Summer 2013

Windes Nonprofit Advisor

The Windes Nonprofit Advisor is a periodic technical publication focusing on the tax, regulatory, and accounting issues that nonprofit organizations routinely confront.

On the tax side, the Windes Nonprofit Group possesses experience in preparing and reviewing Forms 990, 990-T, 990-PF, and state tax-exempt forms, in addition to having experience in the preparation and filing of both federal and state tax exemption applications for public charities, private foundations, and other exempt organizations. Additionally, the Group can assist in providing valuable guidance (governance / reasonable compensation documentation / public support test / special events / lobbying / transactions with related parties) to nonprofit organizations.

On the audit side, the Windes Nonprofit Group prepares audited financial statements and ERISA audits for over 80 nonprofit organizations. For retirement plans, Windes & McClaughry has experts on staff for §403(b) plan administration and compliance, including plan document issues, Form 5500 preparation and filing, non-discrimination testing and government compliance programs.

The Windes Nonprofit Group is composed of the following individuals who are dedicated to providing nonprofit organizations with high-level tax, regulatory and accounting consulting, tax compliance services, and financial statement audit and assurance services:

Ron Kulek, CPA Audit Partner

Lance Adams, CPA Audit Partner

Tom Huey, CPA Audit Senior Manager

Ryan Choate, CPA, CFE Audit Senior Manager

Jeffrey Fisher, CPA Audit Manager

Richard Green, CPC, APA Employee Benefit Services Partner

Donita Joseph, CPA, MBT Tax Partner

Amy Vaughn, JD, CPA, LLM Tax Senior Manager

Christopher Powers, CPA Tax Manager

Nika Carter, CPA Tax Manager

Cherie Romar Tax Staff

Please do not hesitate to contact any member of the Windes Nonprofit Group at (562) 435-1191 or via email at nonprofit@windes.com.

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Unrelated Business Taxable Income

One of the hot topics important to the Internal Revenue Service (IRS) in the nonprofit realm is Unrelated Business Taxable Income (UBTI). It is one of the few ways for the IRS to generate revenue from exempt organizations, and its purpose is to put tax-exempt entities and “for-profit” enterprises on equal footing with respect to their trade or business activities. UBTI can be best defined as the gross income derived by any organization from any unrelated trade or business less any deductions allowed that are directly connected with the carrying on of such trade or business.

In addition to certain activities being excluded from the definition of an unrelated trade or business, certain income is generally excluded by statute from being treated as UBTI, including interest, dividends, royalties, rental income, and gains and losses from the disposition of property. There are three elements to the definition of an unrelated trade or business. It is important to note that all of these elements must be met for the tax on unrelated business taxable income to apply. The tax may not be assessed by the Internal Revenue Service if any of the elements is not present.

1. The activity must constitute a trade or business.

The term “trade or business” as it relates to an unrelated trade or business is defined by Treasury Regulation (Treas. Reg.) 1.513-1(b) and includes any activity carried on for the production of income from selling goods or performing services. However, the lack of intent to make a profit may indicate that an activity is not a trade or business. Example: The Crosstown Medical Society (Crosstown) publishes a quarterly journal containing

articles on topics of interest to Crosstown's members and related to Crosstown's exempt function.

It also contains advertising of vendors of medical products. The solicitation and selling of the

advertising is handled by Crosstown's sole paid employee. Crosstown has consistently lost money on

its advertising activities for the entire 21-year history of the journal. There has been no attempt

to change these activities to make them profitable. Crosstown did not avoid additional losses by

discontinuing the advertising activity. Therefore, Crosstown lacks a profit motive with respect to the

advertising activity and, thus, the activity is not a trade or business.

2. The activity must be regularly carried on.

A trade or business is “regularly carried on” if it shows a frequency and continuity and is pursued

in a manner similar to comparable commercial activities of nonexempt organizations *Treas. Reg.

1.513-1(c)+. Activities that occur annually are not considered to be regularly carried on. Activities

that occur intermittently must be compared with the manner in which commercial activities are

normally pursued by non-exempt organizations.

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Unrelated Business Taxable Income (continued)

Example: The United Charities, Inc. (United) operates an ice cream stand at the county fair during the fair's annual two-week run. Commercial ice cream stores are normally open year-round, or at least for a substantial part of the year. Thus, operating an ice cream stand for a two-week period once a year is not an activity that is regularly carried on, even if several more weeks are involved in preparation activities.

3. The trade or business must not be substantially related to the organization’s tax-exempt purpose.

A trade or business is not substantially related to an organization’s exempt purpose if it does not contribute importantly to the accomplishment of a proper tax-exempt purpose. This is usually a facts-and-circumstances test and is based on the size and extent of the activities involved related to the scope and nature of the exempt function that they are intended to serve *Treas. Reg. 1.513-1(d)+. Example: The Topeka Boys Club (T) operates a sports program for boys from low-income families. Most of the funding for this program comes from the profits of a year-round car wash facility owned by the club. The car wash facility is operated on a regular basis and is a trade or business. Although the funds from the activity provide critical support for T's program services, the car wash is not otherwise related to T accomplishing its exempt purpose. Thus, the activity is an unrelated trade or business. If it is determined that one or more of an exempt organization’s activities meet these tests, the organization should file Form 990-T Exempt Organization Business Income Tax Return by the 15th day of the fifth month after the end of its tax year. If you have questions or would like more information about Unrelated Business Taxable Income, please contact Chris Powers at (562) 435-1191 or cpowers@windes.com.

Chris Powers, CPA Manager

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403(b) Plans - Eligible Sponsors

In July 2007, the Internal Revenue Service (IRS) issued the first comprehensive regulations for 403(b) plans in 43 years to increase the diligence and compliance criteria for 403(b) plans. These regulations implemented annual Form 5500 reporting, disclosure and audit requirements under Part 1 Subtitle B of Title I of ERISA for 403(b) plans beginning in 2009. Additionally, in January 2013, Revenue Procedure 2013-12 revised the Employee Plan Compliance Resolutions System (EPCRS), a program that allows plan sponsors to voluntarily make plan corrections to include correction programs for 403(b) plans. The additional reporting require-ments and correction program participation increased the IRS’s visibility on 403(b) plans. This has allowed the IRS to identify common 403(b) plan reporting and compliance errors. One of the top 10 compliance errors noted by the IRS was the operation of 403(b) plans by sponsors that were not eligible to sponsor this type of plan.

Determining Eligibility: Section 403(b) provides an exclusion from gross income for certain contribu-tions made by specific types of employers for their employees. These specific types of employers include:

501(c)(3) tax-exempt organizations;

public education organizations (as defined under Internal Revenue Code Section 170(b)(1)(A)(II);

cooperative hospital service organizations;

certain ministers who are employed by a 501(c)(3) organization; are self-employed and ministers not employed by a 501(c)(3) organization, but functioning as a minister in their daily responsibilities with their employer (for example a hospital Chaplin); and

public school systems organized by Indian tribal governments treated as states.

If your organization does not fit neatly into one of the above categories, you may need to locate your IRS determination letter. All 501(c)(3) organizations must have an IRS determination letter unless they were organized prior to October 9, 1969. Keep in mind the letter may have been issued to a “parent” or group related to your organization. If you are unable to locate your determination letter or are uncertain if the organization has one, you can access Publication 78 for a list of organizations with determination letters. If your organization is not tax-exempt under IRC Section 501(c)(3) or is exempt under a different 501(c) subsection, it may not be an eligible 403(b) plan sponsor.

Organizations that have lost their tax-exempt status are also not eligible to sponsor a 403(b) plan and should stop all contributions to the 403(b) plan until exempt status is restored.

Making a Correction: If you determine your organization is not an eligible sponsor of a 403(b) retirement plan, you can use the IRS Employee Plans Compliance Resolution System’s Voluntary Correction Program (VCP) to resolve this plan failure. The organization should stop all contributions (including salary reductions) beginning no later than the date a written submission has been made

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403(b) Plans - Eligible Sponsors (continued)

to the VCP. Written submissions under the VCP will correct the error and preserve the plan’s tax benefits for both the plan sponsor and employees contributing to the plan. Given the complexity of the regulation it is not surprising plan errors are commonplace. The IRS has compiled a 403(b) Plan Fix-It Guide to assist in identifying common 403(b) errors and correction methods to assist plan sponsors in identifying and correcting errors. For questions regarding your plan or for more information on 403(b) plan eligibility, please contact Lisa Carrick at lcarrick@windes.com or (562) 435-1191.

Lisa Carrick, CPA Senior Manager

Windes’ Presentation on

DOL Investigations

On May 1, 2013, Windes & McClaughry sponsored a presentation

by former Department of Labor Investigator Sam Henson (of

Lockton Retirement Services) on “Top Secrets on How to Avoid

Retirement Plan Audit Violations.” Mr. Henson gave an informative

presentation full of helpful tips for retirement plan sponsors that

was very well received. The presentation focused on the way the

DOL selects plans for investigation and what “red flags” to avoid,

thereby reducing a plan’s audit risk. Included in the seminar

materials was a “Fiduciary Checklist” covering the major issues of DOL concern and a “Retirement

Plan Compliance Calendar” to assist plan sponsors with their obligations throughout the year.

If you are interested in receiving a complimentary copy of the presentation, along with the

plan materials, please contact Craig Ima (cima@windes.com) or any of our team members. The

presentation is available as a DVD or a download.

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IRS Establishes Pre-Approved 403(b) Plans

In the continuing effort to level the playing field between plans sponsored by for-profit entities (Section 401(a) plans) and 403(b) plans sponsored by nonprofits, the Internal Revenue Service (IRS) has established a pre-approved program for such plans. Revenue Procedure 2013-22 established the framework for the eventual adoption of prototype and volume submitter plans that contain IRS-approved language for plan provisions.

The establishment of the program is only the first step in a long regulatory process, and it will be a while before such plans are available to plan sponsors. There is an initial period that stretches until April of next year for the creators of the plans (mass submitters such as Ft. Williams, the Principal, and TIAA-CREF) to submit their language to the IRS for approval. Following an uncertain period for IRS review, those providers will receive their Opinion or Advisor Letters from the IRS and then prepare documents for adoption by plan sponsors. It will likely be several years before these plans are available.

Until the new plans are available, sponsors must continue to adopt and maintain individually designed plans. The language in these plans is not pre-approved by the IRS, and there is no program in place for sponsors to receive a determination from the IRS on their qualification. The IRS has provided relief to plan sponsors who did not timely adopt a written plan as of December 31, 2009, and they likely will not challenge any language in 403(b) plans that were adopted in a good faith attempt to comply with the new regulations.

For questions regarding pre-approved 403(b) plans or for more information, please contact Richard Green at (562) 435-1191 or at rgreen@windes.com.

Richard Green, CPC, QPA, QKA, APA Partner

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Easing the Burdens of A-133 Audits

In 2011, President Obama issued several executive orders requiring federal agencies to review their regulations and make necessary modifications to streamline processes, allowing them to be more effective in providing important benefits and services to the general public. The Office of Management and Budget (OMB), which oversees and coordinates the government’s financial management system, responded to the executive orders by proposing reforms to policies over federal grants issued to state, local, tribal governments, institutions of higher education, and nonprofit organizations. One of the areas being considered for reform is OMB Circular A-133, more commonly referred to as the Single Audit.

Currently, the OMB Circular A-133 requires entities that have expended more than $500,000 of federal funds within a fiscal year to have a Single Audit performed. The main purpose of the audit is to provide assurance that the entity is properly managing and administering the federal funds received in accordance with the terms of the grant agreement and federal regulations. Typically, this would be done in conjunction with an entity’s annual financial audit and would involve the auditor reviewing all the federal funds expended and determining the major program(s) to be tested. The major programs are then tested for compliance with fourteen compliance requirements established by OMB Circular A-133. OMB’s proposed changes would determine if an entity is subjected to the A-133 audit and how the audit would be conducted. The following are some of the key changes that would affect future audits:

Audit threshold – The requirement to have a Single Audit preformed would be raised from $500,000 to $750,000. It is estimated this would eliminate approximately 5,000 annual audits, but would still cover more than 99% of expended federal funds. Program determination – Increases the threshold of identifying a program as Type A from $300,000 to $500,000. Programs are identified as either Type A or Type B during the risk assessment phase. Type A programs are assessed more closely in determining major programs. Minimum coverage – Requires a minimum of 20% audit coverage for a low-risk auditee and 40% for those not meeting the low-risk criteria. Current requirements are 25% and 50%, respectively. The percent coverage would directly affect how many programs are selected for testing. Compliance requirements – Currently there are fourteen potential compliance requirements that must be tested as part of the Single Audit. The proposed change eliminates seven of those requirements.

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Easing the Burdens of A-133 Audits (continued)

The remaining compliance areas that would still require testing by the auditor are:

Activities Allowed or Unallowed

Allowable Costs/Cost Principles

Cash Management

Eligibility

Reporting

Subrecipient Testing

Special Tests and Provision

So what does this all mean and when will this take effect?

In theory, the changes would lessen the administrative burden on entities receiving federal funds and

streamline the Single Audit process. This would allow entities to focus on administering the grants

and providing services to the general public. No timetable has been established to indicate the next

steps.

If you have questions regarding these changes or would like more information about OMB Circular

A-133 Audits, please contact Tom Huey at thuey@windes.com or (562) 435-1191.

Tom Huey, CPA Senior Manager

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Exchange Transactions vs. Contributions

Does your organization provide “services” for your “donors”? Does a govern-ment agency provide monies for no direct benefit? These are common types of issues where the accounting treatment may pose problems for your organization. The accounting treatment for these transactions can have a substantial impact on both your internal bookkeeping and external financial reporting. Internally, tracking contributions and net assets can be an onerous process. Externally, reporting liabilities rather than temporarily restricted net assets can affect debt covenants and may have an impact on the classification of related development expenses.

Accounting Standards Codification (ASC) 958 Not-for-Profit Entities subsection 605-55-3 Distinguish-ing Contributions from Exchange Transactions indicates some exchange transactions may appear to be contributions if the value received is of little consequence to the grantor and is in line with the recipient’s mission. If no value is received or if the value received is incidental to public benefit, the funds received should likely be classified as contributions. In the first example, it is possible you have an “exchange transaction” where the entity providing funds receives something in exchange for dollars provided to you. The accounting for this type of transaction would typically be similar to a for-profit entity, where any funds received in advance would be classified as a liability until the services are provided, at which time the funds (barring any further restrictions) would be released to unrestricted net assets. Such examples of this include research studies for a private foundation. In such case, any funds received in advance would be recorded as deferred revenue until the services are provided. Other examples include membership dues for which the member receives a substantial benefit or payments received from individuals for food and shelter. In the second example, you likely have “contributions,” in which case you follow standard nonprofit

guidance where the contributions are recorded as unrestricted, temporarily or permanently

restricted revenue and released to unrestricted revenue, as applicable, in accordance with the

donor’s requirements. Examples of this that may not be straight-forward include “contributions”

from the Department of Housing and Urban Development (HUD) for low-income housing. Even if

HUD imposes compliance requirements, this type of transaction is often accounted for as a

temporarily restricted contribution. Another example of a contribution would be membership

dues in excess of the benefit provided, in which case you have a transaction consisting of both a

contribution and an exchange transaction. Yet another example would be donors who provide

grants and want monthly status reports. In this case, although they receive something in return, it is

not of a direct benefit to them and inconsequentially related to the grants and, therefore, would be

considered a contribution.

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Exchange Transactions vs. Contributions (continued)

The following table, from ASC 958, can be used as a tool to help determine whether a specific transaction should be accounted for as a contribution or as an exchange transaction.

If you are unsure of whether you have a contribution or exchange transaction, or if you feel the treatment of a transaction in your financial statements may not be accurate, please contact Jeff Fisher at jfisher@windes.com or (949) 271-2600.

Jeff Fisher, CPA Manager

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Gift Acceptance Policies

In today’s tough economic times, nonprofit organizations must be aggressive in fund-raising. However, sometimes the gift is not worth the work and potential cost. There are many stories of nonprofit organizations accepting noncash donations that ended up costing them dearly, such as accepting land that was later found to be contaminated. Implementing a gift acceptance policy will serve the organization by having guidelines to follow that promote efficiency over operations and help to avoid costly mistakes.

Nonprofit organizations have dealt with governance policies in recent years, including conflict of interest, whistleblower, document retention and destruction, and executive compensation policies, as a result of recommended best practices and inquiries added to Form 990. Nonprofit organizations that receive noncash contributions are required to complete Form 990 Schedule M, which inquires into the existence of a Gift Acceptance Policy. If your organization receives noncash contributions, the ability to confirm the existence of a Gift Acceptance Policy further demonstrates “good governance” to the Internal Revenue Service and other readers of your Form 990. In addition, for fiscal years beginning after June 15, 2013, with early adoption permitted, new nonprofit accounting guidance will allow nonprofit organizations to report the sale of donated securities as operating cash flows on their statements of cash flows, provided the board of directors has an approved a policy to sell donated financial assets upon receipt. This policy could be incorporated in the Gift Acceptance Policy. A written Gift Acceptance Policy is important to all organizations, even ones that do not receive noncash contributions, as the importance lies in the evaluation of whether or not to accept any type of gift. Hidden costs that drain the organization’s resources may result if proper due diligence is not performed. A well-thought-out policy will identify acceptable and unacceptable gifts. The National Council of Nonprofits lists the following options to consider when drafting a policy:

Who is the audience for your gift acceptance policy? Will the policy help guide prospective donors who are considering a gift? Or, is the policy for staff and board members?

2. If the policy is for donors as well as board/staff, will it be linked from the non-profit’s website and, if not, how will it be distributed so that individuals who are considering a gift can be informed about the policy?

3. How will the mission of the organization and the policy be related? Should you include a statement that only gifts/contributions that can be used/expended consistent with the mission of the organization be accepted?

4. Will the policy require that prior to accepting certain gifts, the nonprofit will conduct a review and/or consult with legal counsel?

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Gift Acceptance Policies (continued)

5. Should the policy identify circumstances or make reference to the fact that in certain situations, donors should seek professional advice prior to making a gift and that the nonprofit will not provide advice directly to the donor, because that would pose a conflict of interest?

6. Will the policy identify acceptable restrictions that a donor may place on a gift?

7. Should the policy provide that certain gifts will be referred to a “gift acceptance committee” comprised of individuals with appropriate expertise and experience to evaluate gifts and decide whether or not to accept them?

8. Should the policy identify particular types of contributions that are not acceptable to the organization?

9. Should the policy spell out who is responsible for providing written acknowledge-ments of gifts and filing specific IRS forms for certain types of gifts or simply that the organization will comply with IRS regulations?

10. Will the policy be evaluated from time to time, and who should conduct the review? GuideStar, an information service provider specializing in reporting on U.S. nonprofit organizations, recommends that the policy should include the following:

Mission of the organization: keep the organization’s goals in mind

Purpose of the policy: state the purpose clearly

Use of legal counsel by either the donor or the organization: identify circumstances when an attorney should be consulted

Donor conflicts of interest: identify circumstances when the donor should seek professional advice prior to making a gift

Restricted gifts: identify types of acceptable restrictions

Gift acceptance committee: identify individuals with appropriate expertise and experience to evaluate gifts and decide whether or not to accept them

Type and form of gift: identify each type of gift and acceptable forms for each kind

A Gift Acceptance Policy can also be used to provide guidelines for acknowl-edging donors and for keeping private those donors requesting to remain anonymous. Sample Gift Acceptance Policies are available on the internet; however, the above options and recommended format should be specific to your organization. For questions regarding Gift Acceptance Policies, please contact Ron Kulek at (562) 435-1191 or rkulek@windes.com.

Ron Kulek, CPA Partner

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Visit us online at: www.windes.com

Windes & McClaughry is a recognized leader in the field of accounting, assurance, tax, and business consulting services. Our goal is to exceed your expectations by providing timely, high-quality, and personalized service that is directed at improving your bottom-line results. Quality and value-added solutions from your accounting firm are essential steps toward success in today’s marketplace. You can depend on Windes & McClaughry to deliver exceptional client service in each engagement. For over eighty-five years, we have gone beyond traditional services to provide proactive solutions and the highest level of capabilities and experience. Windes & McClaughry’s team approach allows you to benefit from a wealth of technical expertise and extensive resources. We service a broad range of clients, from high-net-worth individuals and nonprofit organizations to privately held businesses and publicly traded companies. We act as business advisors, working with you to set strategies, maximize efficiencies, minimize taxes, and take your business to the next level.

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