists of property of a person domiciled in New York state when such property was transferred to the trust, it is a resident trust.

However, no New York state personal income tax may be imposed on a resident trust if all of the following conditions are met.

Q: A New York state resident establishes an irrevocable trust for the benefit of the resident’s child, who also lives in New York. The trustee is the resident’s attorney, living in New Jersey. The trust’s only asset is a brokerage account containing stocks, bonds and a money market fund. The account was established at a New York brokerage firm. Is the trust taxable in New York?

A: The trust is a resident New York trust that is not taxable in New York. New York tax law (sec. 605(b)(3)) defines a resident trust in part as an irrevocable trust having property “of … a person domiciled in this state at the time such a trust, or portion of a trust, became irrevocable …”

However, section 605(b)(3)(D) of the tax law exempts from New York taxation any resident trust where all the trustees are domiciled outside of New York, the entire corpus of the trust is outside of New York and all the income and gains are from sources outside of the state.

The location of intangible property, such as stocks, bonds or money, is in the state where one or more of the trustees are domiciled.

The above trust is a resident New York trust because a New York domiciliary irrevocably established the trust. The location of the trustees or of the beneficiaries is irrelevant when determining the residency of the trust.

However, since the trustee of the above trust is a resident of New Jersey, the assets are all intangibles and there is no New York source income, the trust is not taxable in New York and therefore need not file a New York fiduciary income tax return.

Q: Does the transfer of a remainder interest from a life estate require that a gift tax return be filed?

A: Yes. Under Code Section 2511(a), any transaction in which an interest in property is gratuitously passed or conferred upon another, regardless of the means or device employed, is subject to gift tax (Reg. Section 25.2511-1(c)).

In addition, the transfer must be complete and irrevocable before the gift tax applies.

For example, a donor was deemed to have made an incomplete gift when he transferred his personal residence to his sons and retained not only a life estate in the property, but also the right to have his personal residence transferred back to him (PLR 200308046).

A gift of a future interest, such as a remainder interest in a life estate, is not eligible for the annual exclusion for gifts, currently $12,000. Calculating the value of the gift to be reported entails applying to the fair market value of the property the appropriate remainder factor based on the age of the transferor and the applicable IRC Section 7520 rate for the month in which the gift was made (see IRS Publication 1457).

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Accounting and Review Services Committee

Q: If we issue a compilation report omitting all disclosures, can we include an emphasis paragraph in the compilation report?

A: No, unless the matter is disclosed in the financial statements. Paragraphs 49 and 50 of Statements on Standards for Accounting and Review Services (SSARS) 15 state that because an emphasis paragraph should not be used in lieu of management disclosures, an accountant should not include an emphasis paragraph in a compilation report on financial statements that omits substantially all disclosures unless the matter is disclosed in the financial statements.

An accountant may include an emphasis paragraph on a matter when management has presented selected information even though substantially all disclosures have been omitted, as long as the matter discussed in the emphasis paragraph is disclosed in the selected information.

Q: In a compilation or review engagement, what is the accountant’s responsibility in communicating to management if a CPA finds evidence or information regarding fraud or an illegal act that may have occurred?

A: Paragraph 61 of SSARS 12 states that when evidence or information comes to the accountant’s attention during the performance of compilation or review procedures that fraud or an illegal act may have occurred, that matter should be brought to the attention of the appropriate level of management. The accountant need not report matters regarding illegal acts that are clearly inconsequential and may reach agreement in advance with the entity on the nature of such items to be communicated.

When matters regarding fraud or an illegal act involve senior management, the accountant should report the matter to an individual or group at a higher level within the entity, such as the manager (owner) or the board of directors. The communication may be oral or written. If the communication is oral, the accountant should document it.

When matters regarding fraud or an illegal act involve an owner of the business, the accountant should consider resigning from the engagement. Additionally, the accountant should consider consulting with his or her legal counsel and insurance provider whenever any evidence or information comes to his or her attention during the performance of compilation or review procedures that fraud or an illegal act may have occurred, unless such illegal act is clearly inconsequential.

Q: Can we issue a review report on financial statements that omit disclosures?

A: No. Paragraphs 16 through 18 of SSARS No. 1, which provide guidance for reporting on statements that omit substantially all disclosures, only apply to financial statements that the accountant has compiled.

Q: Are the titles “Balance Sheet” and “Statement of Income” appropriate for statements prepared using a comprehensive basis of accounting other than Generally Accepted Accounting Principles (GAAP), meaning Other Comprehensive Basis of Accounting (OCBOA)?

A: No, unless the titles are modified. Such unmodified titles are generally understood to be applicable only to financial statements that are intended to present financial position, results of operations or cash flows in conformity with GAAP.

Paragraph 4 of SSARS No. 1 refers to SAS No. 62, paragraph .07 (AU section 623.07), which provides guidance with respect to suitable titles for financial statements that are prepared in conformity with OCBOA other than GAAP.

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Auditing Standards Committee

Q: What are the current CPA firm responsibilities concerning fraud in performing review-level services on a client financial statement issued pursuant to a SSARS engagement, including consideration of documentation through the use of checklists or programs? And will the lengthy and detailed fraud checklist for this type of engagement be time-consuming to prepare?

A: The Statements on Standards for Accounting and Review Services were amended by SSARS No. 12 in December 2005 to parallel changes made in the Auditing Standards (SASs) to better clarify CPA and client responsibilities concerning fraud when a CPA is engaged for services in which historical client financial statements are issued.

The amendment to SSARS was designed to similarly emphasize terminology and concepts concerning fraud in the revised audit literature, which are principally to be reflected in revisions to the structure of engagement letters with management and representation letters received from clients.

The CPA’s engagement cannot be relied upon to disclose errors, fraud or illegal acts that may exist. However, the CPA will inform the appropriate level of management of any material errors and any evidence or information that comes to his/her attention during performing procedures under SSARS that fraud may have occurred.

In addition, the CPA will report any evidence or information regarding illegal acts that may have occurred, unless they are inconsequential.

Management is responsible for the prevention and detection of fraud, and that it has no knowledge of any fraud or suspected fraud affecting the entity involving management or others where fraud could have a material effect on the financial statements, including any communications received from employees, former employees or others.

Accordingly, while the CPA has an awareness of fraud in performing a review or a compilation under current standards, it is not contemplated that he or she will necessarily design procedures to detect material misstatements due to fraud or illegal acts.

Based on the nature and limitations of engagements performed under SSARS, documentation in work files is limited. For example, in a review such documentation would include an engagement letter evidencing an understanding with the client and a representation letter. It would also include documentation of the accountant’s knowledge of the client’s business and the accounting principles and practices in the industry in which it operates, as well as his/her inquiry and analytics procedures and unusual matters related thereto and their disposition.

However, while use of a checklist concerning certain of these matters may be useful, SSARS does not specify the form or content of working papers. Accordingly, while a checklist concerning fraud might be useful, it is not required in a review, and care should be taken in selecting a checklist appropriate to the level of service being performed, which is less than an audit.

Such practice aids are available from secondary sources commonly accessible outside the actual SSARS literature.

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Agri Business Committee

Q: For cash-method taxpayers, what are the IRS’s general rules for deductible prepaid expenses for livestock and farming operations?

A: Expenditures must be for a purchase rather than a deposit, and the prepayment must be made for a business purpose and not tax avoidance. The deduction will not result in a material distortion. Internal Revenue Code (IRC) Section 464(f) limits deductible prepaid farm supplies to 50 percent of deductible farm expenses for the year.

Q: For cash-method farming operations, what are the general rules for inventory?

A: Generally, the purchase price and other acquisition costs of the animals, and cost of seeds, plants, trees and vines with a preproductive period of more than two years must be capitalized, but the cost of raising animals and raising crops can be deducted when expensed. Special preproductive rules apply to timber and Christmas trees. When the farming operations are part of an integrated business not considered farming and requires inventories, the farming operations may be required to use inventories.[(IRC Regulation 1.466-1-(d)(1)].

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Litigation Services Committee

Q: When a CPA takes on a litigation support engagement whereby he would be working for his current client and his current client’s attorney, would the CPA put himself in a conflict of interest situation when he identifies himself as an expert who is independent? As an expert, would the CPA have to rely upon the books and records of the company and/or the tax returns, both of which he was involved in preparing?

A: What arises with Kovel relationships is that practitioners sometimes forget that since the Kovel is a privileged relationship with the client and the client’s attorney (whereby the Kovel accountant is effectively working as a part of the attorney’s staff), the CPA must watch that the entire relationship won’t be defeated by the preparer or other obligations. As a preparer, work product is discoverable; as a Kovel accountant, the work product is protected as attorney-client work product. If you try to be both, you will probably end up in a no-win situation where your only friend may be your malpractice carrier.

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Real Estate Committee

Q: What is the tax impact of a real estate partnership in which the partners have refinanced and are about to redistribute the money?

A: There is generally no tax due on debt-financed distributions. The liabilities associated with the refinancing give the partners additional basis to distribute. The partnership is subject to interest-tracing rules on these debt-financed distributions.

Depending on a number of factors, including the amount of the distributions and the operating expenses of the partnership, the characteristic of the partnership’s interest expense is subject to change. Normally, the interest expense would be treated as passive, like any real estate rental activity. However, if tracing is applicable, the individual partners receiving distributions must determine what kind of interest expense is related to the distribution based on what they do with the distribution. If the money is deposited into stocks and bonds, it would be investment interest. If used to invest in real estate, it would retain its passive character. If it is used to buy a boat, it would be personal interest, and therefore nondeductible.

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Employee Benefits Committee

Q: How should bonuses paid after year-end be handled for both income tax deduction and Internal Revenue Code (IRC) section 409A purposes?

A: Employers frequently pay annual bonuses after the close of their fiscal years. Bonuses earned in 2007 may be paid in 2008, thus deferring the recognition of income by the employee into 2008. The question is whether such payments are treated as “deferred compensation.”

There are two deferred compensation issues. The first concerns timing bonus payments for them to be tax deductible on the return of the employer on account of which the bonuses are paid. The second concerns the application of IRC section 409A. For achieving the deduction, Temp. Reg. section 1.404(b)-1T provides that compensation paid during the 2 1/2 month period after the end of the employer’s taxable year is deductible in the preceding year because it is not considered deferred compensation.

The second issue is the application of IRC section 409A, which imposes specific restrictions on deferred compensation. If a bonus arrangement is deemed to be deferred compensation, it may be subject to IRC section 409A. If the arrangement conforms with the statute, bonuses are currently includible in gross income subject to an additional 20 percent tax, plus a cumulative interest charge at the underpayment of the tax rate plus one percentage point.

IRC section 409A does not apply to deferred compensation that satisfies its so-called short-term deferral rule. Therefore, if a bonus program satisfies this rule, it is not considered deferred compensation and is exempt from IRC section 409A.

To qualify for the exemption, the bonus payment must be required to be made (under the terms of a written document) on or before the 15th day of the third month (i.e., March 15 for a calendar year taxpayer) following the year-end of the year in which the bonus was earned. If the client has adopted a written document reciting the short-term deferral rule, the payments will not be subject to IRC section 409A, as long as it is paid by the end of the year.

Q: Does an S corporation shareholder need wages for retirement plan purposes?

A: A shareholder-employee in a subchapter S corporation must receive taxable wages to be eligible to have a contribution made on his or her behalf to the S corporation’s tax-favored retirement plan. In an S corporation, “pass-thru” income is never considered compensation for qualified plan contribution purposes. Similarly, a partner in a partnership may only use net-earnings from self-employment as the starting point for his or her retirement plan contribution. Thus, in a partnership where capital is a material income-producing factor, a portion of the partner’s share of ordinary income may not be earned income eligible for retirement plan contributions.

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Exempt Organizations Committee

Q: Are contributions to tax-exempt organizations that do not have an IRS Determination Letter tax deductible?

A: Some organizations are not required to file Form 1023, Application for Recognition of Exemption. These include churches and other religious organizations, as well as any organization (other than a private foundation) normally having annual gross receipts of not more than $5,000. These organizations are exempt automatically if they meet the requirements of section 501(c)(3).

Therefore, a donation to a church or an organization with less than $5,000 in annual gross receipts is deductible by the donor as a charitable contribution whether or not the organization has applied for and received tax-exempt status from the IRS.

Additional information and exceptions to this requirement can be obtained from IRS Publication 557 at http://www.irs.gov/publications/p557/ch03.html#d0e3309.

Q: What is the difference between a public charity and a private foundation?

A: All 501(c)(3) organizations have what is called a “foundation classification.” The terms “public charity” and “private foundation” are ways of referring to an organization’s foundation classification. Because of the way the law is written, any organization that qualifies for tax-exempt status under section 501(c)(3) is presumed to be a private foundation, unless it can show that it qualifies for one of the exceptions to private foundation status. Any organization qualifying for such an exception is sometimes called a public charity. Some types of organizations, such as churches and schools, are defined as public charities by law. But most organizations qualifying for public charity status do so because they can show that their financial support comes from a broad cross-section of the public. Organizations that receive their support from a very narrow base, or that were set up by a wealthy individual or family, will typically be classified as private foundations.

Although both types of organizations are tax-exempt under section 501(c)(3), private foundations are subject to certain excise taxes and reporting requirements that do not apply to public charities.

Additional information and exceptions to this requirement can be obtained from IRS Publication 557 at http://www.irs.gov/publications/p557/ch03.html#d0e4612.

Q. When and what types of small or inactive tax-exempt organizations are required to file the e-postcard?

A: Beginning in 2008, small tax-exempt organizations that previously were not required to file returns may be required to file an annual electronic notice, Form 990-N, Electronic Notice (e-postcard) for Tax-Exempt Organizations Not Required To File Form 990 or 990-EZ. This filing requirement applies to tax periods beginning after December 31, 2006. Organizations that do not file the notice will lose their tax-exempt status.

Small tax-exempt organizations whose gross receipts are normally $25,000 or less are not required to file Form 990, Return of Organization Exempt From Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt from Income Tax. With the Enactment of the Pension Protection Act of 2006 (PPA). These small tax-exempt organizations will now be required to file electronically Form 990-N, also known as the e-postcard, with the IRS annually.

The PPA requires the IRS to revoke the tax-exempt status of any organization that fails to meet its annual filing requirement for three consecutive years. Therefore, organizations that do not file the e-Postcard (Form 990-N), or an information return Form 990 or 990-EZ for three consecutive years, will have their tax-exempt status revoked as of the filing due date of the third year.

Additional information and exceptions to this requirement can be obtained from the IRS at http://www.irs.gov/charities/article/0,,id=169250,00.html.


Q: Our organization received exemption under 501(c)(3) of the Internal Revenue Code as a public charity. The IRS issued an advance ruling with respect to our public charity status (i.e., determined that the organization is not a private foundation). The IRS Determination Letter states that the organization is required to file Form 8734 within 90 days after the end of our advance ruling period. Our advance ruling period ends June 30, 2009. Is there any change in connection with the advance ruling process? Is our organization required to file IRS Form 8734, Support Schedule for Advance Ruling Period?

A: New regulations eliminate the advance ruling process under which a section 501(c)(3) organization was required to file Form 8734 to establish that it had been a publicly supported charity during its first five tax years. The new rules apply to organizations with advance rulings expiring on or after June 9, 2008.

On Sept. 9, 2008, the IRS issued temporary income tax regulations that eliminate the advance ruling process for a section 501(c)(3) organization. Under the new regulations, a new 501(c)(3) organization will be classified as a publicly supported charity--not a private foundation-- if it can show that it reasonably can be expected to be publicly supported when it applies for tax-exempt status.

A new Section 501(c)(3) organization that demonstrates a reasonable likelihood of public support in its application for exempt status will be recognized as a public charity without any follow-up requirements [Temp. Reg. 1.170A-9T(f)(5)].

Prior to the adoption of this regulation, a new charitable organization that anticipated being a public charity because of its support could only get an advance ruling granting public charity status for the organization's initial five-year period. At the end of this period, the organization was required to file Form 8734 to confirm the sources of its support and get a final determination letter.

The new rules no longer require the organization to file Form 8734 after completing its first five tax years.

The organization retains its public charity status for its first five years regardless of the public support actually received during that time. Beginning with the organization's sixth taxable year, it must establish that it meets the public support test by showing that it is publicly supported on its Schedule A to Form 990 (The IRS has included additional information on the revised Form 990, Schedule A, to enable organizations and the IRS to determine if the organization satisfies the support test.). Organizations that are currently deemed public charities under an advance ruling letter can now treat the ruling as their final determination letter [Temp. Reg. 1.170A-9T(f)(14)]. The new rules apply to organizations with advance rulings expiring on or after June 9, 2008, and those with applications pending before the IRS, regardless of when Form 1023 was filed.

The IRS previously notified organizations of the need to file by sending a notice and enclosing a copy of Form 8734. With the elimination of the advance ruling period, this notice has been revised and is being used to notify organizations of the new rules; however, Form 8734 was enclosed inadvertently with the revised notice that was mailed to some organizations. An organization that received such a form should not file it unless its advance ruling period expired before June 9, 2008.

IRS guidance can be accessed on the IRS Web site.


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