Tax-Exempt Nonprofits: No Longer Untouchable

1. Tax-Exempt Nonprofits:No Longer Untouchable Thomas A. Tupitza, Esq.Knox McLaughlin Gornall& Sennett, P.C.120 West Tenth StreetErie, PA 16501ttupitza@kmgslaw.com Vincent F. Halupczynski, CPA Malin, Bergquist & Company, LLP 2402 West 8th Street Erie, PA 16505

2. Background Facts* Number of Nonprofit Organizations in Pennsylvania? At least 41,000. Number of PA residents employed by the PA nonprofit sector? 1 out of every 9 full-time workers. *Source: Pennsylvania Association of Nonprofit Organizations presentation to PA Joint Legislative Budget and Finance Committee (May 2009).

3. Why is PA concerned about nonprofit tax exemption? Philadelphia has more tax-exempt land (by value) than any other major city in the United States―an estimated 10.8 percent in 2006. Source: Daniel Denvir Philadelphia City Paper , “Pay up: Penn and other wealthy nonprofits pay nothing to city.” (March 15, 2012).

4. Real Estate Tax 101 • With a few exceptions (e.g. religious organizations), taxable property includes any real estate not owned by the government. • Property divided into assessment areas. • A tax assessor assesses his or her own assessment area according to the local rules. • Instead of changing the rates, change the assessment. • Pennsylvania law allows purely public charities to receive exemption from Pennsylvania Real Estate Tax.

5. Pennsylvania Legislature Under the Pennsylvania Constitution, the General Assembly is empowered to confer tax-exempt status on “institutions of purely public charity.” Pa. Const. art. VIII, §2(a)(v).

6. PA Real Estate Tax Exemption For Real Estate Tax, the General Assembly may exempt “only that portion of real property of such institution [purely public charity] which is actually and regularly used for the purposes of the institution.” Pa. Const. art. VIII, § 2(a)(v). The General County Assessment Law, 72 P.S. § 5020-101 et seq. provides for the imposition of local tax on real estate and exemptions from local real estate tax.

7. What is a “purely public charity”? • PA Constitution does not define “purely public charity”. • PA Supreme Court creates HUP Test: Hospital Utilization Project v. Commonwealth of Pennsylvania, 501 Pa. 1 (1985). • PA Legislature enacts Institutions of Purely Public Charity Act (“Act 55”) on November 26, 1997 which adopts the same factors set forth by HUP Test, but adds additional factors. ACT 55 (10 P.S. § 371 et seq.)

8. Hospital Utilization Project v. Commonwealth of Pennsylvania • 1963: Allegheny, Beaver, Lawrence, and Westmoreland counties form a Hospital Council and engage in the Hospital Utilization Project to gather, analyze, and compare hospital utilization statistics (e.g. length of stay, diagnosis, treatment, etc.). • 1963 – 1966: HUP funded by charitable contributions. • 1967: Hospitals fund HUP through direct payment (i.e. hospital is charged a set fee for each patient abstract it submits to HUP and then receives access to all of HUP’s reports). Non-submitting entities pay fees to receive reports.

9. Hospital Utilization Project v. Commonwealth of Pennsylvania • 1969: HUP organizes as a nonprofit corporation under PA law and obtains “501(c)(3) status.” • 1980: HUP’s petition for refund of sales and use tax denied by Board of Appeals of the Department of Revenue, the Board of Finance and Revenue, and the Commonwealth Court. HUP appeals to the Supreme Court of Pennsylvania. • 1985: PA Supreme Court reviews case law, sets forth HUP Test, and finds that HUP is not a “purely public charity” entitled to exemption from taxation.

10. HUP Test • advances a charitable purpose; • donates or renders gratuitously a substantial portion of its services; • benefits a substantial and indefinite class of persons who are legitimate subjects of charity; • relieves the government of some of its burden; and • operates entirely free from private profit motive.

11. Act 55 The institution must relieve the government of some of its burden. This criterion is satisfied if the institution meets any one of the following:(1) Provides a service to the public that the government would otherwise be obliged to fund or to provide directly or indirectly or to assure that a similar institution exists to provide the service.(2) Provides services in furtherance of its charitable purpose which are either the responsibility of the government by law or which historically have been assumed or offered or funded by the government.(3) Receives on a regular basis payments for services rendered under a government program if the payments are less than the full costs incurred by the institution, as determined by generally accepted accounting principles.

12. Act 55 (Con’t.) (4) Provides a service to the public which directly or indirectly reduces dependence on government programs or relieves or lessens the burden borne by government for the advancement of social, moral, educational or physical objectives.(5) Advances or promotes religion and is owned and operated by a corporation or other entity as a religious ministry and otherwise satisfies the criteria set forth in section 5.

13. Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals • Mesivtah Eitz is a nonprofit religious entity related to the Bobov Orthodox Jewish community in Brooklyn, NY that operates a summer camp in Pike County which provides classes on the Jewish faith and recreational activities for campers.

14. Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals • Mesivtah Eitz seeks property tax exemption as a purely public charity which is denied by Pike County Board of Assessment. • By applying the HUP Test, the Board of Assessment Appeals and the Commonwealth Court affirm the denial of tax exemption. • Mesivtah Eitz appeals to the Supreme Court of PA arguing that the lower courts erred in using the HUP Test. It argues that Act 55 is more recent and broader than the HUP Test.

15. Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals Does the Pennsylvania Legislature’s enactment of Act 55 for determining if an organization qualifies as a “purely public charity” under Pennsylvania’s Constitution deserve deference in deciding whether an organization qualifies as a “purely public charity” or has the HUP Test occupied the constitutional field, leaving no room for legislative input?

16. Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals “To receive a real estate tax exemption without violating the Pennsylvania Constitution, the party must meet the definition of purely public charity as measured by the test in HUP. If it does so, it may qualify for exemption if it meets the statute’s requirements. Act 55, however, cannot excuse the constitutional minimum: if you do not qualify under the HUP test, you never get to the statute.” Mesivtah Eitz, 44 A.3d at 14 (April 25, 2012).

17. Real Estate Tax Exemption Process • Complete Application for Exemption of Real Estate. • One application per parcel. • “Legal” basis for request. • General information about property. • Comply with specific requirements of applicable county.

18. Real Estate Tax Exemption Process • Comply with General County Assessment Law (72 P.S. § 5020-204) • Properly completed assessment appeal form. • Proof of nonprofit status. • IRS ruling letter granting exempt status. • Three (3) years of income tax returns. • Copies of organization documents, bylaws and amendments .

19. Real Estate Tax Exemption Process • Cont’d. • Current list of Board Members. • Verified statement of no private inurement or Articles of Incorporation stating the same. • If not in tax returns, statements of salaries for officers, directors, and five highest paid salaried employees. • Copies of deeds of property in question. • Verified statement of authorization if the appeal is filed by an officer or employee of the corporation.

20. Real Estate Tax Exemption Process • Burden of Proof • Hearing Process • Board Decision • May be from solicitor and set forth reasons for denial. • May be from Board or Board Secretary and MAY NOT set forth reasons for denial. • Appeal • Must be filed within 30 days from date of filing of decision of denial. • Notice of Appeal must be served on Assessment Board within ten days of filing an appeal.

23. PA Sales and Use Tax Vincent F.

24. PA Sales & Use Tax • 501(c)(3) is for exemption from federal and state income taxes (not sales/use, real estate, and other taxes). • PA requires a separate application (PA Form REV-72) for sales/use tax exemption. • Basically, the same criteria that applies to real estate tax exemption applies to sales/use tax.

25. PA Sales & Use Tax Transactions exempt from sales/use tax: • Purchase and use of tangible property or services that are used in an activity which bears a reasonable relationship to the purpose for which the exempt organization exists.

26. PA Sales & Use Tax Transactions exempt from sales/use tax: • Purchase and use of tangible property qualifying as a material or supply which is used for the routine maintenance or repair of real estate which is used in an activity which bears a reasonable relationship to the purpose for which the organization exists.

27. PA Sales & Use Tax Transactions subject to sales/use tax for NPO’s: • Property used in an activity which is not the exempt purpose of the organization. • Materials, supplies and equipment used and installed in the construction, remodeling, repair and maintenance of any real estate so as to become a permanent part of the real estate.

28. PA Sales & Use Tax Transactions subject to sales/use tax for NPO’s (continued): • Equipment used but not installed in the construction, remodeling, repair and maintenance of real estate. • Charges subject to hotel occupancy tax • Purchases of alcohol

29. What You Should Do. . . • Educate your people on the regulations, typically this would be your accounts payable accountant, controller, and/or CFO. • Review your vendor invoices to be sure they charge you sales tax for the appropriate taxable purchases. If not charged by the vendor you should remit the use tax. • Anytime you have a construction project be sure to review the rules very carefully, and be sure you and the contractor are “getting it right”.

30. Nonprofits and Political Activity

31. PA Lobbyist Disclosure Act • Lobbyist: “Any individual, association, corporation, partnership, business trust or other entity that engages in lobbying on behalf of a principalfor economic consideration.” • Lobbying: “An effort to influence state legislative or administrative action.” The term includes (1) direct or indirect communication, (2) office expenses, and (3) providing any gift, hospitality, transportation or lodging to State official or employee for the purposes of advancing the interest of the lobbyist or principal.

32. PA Lobbying Reporting Requirements When total expenses for lobbying activity exceed $2,500 for a registered principal in any calendar quarter. NOTE: There are also federal and IRS lobbying rules for nonprofit organizations.

33. Political Activity Under Federal law, a 501(c)(3) organization may “not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of, or in opposition to, any candidate for public office.”

34. Political Activity • No campaign contributions. • No endorsement. • No polls or surveys. • No candidate position papers. • No advertising or publicity. • No money paid to candidates for speeches or other services.

35. Political Activities PENALTIES • Loss of exemption; • Injunction requiring immediate cessation of political activities; • Excise tax; and/or • Penalty for failure to correct illegal activities.

36. Lobbying Political Activity An attempt to influence legislation through communication with members or employees of a legislative body or with governmental officials or employees who may participate in formulating legislation. An attempt to influence the selection, nomination, election or appointment of an individual to a federal, state or local public office or office in a political organization, or the election of a presidential or vice-presidential elector.

37. Worker Classification

38. Worker Classification Employee vs. Independent Contractor • 20 common law factors (IRS Rev. Rule 87-41) • 1099-MISC • Penalties for failure to file • 990 questions regarding 1099’s • IRS audit focus

39. Ramifications • Taxes, penalties, interest if worker is misclassified: • Federal income taxes • Social security (employee and employer) • Medicare (employee and employer) • Federal U/C • PA income taxes • PA U/C • Local income taxes • Penalties for failure to withhold • Penalties for failure to remit • Interest

40. What You Should Do. . . • Review the individuals you are sending 1099’s to be certain that is the appropriate treatment. • Use IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to help guide your fact gathering. • Review workers who received Form W-2 and a 1099 in the same year. • Review your vendor list and check register to be sure you are sending 1099’s to all appropriate individuals (penalties apply for failure to file)

41. Other • 403(b)/401(k) • DOL Audits • Timely remittance of employee withholding • Small plan safe harbor • Get to know “best practices” for sponsoring and operating the plan • Deductibility of Charitable Contributions • EITC Organizations • New certification requirements

42. Thank You! Thomas A. Tupitza, Esq.Knox McLaughlin Gornall& Sennett, P.C.120 West Tenth StreetErie, PA 16501ttupitza@kmgslaw.com Vincent F. Halupczynski, CPA Malin, Bergquist & Company, LLP 2402 West 8th Street Erie, PA 16506