[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]




 
                 PUBLIC CHARITY ORGANIZATIONAL ISSUES,
                   UNRELATED BUSINESS INCOME TAX, AND
                          THE REVISED FORM 990

=======================================================================

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 25, 2012

                               __________

                          Serial No. 112-OS14

                               __________

         Printed for the use of the Committee on Ways and Means





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                      COMMITTEE ON WAYS AND MEANS

                     DAVE CAMP, Michigan, Chairman

WALLY HERGER, California             SANDER M. LEVIN, Michigan
SAM JOHNSON, Texas                   CHARLES B. RANGEL, New York
KEVIN BRADY, Texas                   FORTNEY PETE STARK, California
PAUL RYAN, Wisconsin                 JIM MCDERMOTT, Washington
DEVIN NUNES, California              JOHN LEWIS, Georgia
PATRICK J. TIBERI, Ohio              RICHARD E. NEAL, Massachusetts
GEOFF DAVIS, Kentucky                XAVIER BECERRA, California
DAVID G. REICHERT, Washington        LLOYD DOGGETT, Texas
CHARLES W. BOUSTANY, JR., Louisiana  MIKE THOMPSON, California
PETER J. ROSKAM, Illinois            JOHN B. LARSON, Connecticut
JIM GERLACH, Pennsylvania            EARL BLUMENAUER, Oregon
TOM PRICE, Georgia                   RON KIND, Wisconsin
VERN BUCHANAN, Florida               BILL PASCRELL, JR., New Jersey
ADRIAN SMITH, Nebraska               SHELLEY BERKLEY, Nevada
AARON SCHOCK, Illinois               JOSEPH CROWLEY, New York
LYNN JENKINS, Kansas
ERIK PAULSEN, Minnesota
KENNY MARCHANT, Texas
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York

        Jennifer M. Safavian, Staff Director and General Counsel

                  Janice Mays, Minority Chief Counsel

                                 ______

                       SUBCOMMITTEE ON OVERSIGHT

             CHARLES W. BOUSTANY, JR., Louisiana, Chairman

DIANE BLACK, Tennessee               JOHN LEWIS, Georgia
AARON SCHOCK, Illinois               XAVIER BECERRA, California
LYNN JENKINS, Kansas                 RON KIND, Wisconsin
KENNY MARCHANT, Texas                JIM MCDERMOTT, Washington
TOM REED, New York
ERIK PAULSEN, Minnesota


                            C O N T E N T S

                               __________

                                                                   Page

Advisory of July 25, 2012 announcing the hearing.................     2

                               WITNESSES

Panel 1:

Hon. Steven T. Miller, Deputy Commissioner for Services and 
  Enforcement, Internal Revenue Service, Testimony...............     5

Panel 2:

Ms. Eve Borenstein, Borenstein and McVeigh Law Office LLC, 
  Testimony......................................................    33
Mr. Thomas K. Hyatt, Partner, SNR Denton, Testimony..............    49
Mr. John Colombo, Albert E. Jenner, Jr., Professor, University of 
  Illinois College of Law, Testimony.............................    60
Mr. Donald Tobin, Associate Dean for Faculty and the Frank E. and 
  Virginia H. Bazler Designated Professor in Business Law, The 
  Ohio State University Moritz College of Law, Testimony.........    91

                       SUBMISSIONS FOR THE RECORD

American Bankers Association.....................................   118
Center for Fiscal Equity.........................................   125
Economic Research Institute......................................   129
Elizabeth Boris, Thomas Pollak, Charles McLean and Jeffrey 
  Falkenstein....................................................   134


 PUBLIC CHARITY ORGANIZATIONAL ISSUES, UNRELATED BUSINESS INCOME TAX, 
                        AND THE REVISED FORM 990

                              ----------                              


                        WEDNESDAY, JULY 25, 2012

             U.S. House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 9:30 a.m., in 
room 1100, Longworth House Office Building, Hon. Charles 
Boustany (Chairman of the Subcommittee) presiding.
    [The advisory of the hearing follows:]

HEARING ADVISORY

  Boustany Announces Hearing on Public Charity Organizational Issues, 
        Unrelated Business Income Tax, and the Revised Form 990

Wednesday, July 25, 2012

    Congressman Charles W. Boustany Jr., MD (R-LA), Chairman of the 
Subcommittee on Oversight of the Committee on Ways and Means, today 
announced that the Subcommittee will hold the second in its series of 
hearings on tax-exempt organizations, this time examining the revised 
Form 990, reasons for the increasing organizational complexity of 
public charities, including unrelated business income tax issues, and 
their effect on transparency and tax compliance. The hearing will take 
place on Wednesday, July, 25, 2012, in room 1100 of the Longworth House 
Office Building, beginning at 9:30 A.M.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. However, 
any individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing. A list of invited 
witnesses will follow.
      

BACKGROUND:

      
    Over the last two decades, public charities have grown increasingly 
more complex in their organizational structures and operations. 
Contributing to the complexity is the prevalence of profit-generating 
arms and investment activities within the tax-exempt organizational 
structure. Tax-exempt organizations are governed by a variety of rules 
to ensure compliance with Federal tax law and limit abuses, including 
rules that subject business income from for-profit activities to income 
tax (the unrelated business income tax, ``UBIT''), unless explicitly 
exempted. These issues, among others, may affect how a public charity 
chooses to organize and operate.
      
    To address increased complexity and to promote greater transparency 
and compliance within the sector generally, the Internal Revenue 
Service (``IRS'') released a redesigned Form 990, Return of 
Organization Exempt from Income Tax, in 2008. The principal goal behind 
the redesigned Form 990 was to facilitate improved IRS compliance 
efforts. The Form was also intended to provide all interested parties 
with a clearer picture of a tax-exempt organization's activities, 
including those that further its exempt purpose and related party 
transactions. In an October 6, 2011 letter to the IRS, Chairman 
Boustany sought to assess whether the goals for the newly redesigned 
Form 990 have been achieved, the challenges the IRS faces with respect 
to compliance areas such as UBIT, and how the information required on 
the new form is being used. The hearing will, in part, follow up on 
this inquiry.
      
    In addition to the importance of continuing oversight by this 
Subcommittee of the IRS and the tax-exempt sector, the Committee is 
working on comprehensive tax reform. Thus, the hearing will also 
provide an opportunity to discuss how current issues for public 
charities may inform the Committee's ongoing tax reform efforts.
      
    In announcing this hearing, Chairman Boustany said, ``Given the 
size and scale of the operations of public charities, which in 2008 had 
over $2.5 trillion in assets, it is critical that the Subcommittee 
continue its review of the tax-exempt sector. Indeed, over the last two 
decades, the organizational structures of public charities have become 
increasingly complex, creating compliance and transparency issues. This 
hearing is an excellent opportunity for the Subcommittee to hear from 
the IRS and experts in the tax-exempt community. Their insight will 
allow the Subcommittee to better understand what is driving 
organizational complexity, and to learn about the new compliance 
efforts by the IRS and the UBIT rules.''
      

FOCUS OF THE HEARING:

      
    The hearing will focus on organizational and compliance issues 
related to public charities, including the increased complexity of 
public charity organizational structures, the rules governing profit-
generating activities giving rise to unrelated business income tax, and 
whether the newly redesigned Form 990 is promoting increased compliance 
and transparency.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
written comments for the hearing record must follow the appropriate 
link on the hearing page of the Committee website and complete the 
informational forms. From the Committee homepage, http://
waysandmeans.house.gov, select ``Hearings.'' Select the hearing for 
which you would like to submit, and click on the link entitled, ``Click 
here to provide a submission for the record.'' Once you have followed 
the online instructions, submit all requested information. ATTACH your 
submission as a Word document, in compliance with the formatting 
requirements listed below, by the close of business on Wednesday, July 
25, 2012. Finally, please note that due to the change in House mail 
policy, the U.S. Capitol Police will refuse sealed-package deliveries 
to all House Office Buildings. For questions, or if you encounter 
technical problems, please call (202) 225-3625 or (202) 225-2610.
      

FORMATTING REQUIREMENTS:

      
    The Committee relies on electronic submissions for printing the 
official hearing record. As always, submissions will be included in the 
record according to the discretion of the Committee. The Committee will 
not alter the content of your submission, but we reserve the right to 
format it according to our guidelines. Any submission provided to the 
Committee by a witness, any supplementary materials submitted for the 
printed record, and any written comments in response to a request for 
written comments must conform to the guidelines listed below. Any 
submission or supplementary item not in compliance with these 
guidelines will not be printed, but will be maintained in the Committee 
files for review and use by the Committee.
      
    1. All submissions and supplementary materials must be provided in 
Word format and MUST NOT exceed a total of 10 pages, including 
attachments. Witnesses and submitters are advised that the Committee 
relies on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. All submissions must include a list of all clients, persons and/
or organizations on whose behalf the witness appears. A supplemental 
sheet must accompany each submission listing the name, company, 
address, telephone, and fax numbers of each witness.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://www.waysandmeans.house.gov/.

                                 

    Chairman BOUSTANY. Welcome to this morning's hearing on 
public charities. This hearing is second in a series of 
hearings exploring tax-exempt issues and IRS compliance 
efforts. The focus of today's hearing is on 501(c)(3) public 
charities, the largest category of tax exempt organizations.
    In particular, for public charities, we are focused on 
transparency, compliance efforts, organizational complexity and 
commercial activities. Over the past several decades, public 
charities have become increasingly complex organizations. While 
universities and hospitals are notable examples of this, 
complexity has not been limited to these types of 
organizations. A number of factors have driven this trend, 
including the Federal tax law itself and the expansion of the 
types of exempt and commercial activities that public charities 
engage in.
    About a decade ago, there was a growing recognition that 
the Form 990, the Federal return used by most tax-exempt 
organizations, was not collecting the kind of information 
needed by the IRS or the public to understand the activities of 
this increasingly complex sector. To ensure a greater level of 
transparency across the sector, the IRS substantially 
redesigned the Form 990, rearranging how information is 
reported and expanding the breadth of information requested to 
draw out critical issues, such as related party transactions, 
governance and commercial activities.
    We will discuss today how the Form 990 was changed, whether 
those changes have promoted compliance and transparency. Today 
we have two panels that will help the Subcommittee explore 
public charity compliance issues, such as the redesigned Form 
990 sector transparency, organizational complexity and 
commercial activities. This exercise also will provide 
important information to the Subcommittee as it begins to look 
to the future and think about changes that will help tax-exempt 
organizations work most effectively to meet their goals. Now I 
am pleased to yield to my friend and colleague, the Ranking 
Member of the Subcommittee, Mr. Lewis, for purposes of an 
opening statement.
    Mr. LEWIS. Thank you, Mr. Chairman, for yielding.
    This is the Subcommittee's second hearing on tax-exempt 
organizations in this Congress. Today we will examine public 
charities and their complex structures.
    Public charities serve as an important role in our society. 
They often fill the gap between what the government can provide 
and Americans' basic needs. These charities feed our hungry, 
care for our sick and preserve our culture and the arts.
    As public charities become larger and more complex, I am 
concerned that they may be engaging in activities that are not 
part of their charitable mission. Some may be using for-profit 
subsidies to engage in business that is not related to their 
charitable mission. Some may be used in related organizations 
to engage in certain activity indirectly that they could not 
engage in directly.
    As we move toward tax reform, we should consider whether 
these rules are working as intended. I look forward to hearing 
from our witnesses today about these issues. I would like to 
learn more about how the Internal Revenue Service oversees 
nearly 2 million tax-exempt organizations with a budget of 
about $100 million and about 860 employees.
    I also look forward to hearing how the new Form 990 helps 
both the agents and the public oversee the activities of 
charitable organizations. And Mr. Chairman, I yield back my 
time. And thank you very much again for holding this hearing.
    Chairman BOUSTANY. Thank you Mr. Lewis.
    Chairman BOUSTANY. And next--I would like to say, first of 
all, we have two very distinguished panels today, who will be 
excellent witnesses as we delve into these issues. Today's 
witnesses have extensive experience studying or working with 
tax-exempt organizations, and their experience will certainly 
be very, very helpful as we examine the current state of the 
tax-exempt sector. Our first panel will be Deputy Commissioner 
Steven Miller.
    The Committee has received your formal statement, Mr. 
Miller. And as deputy commissioner for services and 
enforcement, we know that you are dealing directly with all 
these issues, the complexity of it, and so we are very eager to 
hear your testimony and to follow up with questions.
    So, Mr. Miller, you may proceed.

STATEMENT OF STEVEN T. MILLER, DEPUTY COMMISSIONER FOR SERVICES 
   AND ENFORCEMENT, INTERNAL REVENUE SERVICE, WASHINGTON, DC.

    Mr. MILLER. Thank you.
    Good morning, Chairman Boustany, Ranking Member Lewis, 
Members of the Subcommittee. My name, as indicated, is Steve 
Miller, Deputy Commissioner at the IRS.
    At the request of the Subcommittee, my testimony this 
morning will offer an overview of one segment of the tax-exempt 
community, specifically the 501(c)(3) charitable sector, and 
our role in regulating that community. Let me begin with some 
observations.
    First, the charitable sector deserves to be commended for 
its vital role in our society. Second, on the whole, we believe 
the charitable sector is or tries to be compliant with the 
Internal Revenue Code. Finally, the sector is incredibly 
diverse in size and function, ranging from store-front soup 
kitchens to large complex hospital systems. This means our 
approach in regulation has to be flexible.
    Currently there are more than 1 million section 501(c)(3) 
organizations. In the tax-exempt area, almost more than in any 
other area we cover, we serve more as a regulator and less as a 
revenue authority. In light of this, we have a balanced program 
which ensures that congressional intent is honored and that the 
public confidence in the integrity of the charitable sector is 
maintained. Our program is carried out, as Mr. Lewis says, by 
around 860 employees.
    Our approach in regulation is comprised of education, the 
determination letter process, Form 990 filing and a robust 
examination and review program.
    Let me touch on a couple of these. In our Determination 
Letter Program, which is in many respects a continuation of our 
educational efforts, we review the intended operations of 
organizations seeking exempt status. We receive more than 
50,000 applications a year for charitable status. Our 
specialists review them and, where appropriate, work 
individually with the applicant to ensure the organization 
understands and meets the requirements of the Code.
    Most exempt organizations also have an annual filing 
requirement and must file one of the Form 990 series returns. 
The Form 990 is a unique and essential part of our regulatory 
process. It is an information return made widely available to 
the public. We and other stakeholders use the information to 
review the operations of the organization. The 990 is also 
utilized by nearly 40 states to satisfy at least a part of 
their filing requirements. Given our limited resources, the 
Form 990 is particularly important. It allows the public to 
review, rate, compare and otherwise make their own decisions 
about organizations. Thus it promotes transparency and 
accountability.
    There has been much discussion of the Form 990 revision 
which we began in 2004. The basic format and content of the 
form had remained essentially the same since 1979, while the 
community had grown dramatically in size, variety and 
complexity. After two drafts were released to the public over 
several years and after hundreds of comments were received and 
acted upon, we made the form effective with a generous 
transition rule beginning with tax year 2008. The process 
continues as the law changes and as we continue discussions 
with stakeholders.
    The last aspect of our work I will mention is our robust 
and multi-faceted post-filing compliance program. We constantly 
seek more efficient and effective ways to conduct examinations 
or other reviews. And we continuously refine our selection 
criteria to help apply compliance resources where they are most 
needed.
    I will wind up by talking about some of our challenges. 
First, given the size, breadth and growth of the sector we have 
a great deal of ground to cover with the available resources we 
have. Secondly, this is a difficult area to regulate. That is 
because the law deals most often in general principles and not 
specifics. The lines are not bright. While this leaves a great 
deal of flexibility for organizations and how they operate, it 
also makes it harder to judge where noncompliance begins or to 
give the organizations the certainty that they need to operate 
within clear lines. Third, with some key exceptions, the 
current law gives us limited options when we find 
noncompliance. We are often left with the question of whether 
to revoke an organization's tax exemption. Revocation is a 
draconian step, one that may not be proportionate in any given 
case.
    Finally, the IRS role may at times not match the public's 
expectations. For example, it is difficult for the IRS to 
assess the quality of an organization's performance or measure 
its comparative worth. Thus it may be difficult for us to take 
action with respect to an organization that the public believes 
is not spending sufficiently on charity or is not doing a 
preferred type of charitable work. An example, the IRS cannot 
differentiate between an organization that gives out candy to 
flood victims versus one that distributes food or clothing. The 
IRS is neither equipped nor is it our role to make such 
determinations. The best we can do is make all the facts 
available for others to see and make their own decisions. That 
concludes my comments. Thanks for the opportunity to testify.
    Chairman BOUSTANY. Thank you, Mr. Miller.
    [The prepared statement of Mr. Miller follows:]

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    Chairman BOUSTANY. I failed to mention earlier that your 
full testimony will be made part of the record.
    You very succinctly outlined a number of challenges, both 
with some of the generalities of a law that create problems, as 
well as the rapidly growing nature of this sector, both in 
terms of size and complexity. The revision of the Form 990 was 
a multi-year process involving comments from hundreds of 
stakeholders. Clearly, it was a very important initiative of 
the IRS and the taxpayers. Can you describe the compliance 
issues that gave rise specifically to the revision of Form 990? 
Can you outline some of those?
    Mr. MILLER. Certainly, Chairman.
    In talking about how we dealt with the 990, as I mentioned 
in my testimony and is in my written testimony in more detail, 
we had not modified the form in any realistic way since 1979. 
In 1979, organizations were much simpler, they were much 
smaller. There was great diversity still, but it was a very 
different world. As it is in the corporate world, the world of 
nonprofits truly has changed over time. We did not have a good 
enough vision into things, such as compensation, things such as 
related organizations. What did the entire organization look 
like, in fact. We did not have a great deal of information on 
the largest of the organizations, colleges and universities, 
hospitals.
    So there were several areas that we did not have sufficient 
information really to regulate in and that as we revised the 
form decided to try to----
    Chairman BOUSTANY. So these were some of the areas that 
were targeted from a compliance standpoint?
    Mr. MILLER. These were areas that we saw huge amounts of 
resources in the sector dedicated to, and we did not have a 
good enough vision into what was happening there.
    Chairman BOUSTANY. With regard to the Form 990, are you 
satisfied with the progress, the type of information coming in, 
and from an administrative standpoint, has it been something 
that has worked both ways? In other words, you are able to 
collate this data and use it effectively?
    Mr. MILLER. So I think it has been a success. I also think 
it is an ongoing effort. I absolutely don't want anyone to come 
away from this thinking that we are done, that we haven't--what 
we did--I will do it in three parts.
    First, was it necessary? I think it absolutely was, and I 
don't think you will get any argument about that.
    Second, did we engage in an extensive discussion with the 
industry? Absolutely did. It started in 2004 for a 2008 return, 
put out two drafts, significantly modified the second draft 
specifically for the comments that were made. So I think if you 
talk to folks they will say, yes, it was a participatory 
process. Are we done? Is there too much burden on some of it? 
Probably, is the answer to that, unfortunately. It has got to 
be a living document, and we need to talk to folks and look at 
what they are saying in terms of have we gotten it right. 
Because I think we have, but by no means is the discussion 
over.
    Chairman BOUSTANY. Thank you. Now I would like to pivot to 
a different issue and look at some of the compliance challenges 
with regard to unrelated business income tax. The unrelated 
business income tax rules are an ongoing source of confusion 
and certainly a challenge from a compliance standpoint. Can you 
describe for the Committee the types of compliance challenges 
the IRS faces in enforcing UBIT and how the redesigned Form 990 
addresses some of those concerns?
    Mr. MILLER. So this is probably less about the redesign 
than it is about a general rules here. We have several problems 
and issues in addressing the Form 990-T, which is actually the 
form that gets used here. There are three generalized 
requirements for what is unrelated, and it starts with is it 
regularly carried on? Is it a trade or business? These are 
things that we sort of can deal with. The third one, is it 
substantially related? And that is a remarkably difficult and 
soft sort of issue to deal with. Is it related to have a gift 
shop sell postcards of things that are in the museum that is 
attached to it? These are the sorts of issues that we actually 
have to parse through in dealing with that particular issue. 
Other issues also exist in the area. A key issue is exactly 
what expenses are taken against the unrelated business income, 
especially where there are indirect expenses being taken. Those 
are things that are very hard I think for the taxpayer to do 
and very hard for us to do as well. So those would be the two 
things that are mainly our issue: What is substantially 
related, and how do you deal with expenses, in particular 
indirect expenses?
    Chairman BOUSTANY. Is there any move on the part of IRS to 
start looking at revising some of those regulations, looking at 
those definitions and the complexity there?
    Mr. MILLER. I think it would be good if we had the 
resources to do that. I don't think that right now we are 
looking at that. It is not at the top of our list of things 
that we can get to, to be honest with you.
    Chairman BOUSTANY. From your standpoint, do you think--is 
there anything Congress needs to do from a legislative 
standpoint to provide more clarity with regard to some of those 
areas that are murky?
    Mr. MILLER. I am more than happy for us to talk to staff on 
that issue. I don't know of anything off the top of my head. As 
I said, substantially related is just a very difficult, 
difficult concept.
    Chairman BOUSTANY. Right. And I know there is a multi-step 
process as you work through the Form 990 and sort of working 
through your entire compliance process. How does the IRS 
determine whether an audit related to UBIT is warranted?
    Mr. MILLER. So we will be looking at the Form 990 itself to 
see what an organization is doing. And then we receive about 
40,000 to 50,000 Form 990-Ts. And that is where a particular 
organization will outline all of the necessary information that 
it has done in order to calculate whether it owes unrelated 
business income tax. We will be looking at both of those in 
order to make that determination.
    Chairman BOUSTANY. Were there any particular red flags that 
an auditor would--you know, that would prompt an auditor to 
take a closer look at a public charity, for instance?
    Mr. MILLER. I don't off the top of my head know what a red 
flag would be in this area, and I am not sure I would throw it 
out for public discussion.
    Chairman BOUSTANY. I understand. All right. Thank you. That 
is all I have.
    Mr. Lewis, you are recognized for questions.
    Mr. LEWIS. Thank you, Mr. Chairman.
    Mr. Miller, thank you for being here today, and again 
welcome.
    I must tell you that I am deeply concerned about the IRS' 
ability to oversee about 2 million tax-exempt organizations 
when your budget has been cut. Public charities alone have over 
$2.5 trillion in assets and $1.5 trillion in revenue each year. 
I understand that the funding and number of employees for the 
exempt organization division have been cut this year. Are you 
trying to do more or the same with less? Could you explain to 
the Committee?
    Mr. MILLER. Certainly, Mr. Lewis. Across the service, we 
have had to face decisionmaking with respect to a declining 
budget over the last couple of years. Probably at its height, 
in recent years, the exempt organizations division had about 
950 people, 940, 950 people. We are down to about 860. We will 
be down from there by the end of this year.
    We are trying to maintain current levels as best we can, 
but it has been a challenge. Now we are getting smarter, I 
hope, with the types of things that we do, and we have 
efficiencies that we are doing. But it is a challenge, as it is 
across the service.
    Mr. LEWIS. Could you tell me how many tax-exempt 
organizations exist?
    Mr. MILLER. We have--I think the latest data that I have 
publicly available is about 1.85 or something like that million 
organizations, 1.3 of which are 501(c)(3) organizations. Now, 
those are somewhat dated numbers, but that is roughly right.
    Mr. LEWIS. Now you have less money, right, you have less 
money?
    Mr. MILLER. We do.
    Mr. LEWIS. Less resources, fewer employees to monitor and 
oversee the sector. Given the IRS budget constraints, how does 
the IRS oversee this sector--or do you think you are doing the 
best possible job with less money and less employees? Is 
something falling through the cracks? Are we missing something?
    Mr. MILLER. Mr. Lewis, I would be obviously remiss if I 
didn't take you up on the opportunity to ask for more 
resources, which we could certainly use.
    Do I believe we are missing something? I don't believe so. 
I believe we have to be efficient in the way we do business. 
But we certainly could use more resources. This sort of toggles 
back, Mr. Chairman, to your discussion of the Form 990. We have 
always been somewhat understaffed in this area. That has not 
changed. We are a little more understaffed than we were. We 
have always relied upon the transparency of the annual 
reporting to leverage other folks taking a look, finding 
problems, coming to us with the problems. That has always been 
a help to us and an essential part of our regulatory regime in 
the exempt organizations area.
    Mr. LEWIS. Thank you very much, Mr. Commissioner.
    Thank you, Mr. Chairman.
    Chairman BOUSTANY. I thank the gentleman. Lest anybody 
thinks this is quite as simple as just simply improving 
resource allocation, I think we also have to mention the 
complexity of tax law. And in the spirit of moving forward with 
the tax reform, I am hopeful that our Full Committee in a 
bipartisan way will be able to move forward with the tax reform 
to lend greater clarity to the Tax Code, but also simplicity 
that will make compliance easier. With that, I will yield to 
Ms. Jenkins.
    Ms. JENKINS. Thank you, Mr. Chairman, and thank you for 
holding this hearing.
    Thank you for being here Mr. Miller. What is the process 
for an organization that applies to be a public charity? I am 
aware that you submit a Form 1024 and that begins the 
application on a review process. But what are the specific 
steps an applicant can expect.
    Mr. MILLER. So, actually, if you are talking about a public 
charity it would be a Form 1023 that has to be filed by all, 
with the exception of very small organizations and churches and 
church affiliates. But an organization would prepare the Form 
1023, which basically outlines its prospective operations. What 
are its budgets going to be? What are its activities likely to 
be? Who is going to run the organization? What are they going 
to be paid? All of these things so that we can take a look to 
see whether they meet the requirements. Those are filed with us 
in Cincinnati, Ohio; Covington, Kentucky, and are reviewed in 
our Cincinnati office by specialists. Some are very easy. If 
they are small organizations, they don't get a very detailed 
look. We look, we say, okay, this seems right. Some may be very 
simple but are being done by folks who don't really have 
experience. Those may take a little longer because we will work 
to have them understand exactly what their obligations are and 
what their rights and responsibilities are as a tax-exempt 
organization. Some come in and they are doing things that 
either are close to the line, impermissible, unclear as to 
which of those two that they might be and those may take a 
longer time still, and they will be referred to specialists in 
Cincinnati and elsewhere that will take a look to justify it 
and see whether or not the organization qualifies as a public 
charity.
    Ms. JENKINS. Okay. Has the revision of the Form 990 led the 
IRS to approach the application process any differently?
    Mr. MILLER. I don't believe so. I will say that our 
advisory Committee, which is a batch of specialists outside of 
the IRS, has come back and said, what you have done with the 
990, you probably should do with the 1023. And so at some 
point, we probably will take a good hard look. We did redesign 
the 1023 in advance of the 990. It is probably time to take 
another look at it.
    Ms. JENKINS. Okay. Once an organization is approved as a 
public charity, can you explain how the IRS ensures that the 
organization remains in compliance and how do you ensure that 
the organization continues to engage in activities that further 
its exempt purpose?
    Mr. MILLER. So the primary way of our doing that would be 
through the Form 990, through the annual filing requirement of 
the organization. And I mention there is a series of possible 
forms. The very smallest organizations, which have less than 
$50,000 in receipts in a year, they are filing a postcard with 
us, an electronic postcard, with like six items as to, okay, 
how do we contact you and where are you. It is sort of a fact 
of filing so that we can maintain our records in an intelligent 
fashion. There is also a 990-EZ which is a shorter form of the 
990, which if you have less than $200,000 in gross receipts or 
half a million in assets, you will be filing that with us on an 
annual basis. And then there is the Form 990 that was the 
subject of the large scale redesign for larger organizations. 
And that really is the way we can take a look at these 
organizations across the country and see whether they are 
meeting the requirements.
    Ms. JENKINS. Okay. Thank you.
    Mr. Chairman, I yield back.
    Chairman BOUSTANY. Thank you.
    The chair now recognizes Mr. Kind for 5 minutes.
    Mr. KIND. Thank you, Mr. Chairman, and thanks for holding 
this hearing today. I think it is very important because it is 
such a fast moving area of IRS jurisdiction and oversight that 
I think it is incumbent on the Committee to pay a little more 
attention to. I appreciate your willingness to do so.
    Mr. Miller, almost 2 million tax-exempt organizations; 
obviously, Representative Lewis expressed concern about funding 
and resources and personnel in order to deal with such large 
numbers, and now we are starting to see a lot of tax-exempt 
organizations engaging in blatant political activities. I mean, 
how much is the IRS capable of reviewing these type of 
activities to make sure that these organizations are complying 
with the law, they are meeting their charitable purposes and 
that, given the plethora of other tax-exempt organizations that 
you have to keep an eye on as well?
    Mr. MILLER. Well, we do maintain, and again, we are talking 
about public charities here, we do maintain a process by which 
we take a look at organizations that are either referred to us 
or come up in the papers as having done these sorts of 
political activities in the 501(c)(3) area. Those referrals, 
that information, will make its way to our Dallas office, which 
is the examination function, where a team of three individual 
careerists will take a look and determine, is there enough here 
to start an audit or not? So we do maintain a program in that 
area.
    Mr. KIND. A lot of the casework that I see, I don't know if 
my colleagues share this observation, but it is dealing with 
smaller charitable organizations back home trying to obtain 
tax-exempt status and helping them navigate, make sure they are 
legally compliant and doing everything that they need to do. 
Given the lack of resources that Mr. Lewis just pointed out, 
are you still able to provide sufficient service for the 
smaller charitable organizations and helping them comply with 
the law and everything that they need to do?
    Mr. MILLER. So we are trying, is I think a fair answer to 
that question. Could we do more? Absolutely. We are trying by 
putting more of our work on our Web site so that organizations 
can reach out. I would like to do more small, small 
organization conferences. Right now, that is not really the 
most efficient use of the resources that we have. But our Web 
work is good. We have also begun to partner with local 
educational institutions, universities and such, to try to have 
them take the lift and bring small organizations together so 
that we can get our word out that way as well. So we are 
trying.
    Mr. KIND. Also, the redesigned 990 now has a new schedule 
R. Why was that necessary and how does that help you perform 
your functions?
    Mr. MILLER. So the R, unless I am mistaken, is the related 
entity schedule. And that was essential we think because we 
needed to see--we needed to have a window into what the entire 
organization looks like. A hospital system is more than an 
individual corporation. A college and university is more than 
the very college or university itself. It is an endowment. 
There are numerous things around that organization that we sort 
of needed to take a look at. I will say it is probably one of 
the areas that we should be talking to people about. Is it too 
much information or too many people having to do that?
    It is worth the discussion. It is one of the areas that we 
are beginning to hear maybe there is burden there that we can 
alleviate. But the concept is essential because the largest 
organizations, you need a complete window into what the 
organization looks like, what the web of organizations is.
    Mr. KIND. All right. Great. Thank you.
    Thank you, Mr. Chairman.
    Chairman BOUSTANY. Thank you, Mr. Kind.
    Before I go to Mr. Marchant, I have a quick question I 
would like to ask you, Mr. Miller, in follow-up to Ms. Jenkins' 
questioning. And that is, can you comment on whether the 
thresholds make sense with regard to the different forms? I 
mean, or should that be revised?
    Mr. MILLER. So I am open to the discussion.
    It was placed there basically in conjunction with the 
discussion with the States who are using these numbers as well, 
but it is one of the things we ought to talk about. So 
originally, there was no filing requirement for organizations 
with $25,000 or less in gross receipts. The Pension Protection 
Act of 2006 modified that and said, no, everybody has to file. 
We moved that group up to $50,000. And we also modified the 
other numbers a bit as well to try to provide some relief from 
what we knew was going to be a somewhat more burdensome 990. We 
are open to the discussion as to whether those thresholds are 
correct.
    Chairman BOUSTANY. Fair enough.
    Mr. Marchant, you are recognized.
    Mr. MARCHANT. Thank you, Mr. Chairman.
    In my discussion this morning, I would like to focus on 
some of the smaller local groups that are claiming tax-exempt 
status. And these are groups that are unapologetically 
politically involved. I mean, in fact, they were formed around 
that idea. What would a small group in a suburban town that 
might have 60 to 80 Members, what is the most likely 
organizational tool that they would file in order to be tax 
exempt?
    Mr. MILLER. Are these organizations coming in as 
501(c)(3)s, or would they be coming in as 501(c)(4)s?
    Mr. MARCHANT. I think that is my question. What would be 
the most efficient as far as compliance goes?
    Mr. MILLER. So if they are really doing politics, 
Congressman, they really can't be a charitable organization 
under the Internal Revenue Code.
    Mr. MARCHANT. So would they be a tax-exempt organization?
    Mr. MILLER. So they could be one of a couple of things. 
They are permitted to have some politics in their business if 
they are a 501(c)(3) social welfare organization, although they 
need to primarily be engaged in other than politics. They can 
do some work if they are a labor union to qualify that way or 
as a trade association. Those are also able to do some 
politics.
    But really, if all they are going to be doing is politics, 
then they probably should be a political organization, that we 
would describe under section 527, a PAC.
    Mr. MARCHANT. And so if they don't file for the 527 PAC 
designation, many of these groups are now contacting our 
offices. I can speak for myself. I have been contacted by 
several of the groups in my district. And they feel like they 
are being harassed. I don't have any evidence that that is the 
case. But they feel like they have been harassed and feel like 
the IRS is threatening them with some kind of action or audit. 
What kind of a letter or action is taking place at this time 
that you are aware of?
    Mr. MILLER. So if we are talking about social welfare 
organizations, (c)(4)s, 501(c)(4)s, then we did receive quite a 
few. We received an uptick, an increase in the number of (c)(4) 
organizations that were advocacy organizations, they were 
advocating on various things, which is a fine thing for a 
501(c)(4) to do. It is politics that isn't really considered to 
be appropriate 501(c)(4) behavior past a certain threshold 
because they can do politics. And what is politics also, 
Congressman, is, you know, it may not be what you and I would 
think of politics as; it is politics under the Internal Revenue 
Code, which is really campaign intervention. It is endorsing or 
arguing against a particular candidate for public office, that 
is politics.
    So you know I am aware that there is an uptick of 
organizations that came into us for exemption. So it was the 
determination letter process, not the examination process.
    I am aware that some 200 501(c)(4) applications fell into 
this category. We did group those organizations together to 
ensure consistency, to ensure quality. We continue to work 
those cases.
    My understanding, Congressman, is something over 50 of the 
200 have received exemption already, more will. But many of 
these organizations fall into the category that I was talking 
about with Congresswoman Jenkins, where they are very small 
organizations and they are not quite sure what the rules are, 
and so we are working with them to ensure that they understand 
what the rules are. It is my hope that some of the noise that 
we heard earlier this year has abated as we continue to work 
through these cases.
    Mr. MARCHANT. Yes, we have had many constituents call, and 
there is a lot of blog activity. There is a lot of activity on 
the Internet talking about potential legal fees in the hundreds 
of thousands of dollars in fines in this group. So what is the 
potential if a group crosses over the line from being advocacy, 
advocating certain policy, over into the endorsement, the 
campaign endorsement realm?
    Mr. MILLER. So if they are coming in for application to be 
recognized as a social welfare organization, and they don't 
receive that recognition, then they would just not be a tax-
exempt organization.
    Mr. MARCHANT. So what about organizations that have already 
received the recognition but somewhere along the way have 
shifted their emphasis to where--is there an audit process?
    Mr. MILLER. There would be an audit process to determine 
what was their primary activity. Was their primary activity 
good 501(c)(4) work, societal benefit, community benefit, 
social welfare or something else. And the something else could 
include much more than politics. It is just non--and so if we 
found that they were not primarily engaged in social welfare 
activities, we would revoke their exemption or work with them, 
as we do oftentimes, to move forward in an improved way.
    There also would be under the tax rules some possible tax 
based on the lesser of net investment income that they had or 
the political expenditure itself under the Code.
    Mr. MARCHANT. Thank you, Mr. Chairman.
    Chairman BOUSTANY. Thank you.
    I thank the gentleman. Mr. Becerra, you are recognized for 
5 minutes.
    Mr. BECERRA. Thank you, Mr. Chairman.
    Mr. Miller thank you for being here. Is there a section on 
Form 990 that requires a social welfare organization to 
document what portions of that organization's activity or 
portions of those activities are devoted to political activity 
specifically?
    Mr. MILLER. Yes, sir, I believe there is.
    Mr. BECERRA. And does the IRS have a bright line in terms 
of how much of that 501(c)(4)'s activities can be spent as 
political expenditures?
    Mr. MILLER. We do not have a bright line, no.
    Mr. BECERRA. Does the IRS plan to try to provide better 
guidance to 501(c)(4)s as to at what point that bright line is 
crossed?
    Mr. MILLER. So we have received obviously some inquiries, 
both from your colleagues and from others in the community, to 
look at the area. I don't think we have made a decision as to 
whether to do guidance one way or another, but we have agreed 
to take a look and have that discussion.
    Mr. BECERRA. So for any organization that is looking to 
stay within the law and also wants to engage in some aspect of 
political activity, what guidance would IRS give that 
organization?
    Mr. MILLER. Well, they ought to get professional help, 
obviously, because this is not a----
    Mr. BECERRA. We know they need professional help.
    Mr. MILLER. We will move on from that.
    So the general rule, as I was mentioning to Mr. Marchant, 
the rule is that a 501(c)(4) organization must be primarily 
engaged in activities that further and promote community 
benefit, social welfare. We have been asked to primarily test a 
bright line, and we don't believe it is. It is not a 
qualitative test--or rather it is a qualitative test versus 
quantitative. We would be looking at things like expenditures. 
We would be looking at things like staff time, including 
volunteer time. We would be looking at what dollars are being 
devoted to this activity, what dollars are being derived from 
this activity, what sorts of assets are being dedicated to this 
outside of fixed assets, what kind of building and equipment. 
All of those things would come into sort of the conversation. 
And that guidance is sort of out there in terms of both court 
cases and revenue rulings to give people sort of a guide way to 
make that determination on their own.
    Mr. BECERRA. Now, what about this whole notion that social 
welfare should be the principal purpose of the activities of 
some of these 501(c)s, (c)(4)s, (c)(3)s and so forth, and the 
fact that it seems like some of these 501(c)(4)s are stretching 
what might be considered social welfare to the point where it 
is blurred and it looks nothing like a social welfare activity 
that most Americans would reasonably think can be applied to 
that term.
    Mr. MILLER. So, again, the general rule would be a 
501(c)(4) organization can do campaign work, but it must be 
primarily engaged in social welfare activities, and it can't 
operate for the private benefit of a select group.
    To your point, first, there is no bright line, and we would 
take a look at organizations that were involved in politics.
    Secondly, this is an area obviously that for us is somewhat 
difficult, because for a 501(c)(4) organization, when I talk 
about how do you calculate out the primarily test, you look at 
the entire year. So the fact that an organization is doing 
something today might be relevant to the inquiry, but it is not 
the end of the inquiry. The inquiry is, what are your 
activities for the year? What did you do, and how much of it 
did you do? So it is almost always going to have to be after 
the year is up that we have sufficient information in a 
501(c)(4) context to make a determination as to whether there 
is a problem or not.
    Mr. BECERRA. And do you have the resources and staff to try 
to monitor and oversee all the different 501(c)(4)s and how 
they apply that social welfare test?
    Mr. MILLER. We could always use more resources. I believe 
we have sufficient resources if we decide to place them in the 
places we need to place them, is sort of the answer there, 
Congressman.
    Mr. BECERRA. I will try to decipher that answer. Thank you 
very much.
    I yield back Mr. Chairman.
    Chairman BOUSTANY. I thank the gentleman.
    This hearing is really intended to focus on the public 
charities and the (c)(3)s. I know the activities with (c)(4)s 
is an issue, and it is something we will get to down the line. 
But right now with this hearing, I wanted to keep the focus on 
the (c)(3) organizations and the complexities with regard to 
organizational structure, UBIT, and some of the vagaries that 
attend those issues and the problems that arise as a result. So 
I appreciate the gentleman's questioning, but hopefully, we 
will keep it to the public charities.
    Mr. Reed.
    Mr. REED. Well, thank you, Mr. Chairman.
    I was going to continue on that line of questioning, but I 
will back off to another day.
    But I am interested at some point in time if you could, Mr. 
Miller, get to my office, you referenced three careerists who 
make these decisions on political activity or not. I would like 
to know who they are, how they are appointed, what their tenure 
is and what the process is that they use to adjudicate whether 
or not it is a political activity. Do you mind doing that for 
me?
    Mr. MILLER. As to the names, I will have to see about that 
one. Mr. Reed, these are careerists, these are lower graded 
folks who are managers, group managers at some point, and they 
cycle in and out. It is not only a--it is not one single three 
person.
    What we have tried to do in the area is make sure that one 
individual at the service can't start an examination that is a 
politically charged type of examination.
    Mr. REED. But if I understand your testimony, there are 
three individuals that are kind of the sounding board.
    Mr. MILLER. There is a referring committee that as a normal 
course of its business and under established procedures of the 
Internal Revenue Service receive referrals, evaluate the 
referrals.
    Mr. REED. That is what I would like to get to. I am new 
here, so how you operate and what the background is.
    Mr. MILLER. I would be glad to walk you through the 
referral process.
    Mr. REED. I really do appreciate that. It is more of an 
educational exercise for me and making sure that we are aware 
of it and getting up to speed on it.
    But I do want to challenge you on one thing, Mr. Miller--
and I appreciate the work you do. I totally appreciate what the 
IRS is under and the burden that the IRS faces with managing 
the whole tax issue and revenue job mission that you have for 
America.
    But many witnesses come up here and they state a conclusion 
to us, and you have stated it again today. You have stated that 
you are understaffed. And my colleagues on the other side have 
raised that issue repeatedly. I want to know from you as a 
deputy commissioner, a leader of a large organization, how do 
you determine that conclusion? Are there metrics? I mean, is 
your goal then--and then also the flip side of that, what is 
fully staffed? I can't imagine you are advocating to have 2 
million IRS employees added to monitor one for one each of the 
organizations. So obviously to illustrate my point, I am taking 
it to the extreme.
    So I want to understand what allows you to state that 
conclusion to us as Members of Congress that you are 
understaffed? What is not getting done that should be getting 
done? And what is your definition of fully staffed?
    Mr. MILLER. So I will start with what I don't have. I don't 
have a definition of fully staffed. Congress determines what 
our full staffing is. Are we understaffed? We have enough 
people to do the job we need to do. Could we use more? 
Absolutely, Mr. Reed. The way I would like, and it is not only 
staffing, right, it is IT money as well, I would like, I would 
very much like, especially for small organizations but for all 
organizations, to modernize the way they fill out an 
application form, to sort of have a 1023 that is online that 
they can fill out easily with help along the way, not unlike 
the tax software that we all sort of use; what does this mean, 
and there will be information right there for them to pull down 
and get that information. I would love to be able to build that 
system. And I would like to be able to say to you that I have 
better and more robust number of examinations that I am doing 
relative to the 1.3 million organizations that are out there.
    So my metrics are difficult, but my metrics would be how 
many people contacted my various education sites; how fast did 
I do my work for people, customer satisfaction again; how many 
people was I able to touch in a compliance fashion to try to 
influence future behavior by the whole of the group and not 
just the people that I touched; and am I doing enough of those? 
And I would say that it is close, Mr. Reed, it is close on that 
one. But those are the sorts of metrics we would look at.
    Mr. REED. And I appreciate that. So my takeaway is that 
essentially, from your testimony and just correct me if I am 
misunderstanding it, is that right now staffing resources, 
making do, you would like to have more, you would love to have 
more, I believe is your testimony, which I can appreciate, but 
you are making the best of what you have and you seem to be 
hitting the targets of the metrics of doing your job. And so is 
that a clear understanding of your testimony?
    Mr. MILLER. So the last bit of it I would say we are 
getting to the point where I think it is taking us a little too 
long to get to determination letter requests. I think we may 
not be doing everything we need to do in the educational area. 
And we are getting to the point where I would worry about our 
coverage rate in the exam area. But I am not going to quibble 
with the discussion. That is roughly right.
    Mr. REED. Okay. Thank you. I appreciate that, Mr. Miller.
    I appreciate the candor. With that, I yield back.
    Chairman BOUSTANY. Thank you, Mr. Reed.
    Mr. McDermott, you are recognized for questions.
    Mr. MCDERMOTT. Mr. Chairman, I appreciate that you wanted 
to be on (c)(3)s, but some of my colleagues have gone down 
another alley. And I see--first of all, I want to ask a 
question.
    Chairman BOUSTANY. Mr. McDermott, you don't have to make 
the same mistake.
    Mr. MCDERMOTT. I think emulation is the high pride of 
authorship. One of the things that is raised here is, are you 
doing your job? You didn't mention audits. You sort of 
obliquely did, that is to get people to you know sort of do 
what ought to be done in the future. But if you don't have a 
lot of people, you just don't audit people. That is the place 
where you make cuts, right?
    Mr. MILLER. That and in the determination letter process. 
There is education, there is----
    Mr. MCDERMOTT. You can't avoid that. If they call in asking 
questions, you got to answer them, right?
    Mr. MILLER. Well, I would like to reach out more. I would 
like to have people available to reach out to these folks 
rather than wait for the questions.
    And the determination letter process is a customer-driven 
process. You will come in to me with a 1023 or a 1024. I have 
to work that case. How fast I work it will depend on how many 
folks I have. And as the folks dwindle, that will suffer as 
well. So it is more than just exam, but exam clearly is part of 
that.
    Mr. MCDERMOTT. And if you have these targets and something 
pops up to be audited, do you audit 100 percent of those people 
whose names come up along because of what something in their 
account?
    Mr. MILLER. We never did, and we never will audit everybody 
who comes onto our radar screen. We have to make intelligent 
decisions about how far we can go based on resources and other 
topics.
    Mr. MCDERMOTT. Do you get back money when you audit?
    Mr. MILLER. So we do get back some money. As I indicated in 
my oral testimony, Congressman, we regulate here more than 
derive revenue from the sector. We seek to protect the 
investment that the U.S. Government has made in the tax-exempt 
sector. Mr. Lewis spoke about the amount of revenues. Mr. Lewis 
spoke about the amount of resources, the $2.5 trillion in 
assets that sit out there. We are there to sort of ensure not 
that we take more of that $2.5 trillion, but that it is being 
utilized within congressional intent.
    Mr. MCDERMOTT. When people fight back against you, I walked 
in here and the discussion was about the Tea Party and the 
Richmond Tea Party, and I am looking at the letter that you 
have and these questions--provide a resume for each Member of 
your governing body, and provide copies for all your 
newsletters, provide promotional literature developed by your 
activist committee, provide a list and description of specific 
events. What is unreasonable about those questions? They say 
you are being unreasonable in asking for these. Do you think 
those are unreasonable questions?
    Mr. MILLER. So I am not going to speak to the specifics of 
any given case because I can't.
    Mr. MCDERMOTT. Right.
    Mr. MILLER. We ask questions. And in the cases that we 
talked about, we asked a series of questions. We also went back 
afterwards and said, by the way, if these questions are too 
much for you, let's talk. And that is what we did in this case.
    Mr. MCDERMOTT. So these questions, this is kind of a 
standard letter here I have, which you send out to anybody you 
audit--or you are questioning their exemption, is that correct?
    Mr. MILLER. So I don't know the letter that you are looking 
at, Congressman, so I can't say. But we don't send out a 
standard letter to everyone in any event.
    Mr. MCDERMOTT. It is from the IRS, dated 9-17-2010. And it 
is to this organization, and dear sir or madam. So it sounds 
like it is a kind of a standard letter.
    Mr. MILLER. It might have been standardized to a group of 
cases, sir, but I can't really speak to this.
    Mr. MCDERMOTT. If they call in and say, this is too 
burdensome for us, we can't do it, do you then talk to them 
orally. Well, how do you do that? Get them into the office or 
over the phone?
    Mr. MILLER. So these are almost always going to be over the 
phone because our folks generally are going to be in 
Cincinnati, and a lot of organizations aren't and don't have 
the ability to either hire somebody to wander over to 
Cincinnati or come themselves to Cincinnati. These are almost 
always a review of paper and additional letters that go out, 
like the one you are talking about, and responses and a 
discussion on the phone in conference of right if we are going 
in a particular direction. But these are more office audits 
than they are sort of a field audit.
    Mr. MCDERMOTT. And from that, you make a determination as 
to whether they are doing social activities?
    Mr. MILLER. Whatever the particular requirements are----
    Mr. MCDERMOTT. Under a (c)(3).
    Mr. MILLER. So under (c)(3), it would be, are they 
charitable, and do they have a charitable purpose? Under 
(c)(4), we would be looking at what they are doing, and does 
that promote social welfare? Different requirements for 
different code sections.
    Mr. MCDERMOTT. And is the standard for promoting social 
welfare--my time is up. I would like to see the standard. If 
you would send us the standard you use for determining social 
welfare.
    Mr. MILLER. Surely. We can do that, sir.
    Mr. MCDERMOTT. Thank you.
    Chairman BOUSTANY. I thank the gentleman.
    Mr. Paulsen.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    And thank you, Commissioner, for being here. I want to ask 
a question on a slightly different subject as well because we 
have heard a great deal from the IRS about a realtime tax 
system. And there have been a number of public meetings that 
have taken place on this issue. And many are concerned that 
this type of a filing system could lead to a very burdensome 
reporting component, similar to what we saw in the 1099 debate 
that took place not too long ago. And I think this would be a 
nightmare for American companies, for businesses, whether you 
are small or large, and the IRS is going to now make this 
realtime system work. If you are going to make this realtime 
system work, I am sure you are going to want to have all the 
data earlier to collect information than is required today, you 
are probably going to want to have more 1099 data. Just looking 
at what has been discussed today, it seems that compressing the 
report and timeline and potentially increasing the reporting 
requirements would make an already onerous process even more 
onerous or more burdensome.
    And I sent a letter not too long ago, I think the Chairman 
followed up and sent a letter as well to Commissioner Schulman, 
about the realtime taxes a few months ago. I haven't heard 
back. But can you help get a response to that in particular in 
looking at that, and do you have some comments on the realtime 
tax?
    Mr. MILLER. So we will certainly look at getting a letter 
back to you all. On realtime, let me just say a couple of 
things. First, we are very far away from making any decisions 
that would move up or even draw a picture of what this might 
look like. But the conversation--we can't be scared of the 
conversation, because the concept of our having and the 
taxpayer having the information available earlier, we can't shy 
away from that conversation because it is an important area. 
And in a perfect world, all that information would be 
available. It would be available for us to make a decision 
around whether the refund was a good refund or a bad refund 
going out. And it would allow us to go back and say up front, 
by the way, you know, we have information that indicates you 
should have X here versus X minus Y here, do you want to work 
through that and finalize a return?
    But what I would say, again Congressman, is we are very far 
away from any sort of decision as to what exactly this would 
look like. What we are doing at this point is building 
scenarios as to what this might look like for a given taxpayer? 
We will then engage the public again and throughout this entire 
process, which will be a multiyear process.
    Mr. PAULSEN. So you say you are far away; you are building 
scenarios. Do you believe that the creation of such a system 
under it is authorized right now under the IRS charter?
    Mr. MILLER. It depends what the system looks like. If we 
were moving the filing date, no, it wouldn't be. That is a 
legally set date. Certainly there would be discussions with the 
Hill before we move forward with anything that even remotely 
touched on those issues.
    Mr. PAULSEN. So you believe you need to have congressional 
authorization for those types of changes?
    Mr. MILLER. For some of the changes, absolutely.
    I also want to say, you know, and there has been concern 
about this, this is not in order to send out pre-filed returns, 
that is not really what we are talking about here. And I know 
there has been concern by some in the industry that this is a 
stalking horse for that. It simply isn't.
    Mr. PAULSEN. Do you have any sort of estimates on what the 
cost would be, because given that we are talking about I had 
heard some conversation and testimony about resources and 
employees and staff and how--the intention--to be--to pay for 
that or what the cost would be on a realtime system for 
preparing for that as well?
    Mr. MILLER. So absent a blueprint of what it would look 
like, we have no way of doing a cost estimate at this point, 
sir.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    I yield back.
    Chairman BOUSTANY. Thank you, Mr. Paulsen.
    That concludes our questioning, Mr. Miller, and we thank 
you for coming before the Committee once again, and I look 
forward to future visits, and this Subcommittee particularly 
looks forward to working with you going forward to resolve some 
of these issues.
    Mr. MILLER. Thank you.
    Chairman BOUSTANY. I would like to call up the next panel. 
Next we have four witnesses on our second panel, all 
distinguished witnesses who will lend some clarity to this 
debate. We will hear from Eve Borenstein.
    Ms. Borenstein is a partner with Borenstein and McVeigh Law 
Office in Minneapolis, Minnesota, and is known as the queen of 
the 990.
    So we welcome you.
    Second, we welcome Mr. Thomas Hyatt. Mr. Hyatt is a partner 
with SNR Denton here in Washington and is chair of SNR Denton's 
health care practice focusing on tax-exempt organizations.
    Sir, welcome.
    Thirdly, Mr. John Colombo.
    Mr. Colombo is the Albert E. Jenner, Jr., Professor at the 
University of Illinois, College of Law, in Champaign, Illinois. 
And Mr. Colombo has written extensively on tax-exempt 
organizations.
    Mr. Colombo, thank you for being here today.
    And finally, we will hear from Donald Tobin. Mr. Tobin is 
associate dean for faculty and the Frank E. and Virginia H. 
Bazler Designated Professor in Business Law at the Ohio State 
University's Moritz College of Law in Columbus, Ohio. Mr. Tobin 
is an expert on campaign finance law and previously worked on 
the Joint Economic Committee.
    Mr. Tobin, welcome.
    You will each have 5 minutes to given us your oral 
testimony. Keep in mind that your full written statements will 
be made part of the formal record, and so I ask you to keep 
your oral comments to 5 minutes so we can get to questions.
    Ms. Borenstein, we will begin with you.

STATEMENT OF EVE BORENSTEIN, BORENSTEIN AND MCVEIGH LAW OFFICE 
                  LLC, MINNEAPOLIS, MINNESOTA

    Ms. BORENSTEIN. Thank you Chairman Boustany, Ranking Member 
Lewis, Members of the Committee.
    I thank you for inviting me to testify today. I do not 
elaborate in my written submission as to why I believe that the 
redesigned Form 990 for the most part makes the right asks of 
those who are afforded tax exemption.
    There are four points I want to offer in that regard now. 
One, because the filing is appropriately not just numbers, 
organizations must be proactive and collect from internal 
sources the various information the form seeks, as well as 
prepare written narratives. Accordingly, the amount of 
resources and time that filers expend in favor of preparation 
has undoubtedly increased. This is not a bad thing; it is just 
a fact.
    Two, the information the form provides the IRS is more 
thorough and descriptive than before, allowing the agency to 
more effectively apply its resources toward improved 
enforcement and education.
    Three, the fact that the filing is widely available makes 
filers transparent in ways they never were before, which is 
huge. The public relations power of that transparency leverages 
the IRS's limited resources as the reading audience brings 
their own potential ``enforcement'' forward.
    And four, while the new form does have a sharp learning 
curve, which has burdened the sector, filers are starting to 
master the form, and I am certain further improvement will be 
evidenced over the next few years, particularly if the IRS can 
help.
    It is this last point that generates the recommendations I 
make in my written testimony. As to charges leveled of being 
overly burdensome, the new form makes multiple asks that its 
predecessor did not and imposes new architecture for the form--
a core form with 15 subject schedules tailored to the 
individual topics that the IRS seeks information upon, not all 
of which are in play for most filers.
    But as a result, the form's instructions comprise a new 
playbook for filers and those who assist them. The need to 
master this new regime has clearly shocked many filers, but 
many of those had not properly understood or appreciated the 
form's complexity in the years prior to the redesign. Indeed, 
many filers have misperceived the prior form as only a 
financial statement report to the IRS belonging solely to the 
domain of the organization's accountants.
    The new form is clearly a full information return for 
exempt entities that extends well beyond financial results. It 
cannot be wholesale handed off to auditors or paid preparers. 
Completion requires meaningful participation by the filer, 
whose staff or leadership must now provide firsthand data on 
the group's output and operations, including information that 
resides outside of the finance staff.
    The understanding by groups of all sizes that this is the 
case and that they must have a preparer (either internal and/or 
external) who is committed to mastering more of the new form's 
learning curve each year has been evidenced as we have moved 
from the form's filing season in 2009 to today.
    Ms. BORENSTEIN. In the recommendations section of my 
written testimony, I make five specific suggestions and note 
that comments on overlapping burdens of two schedules should be 
opened. I urge this Committee and the tax press to read each of 
those six points not as signs of the redesign's failure or 
overreach but as lessons from the field.
    In that spirit, I want to offer three realities that need 
to be taken into account before we start assigning final grades 
to the Redesigned Form and its results to date. First, the IRS 
should not change the form now, midstream, but instead focus on 
the few areas where it is clear that burden could be decreased 
and take advantage of the opportunity to better the form by 
getting those areas right. As set out in my recommendation, the 
first one, this is particularly urgent with respect to helping 
organizations and users of the form understand that the IRS's 
semantics and reporting requirements are not necessarily value-
laden, especially in regards to reporting insider transactions 
and counting directors as ``independent'' or not.
    Second, we should not conflate the fact that reporting 
organizations will be burdened by the resources required to 
complete this annual filing--that is a cost of exemption--with 
the fact that many organizations do not and will not have 
access to an accountant or other professional who is qualified 
to assist in preparing this filing. It is appropriate to keep 
the preparation challenge situated with filers at all times, 
regardless of whether they have access to competent paid or pro 
bono professionals.
    And third, the Redesigned Form does a great job of using 
the form's transparency factor and the certainty of public 
access by funders, whistleblowers, competitors, reporters, et 
cetera. The form sets out affirmative reporting 
responsibilities that I have seen promote far greater 
compliance and appreciation of tax mandates and charitable 
precepts than ever before. This is notably evident in the 
management of compensation and certain other governance arenas, 
as well as in portions of the form's most complicated schedule, 
the Schedule L, where filers are to disclose intersections with 
insiders. That disclosure responsibility has, as it should, 
generated valuable self-reflection by reporting organizations 
as to the motives and results obtained from such opportunities.
    I can talk about the 990 for hours at a time, but I see my 
time is up. I look forward to answering any questions you may 
have. Thank you.
    Chairman BOUSTANY. Thank you, Ms. Borenstein.
    [The prepared statement of Ms. Borenstein follows:]

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    Chairman BOUSTANY. Mr. Hyatt, you have 5 minutes.

STATEMENT OF THOMAS K. HYATT, PARTNER, SNR DENTON, WASHINGTON, 
                              DC.

    Mr. HYATT. Thank you, Mr. Chairman.
    Chairman Boustany, Ranking Member Lewis, and Members of the 
Subcommittee, I really appreciate the opportunity to testify 
before you this morning. I have been invited to testify as to 
the current state of complexity in the organization and 
operation of nonprofit tax-exempt public charities. As has been 
reported to this Committee, there are some 1.6 million tax 
exempt organizations known to the IRS, give or take different 
sources of data. Over 60 percent of these are 501(c)3 public 
charities.
    Now while many nonprofit organizations are small 
organizations, small staffs, small budgets, we usually are most 
familiar with the large institutional nonprofits, those with 
regional and national reach. According to the IRS, large 
hospitals and universities dominate the financial activity of 
the nonprofit charitable sector. In fact, by their stats, 9 of 
the 10 largest nonprofit organizations by assets were hospitals 
or university-affiliated organizations. It is this class of 
organizations that I describe today.
    Certainly, there can be no denying that these large 
nonprofit public charities are more complex in their structures 
and in their operations than they were say 40 years ago. Today, 
it is not uncommon to have multiple business entities operating 
within an integrated system. They may have a central parent 
organization charged with strategic oversight of the system; 
brother-sister companies subsidiaries and subsidiaries of 
subsidiaries. These entities may include nonprofit 
corporations, taxable for-profit corporations, nonprofit 
taxable corporation, limited liability companies, limited and 
general partnerships and joint ventures.
    Most institutions understand the cost as well as the 
benefit of operating multiple corporations and they try to err 
on the side of keeping it simple. Still, some organization 
charts appear to be designed by engineers rather than business 
planners and would make Rube Goldberg proud.
    In addition to directly owned and operated business 
entities there has been a substantial increase in the use of 
joint ventures by nonprofits to achieve their goals. The IRS 
over time has determined that joint ventures between public 
charities and for-profit businesses in many different forms are 
consistent with public charity status if they are properly 
structured and properly operated.
    There are many reasons for the increased complexity of the 
corporate organizational structures in the modern nonprofit 
sector, often acting in concert. In my statement, I have 
provided an overview of the key factors as I see them. They 
include protection from liability, operation in highly 
regulated fields, restrictions imposed on public institutions, 
restrictions imposed by overseers, chapter-based organizations, 
improved governance, and Federal tax-exempt organization law 
compliance.
    While corporate complexity is a reality in the 
institutional side of the nonprofit sector, in my view, this is 
not a problem that requires a change in the law to resolve. 
Rather, it is an environment that both invites and deserves 
continuing scrutiny and transparency to ensure that these 
public charities are acting in accordance with their tax-exempt 
purposes and with applicable law.
    There are already important checks and balances in place to 
ensure that a complex corporate structure does not impede 
achievement of charitable goals and legal compliance. At the 
State level, this is primarily accomplished through the State 
Attorney General. In recent years, State Attorneys General have 
been extremely active in overseeing the activities of nonprofit 
organizations within their State. The IRS plays an important 
oversight role both towards enforcement of the Internal Revenue 
Code's tax exemption requirements and implementation of the 
Form 990 with an increasing focus on transparency and 
accountability.
    DCMN BURREL
    It should also be noted that the IRS has undertaken a 
considerable effort in the last few years to learn more about 
this large institution segment of the nonprofit sector through 
a series of what are called compliance checks. The IRS in 2006 
conducted a compliance check of hospitals and health systems, 
and in 2008 a compliance check on colleges and universities.
    When a change in the law is warranted, Congress has not 
hesitated to step in. For example, one type of public charity, 
the supporting organization, was being used for private benefit 
in ways that the Congress never intended in the Internal 
Revenue Code. Through the Pension Protection Act of 2006, 
Congress largely eliminated this type of abuse, including 
through the expansion of the IRS' intermediate sanctions 
penalties authority.
    With that, I will close my oral statement. I, again, 
appreciate this opportunity and would welcome any questions you 
might have.
    Chairman BOUSTANY. Thank you, Mr. Hyatt.
    [The prepared statement of Mr. Hyatt follows:]

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    Chairman BOUSTANY. Mr. Colombo, you have 5 minutes.

 STATEMENT OF JOHN COLOMBO, ALBERT E. JENNER, JR., PROFESSOR, 
   UNIVERSITY OF ILLINOIS COLLEGE OF LAW, CHAMPAIGN, ILLINOIS

    Mr. COLOMBO. Mr. Chairman, Mr. Ranking Member, and Members 
of the Committee, thank you for the opportunity to speak today 
about commercial activity by charities.
    Over the past 20 years or so we have seen a steady 
expansion of commercial activity by charities. In most cases, 
commercial activity provides badly needed revenue to expand 
charitable outputs. But the legal issues surrounding commercial 
activity are complex and I think hopelessly confused.
    When a charity engages in commercial activity, it raises 
two main issues. The first is whether the charity loses tax 
exemption as a result. If the charity does not lose tax 
exemption, then the second issue arises: Whether the commercial 
activity nevertheless should be taxed as though it were a 
freestanding corporate business. This latter issue is the 
providence of the unrelated business income tax.
    Underlying these issues is a third issue: Does it matter 
what kind of business container the commercial activity is 
conducted in; that is, does it matter whether the business is 
conducted directly by the charity versus in a separate 
corporation or via a partnership with a for-profit enterprise. 
Under current law, each of these containers can have different 
tax consequences for the charity.
    With respect to the effect of commercial activity on exempt 
status, the main policy issue is straightforward: How much, if 
any, commercial activity may a charity undertake without 
impairing exemption. Unfortunately, the existing legal 
precedent and Treasury regulations are of little help in 
resolving this issue. The regulations and precedent are clear 
that some amount of commercial activity is permitted, but 
beyond that we don't know much.
    One part of the regulations, for example, suggest that 
charities cannot engage in more than an insubstantial amount of 
such activity, while another part of the same regulation states 
that a charity can operate a commercial business as a 
substantial part of its activities as long as that business is 
not its primary purpose and the business is in furtherance of 
its exempt purpose. But concepts such as substantial and in 
furtherance of are left undefined.
    Think of it this way. Suppose I incorporate a charity to 
operate a soup kitchen. Everyone would agree that, properly 
operated, this organization is tax exempt under 501(c)(3). But 
now suppose that I decide that to expand my revenue base I am 
going to can my soup and sell it to the public. Is that okay? 
Does it depend on the size of my soup business versus the size 
of my soup kitchen relief efforts? If so, how is that measured, 
by gross expenditures, gross revenues, net revenues, number of 
people working in each activity, all of the above? Does it 
matter how much profit I have and how that profit is used? Does 
it matter whether my soup business is in a separate corporate 
container or is operated as a joint venture with a commercial 
soup company? What if I don't operate a soup kitchen directly 
but use profits from my commercial activity to make grants to 
other soup kitchens.
    The UBIT has a similar set of problems. The UBIT was 
designed to tax certain commercial activities by charities but 
not all of them. The main test for applying the UBIT is whether 
a businesses substantially related to accomplishing the 
charity's exempt purpose. If so, it is not taxed. If not, it 
is. In addition, there are specific exemptions for certain 
kinds of activities--activities run completely by volunteers, 
for example, or activities such as a cafeteria run for the 
convenience of employees or patrons.
    Like the commerciality limitation, the UBIT also suffers 
from a lack of theoretical consistency and practical 
definition. Though the classic rationale for the enactment of 
the UBIT was to avoid unfair competition, the test for taxation 
doesn't depend on whether a charity is competing fairly or 
unfairly with the private market, but rather whether the 
business is substantially related to the organization's 
charitable purpose.
    We know that substantially related involves more than just 
providing revenue for charitable purposes. But beyond that, the 
test for relatedness is murky, at best. To go back to my 
previous example, is my selling soup substantially related to 
my charitable purpose of providing a soup kitchen for the poor? 
If a symphony orchestra sells its recordings through commercial 
channels, is that substantially related? What if it has a gift 
shop and sells CDs by popular rock bands? Can it sell musical 
instruments, too? How about an upscale stereo system? How about 
art? After all, Modest Mussorgsky wrote a very famous musical 
composition called ``Pictures at an Exhibition.'' So maybe art 
is substantially related to music.
    These questions go to the heart of what we want our 
charitable sector to look like, and in my written testimony I 
have provided both a structure of how we might analyze those 
issues as well as some suggestions on possible reforms. But 
whether you agree with my suggestions or not, it is time for us 
to reconsider these issues from a policy perspective and 
provide clarity to charities regarding these activities.
    Thank you.
    Chairman BOUSTANY. Thank you, Mr. Colombo.
    [The prepared statement of Mr. Colombo follows:]

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    Chairman BOUSTANY. Mr. Tobin, you have 5 minutes.

 STATEMENT OF DONALD TOBIN, ASSOCIATE DEAN FOR FACULTY AND THE 
    FRANK E. AND VIRGINIA H. BAZLER DESIGNATED PROFESSOR IN 
BUSINESS LAW, THE OHIO STATE UNIVERSITY MORITZ COLLEGE OF LAW, 
                         COLUMBUS, OHIO

    Mr. TOBIN. Thank you, Mr. Chairman.
    Chairman Boustany, Ranking Member Lewis, and Members of the 
Committee, thank you for the invitation to testify today.
    Charities are not just using affiliated entities in the 
for-profit context. They are also affiliating with other tax 
exempt organizations, mainly social welfare organizations and 
political organizations. I want to give you just a brief 
explanation of how these organizations interact.
    Public charities are exempt from tax under 501(c)(3) and 
donations to the charity are deductible by the donor. Public 
charities are not allowed to intervene in a political campaign 
and can only engage in an insubstantial amount of lobbying. 
Social welfare organizations are organized under section 
501(c)(4) and must be operated exclusively for the promotion of 
social welfare, according to the statute. Although the statute 
uses the term ``exclusively,'' Treasury regulations allow 
social welfare organizations to intervene in political 
campaigns as long as the organizations' primary purpose is 
social welfare. Amounts spent by organizations on political 
campaign-related activities are not considered a social welfare 
function. The income of social welfare organizations is tax 
exempt but donations are not tax deductible.
    Then we have political organizations, which are exempt 
under section 527 and are primarily involved in influencing 
elections. Contributions to 527 organizations are not 
deductible and political organizations are required to disclose 
contributions and expenditures.
    Public charities are allowed to create affiliates in order 
to engage in these different types of activities and the Form 
990, Schedule R is important in helping the IRS and others 
understand the various activities that tax-exempt organizations 
are engaged in and their various associations. It also helps 
ensure that the important policy goals of each section is 
honored.
    First, we have the subsidy that is received by public 
charities because the donors get to deduct their donations and 
we want to make sure that isn't transferred improperly to a 
(c)(4) or a 527 political organization.
    Second, there needs to be a continued outlet for 
constitutionally protected speech, and the affiliated entity 
helps ensure that continued outlet exists. The congressional 
goal of having disclosure of amounts spent on political 
activity shouldn't be obfuscated.
    Now when operated correctly, affiliated entities support 
these policy goals. Affiliations between public charities and 
social welfare organizations help cordon off the subsidy to 
public charities while allowing organizations to lobby and 
engage in other activities with non-subsidized dollars.
    So first we want to look at the restrictions that are on 
public charities because they are very important. The 
restriction on lobbying and political campaigning by 501(c)(3) 
public charities is essential for maintaining the special role 
that charities play in our National life. Providing public 
charities with a subsidy to lobby and intervene in political 
campaigns would put that special status at risk.
    The restrictions on lobbying and political intervention for 
public charities ensure that tax deductible donations are not 
used to promote political campaigns. It requires organizations 
that wish to engage in lobbying or political activity to be on 
the same footing as other citizens. Absent a ban on such 
activities, public charities could easily be used as a tax-
subsidized vehicle for political campaigns.
    Now these affiliated entities can be formed in very 
different ways. You can have a public charity with a social 
welfare organization, which in turn has a political 
organization. You can have a social welfare organization with 
an affiliated public charity and an affiliated political 
organization. And you can have loosely affiliated entities who 
aren't actually organizationally connected but have an 
affiliation. The key is that the public charity is not allowed 
to subsidize the activities of the other organizations. We have 
had problems in this area in how we deal with them.
    The first is that this area is incredibly complicated. The 
rules on affiliated entities are very complex. The second is we 
have had very aggressive assignment of tasks between affiliated 
entities that may be inconsistent with our policy goals. Third, 
the IRS has limited resources to enforce, and when it does, it 
is often accused of enforcing on political grounds. Finally, 
the results of investigations by the IRS are not made public so 
it is hard to know what standards are being applied.
    I have some suggestions for the future. We could examine 
the possibility of creating a public complaint and resolution 
process. We could consider allowing the results of audits of 
exempt organizations to be made public. We could streamline the 
rules regarding associated entities to reduce some of these 
regulatory burdens. And we could create disclosure provisions 
that are consistent, or near so, among tax exempt 
organizations.
    I very much appreciate your invitation for me to be here 
today, and I am happy to answer any questions you might have.
    [The prepared statement of Mr. Tobin follows:]

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    Chairman BOUSTANY. I want to thank all of you for really 
excellent testimony, both written and oral. We really 
appreciate what you have brought to the committee.
    Right now I want to start by looking at these complex 
interactions between UBIT rules, complex organizational 
structures, and reporting requirements. It is my understanding 
that passive income, such as royalties and interest, is 
exempted from UBIT.
    So I would like to ask Ms. Borenstein, Mr. Hyatt, Professor 
Colombo several questions about what appears to be a relatively 
simple issue, but clearly is not.
    First, Mr. Hyatt, this Committee has been told that often 
such income is generated in subsidiary organizations instead of 
the parent organization to protect the exempt status of the 
parent. Oftentimes, joint ventures are formed. So explain how 
this type of income can arise for a public charity.
    Mr. HYATT. Certainly, Mr. Chairman. Obviously, the 
fundamental purpose of a charitable organization is tax exempt. 
That doesn't mean that it can't entertain or carry on some 
level of commercial activity. When it does so, the unrelated 
business income rules apply. And back in the fifties when 
Congress first looked at this the idea was to have a level 
playing field. So if you have some level of unrelated activity, 
perhaps you run a hotel to help families that are visiting your 
hospital or your campus, for example, there may be a legitimate 
reason to run that business enterprise as a part of your 
charity. But if you are starting to operate it in a commercial 
fashion and one that looks to the layman like something a for-
profit concern would operate, you can do that as long as you 
pay taxes on that income.
    At some point, however, there is a line that you cross. It 
is, as has been discussed by the panel, a facts and 
circumstances line. It is not a bright line test. But at some 
point that line is crossed where it becomes too commercial in 
nature. And if you were to continue it and if it represents 
what the law calls a substantial nonexempt purpose, you could 
lose your tax exempt status. That would then cause the 
organization to say the best way to protect our exemption and 
continue to carry on this activity is to spin it off into a 
separate corporation, a taxable subsidiary, for example, that 
we would control, and that taxable subsidiary might generate 
interest, royalties, annuities, et cetera, up to the parent as 
passive income.
    Chairman BOUSTANY. Thank you.
    Mr. Colombo, you went at great length in your written 
testimony, which I read, about these regulations and some of 
the conflicts, the definitional issues that have come up. 
Clearly, I think we are going to have to work to provide more 
clarity there. I know passive income is generally exempt from 
taxation under UBIT rules. Just briefly, why does this 
exception for passive income exist?
    Mr. COLOMBO. Well, I think that the answer to that has 
always been that passive income was consistent with the notion 
of charitable expenditures and funding charities. You would get 
money in, if you needed it you would spend it. If you didn't 
need it, you would invest it in a diversified portfolio and put 
it in the bank and then you would use your earnings off of 
that. Endowments have always been a feature of the charitable 
sector. And I think we have always viewed the notion of passive 
investing as being particularly consistent with charitable 
expenditures and charitable operations in a way that we have 
not viewed the direct operation of a commercial enterprise as 
being necessarily consistent.
    Chairman BOUSTANY. Thank you.
    Ms. Borenstein, if a public charity does have passive 
income and it is generated through a subsidiary or involves a 
related party transaction, how is that income reported on the 
new Form 990?
    Ms. BORENSTEIN. Well, one of the points to make is that 
excess capacity is what generates passive income. We have 
excess cash or extra office space, our budget is under stress a 
little bit and now we want to rent out some offices at the end 
of the hallway to other entities. If we turn our building for 
liability purposes over to a for-profit corporation or another 
nonprofit corporation, that we have control over it, we are 
going to report that other entity as a related organization. 
And because of the 512(b)(13) rules--which I am sure everyone 
loves the complexity of that number even having to be cited--it 
is a loophole closer in the Code that requires payments of 
these types of passive, otherwise not subject to UBIT streams 
to be reached by UBIT, and thus so rents from real property 
paid by a controlled organization have to be reported on the 
990. This was an addition from the Pension Protection Act of 
2006 requiring such receipts to be reported on the 990. And so 
now the Schedule R not only gives detail of who are my related 
organizations but requires me to denote dollar amounts of all 
transactions that have passive streams from my related 
organizations that I control, as well as denote any other 
transactions, once they are large enough, by type and 
potentially amount.
    Chairman BOUSTANY. Thank you. Professor Colombo, in your 
written testimony as well as oral testimony you discuss 
commerciality, the commerciality doctrine. Commercial 
activities of public charities and tax exempt organizations in 
general have been an issue raised by Members of this Committee 
several times over the past year-and-a-half. And as you note, 
the policy question is how much if any commercial activity may 
a charity undertake without impairing its exempt status.
    Could you elaborate? The regulation seems very, very 
confusing. We need more guidance on this.
    Mr. COLOMBO. Well, it is very confusing and I think that is 
why we need to have a policy discussion about where we want 
charities to go with respect to commercial activities. I am 
actually not opposed to charities being involved in commercial 
activities. I would probably do so in a manner that, first of 
all, I would tax all commercial activities. I would probably 
get rid of the related versus unrelated distinction.
    And second, I think maybe the more important piece would be 
that I would make sure that charities have to demonstrate to us 
that the commercial activity is enhancing their charitable 
outputs; that that is better for them in some way than simply 
investing in a diversified portfolio. If it is not, if they 
can't show that, then my response to them would be: Well, then 
why are you doing this? Go invest your money in a diversified 
portfolio and use the earnings to do your charitable 
activities.
    So I do believe the law is very, very difficult in this 
particular area and that I think there is an underlying policy 
question that I think Congress should engage.
    Chairman BOUSTANY. Well, I think Ms. Borenstein raised this 
issue of excess capacity and more efficient use of resources. I 
think in your testimony you talked about empire building, on 
the opposite side of the scale. If all commercial activity were 
taxed and we got rid of this distinction, would that ease the 
compliance burden for the IRS?
    Mr. COLOMBO. Well, I think it would ease the burden in the 
sense that they would not be required to deal with this very 
difficult, as Mr. Miller pointed out, very difficult test of 
related versus unrelated. Now pieces of the compliance, 
however, are not going to go away. The issue of how you 
allocate expenditures, particularly how you allocate overhead 
and that kind of thing, are always going to be with us, no 
matter what, when you have a differentiation between charitable 
activities on one side and taxable activities on the other. But 
it certainly would get us out of the business of scratching our 
heads and figuring out whether selling rock CDs is related or 
unrelated.
    Chairman BOUSTANY. I see. Of course, you went at great 
length in analyzing commercial activities by charities and 
showing it is not a really easy task. And to make sense out of 
the area, in your written testimony you talked about five 
categories. And the first categories were commercial activity 
by a charity is also a primary exempt activity. A prime example 
of this type of charity is a nonprofit hospital, for instance.
    Explain in more detail this particular category of 
commercial activity and how it applies to nonprofit hospitals.
    Mr. COLOMBO. Well, the question in my category 1, there are 
certain charities which I would say do nothing except conduct a 
commercial activity. I think the publishing cases are another 
example, where you have a religious publisher for example. The 
question right now is: Does that commercial activity further a 
charitable purpose? Well, in some cases, we have said so, 
right? So in the case of nonprofit hospitals, they sell 
services for a fee. There is not any question that that is what 
they do. But we have said that under certain ancillary rules 
and circumstances that that in effect will be a charitable 
activity.
    We have had a lot of litigation over religious publishers. 
And so my sense of that one is we need to figure out what that 
policy rule is and apply it consistently across all sectors of 
our charitable operation. I am not sure why you wouldn't say 
publishing religious text is as much furthering a religious 
purpose as selling hospital services is furthering a health 
care purpose.
    Chairman BOUSTANY. Thank you.
    Finally, Mr. Hyatt, the last thing I would like you to do 
for us is if you would be so kind as to come up and use this 
white board we have set up to draw what I will call a simple 
complex structure for public charity and briefly explain the 
different elements.
    Mr. HYATT. I would be happy to, Mr. Chairman, if the 
committee will indulge me in any lack of artistic ability I 
might have in doing so.
    Chairman BOUSTANY. We won't criticize your artistic 
ability.
    Mr. HYATT. Simple. A hospital, a college or university. Not 
unusual still today to find a single hospital operating 
corporation running the full enterprises of a hospital or 
university. However, I expect if you were to look at the 
internal organizational chart of that organization, you would 
see the Rube Goldberg scheme. There are a lot of far-flung 
enterprises, services being provided, primarily charitable, 
some taxable, that they pay unrelated business income tax on, 
but it is certainly possible to run it through a single 
operating corporation.
    If you wanted to have a multi-corporate system for some of 
the reasons I mentioned in my statement to deal with competing 
reimbursement and regulatory schemes, to improve the governance 
by division of labor, by helping others get into the mix, to 
really focus on the knitting of particular activities, or 
perhaps to put out, as I mentioned a moment ago, a commercial 
activity that might threaten your exemption if it really took 
off, you might very well look at this type of corporation 
structure.
    Externally, this is a pretty common structure for large 
institutional public charities today. So what would this box 
become then in that complex structure? This would now be what 
is commonly called a parent holding corporation or a parent 
entity. You would see this primarily in health care systems, 
less so in private universities. You would see it in public 
universities, where there is a flagship overseer and then the 
individual colleges and campuses. But commonly a parent 
corporation has its own board of trustees, it is a 501(c)(3) 
public charity as well, and its job is to do the strategic 
thinking here. If each of these boards focuses on their own 
activities, someone has got to see what do we do in concert. 
Are we all pulling in one direction. That is what this board 
would commonly do.
    So, again, this is a public charity, the parent 
corporation. This public charity here might be the primary 
organization in the system. It is a hospital, it is a college 
campus, it is school of medicine or a school of law. It is a 
separately contained organization that carries on that primary 
activity. You might have a separate or distinct activity here 
that is also a public charity focusing on a distinct activity. 
If you are a hospital system, this might be a home health 
agency or a cancer treatment center or laboratory. If you are a 
college or university, this might be an alumni association. It 
might be an investment management company to manage your 
endowment to grow revenues and funds for decreasing the cost of 
tuition and improving faculty, et cetera.
    This might be yet another public charity or it might be a 
taxable corporation. It might be a credit union for your 
employees, for example. Or, it may be some new technology that 
you are developing that you want to be able to license and use 
the revenues to support your mission. It may or may not be a 
public charity or a taxable enterprise.
    If you are a hospital system over here, this, again, would 
typically still be a public charity. It could be a physician 
group that you now employ. It has now become quite common. The 
pendulum has come all the way back for hospital systems to 
employ doctors directly to provide services. So now 
increasingly the IRS is seeing, again, applications for tax 
exempt status by physician groups, whereas they used to be solo 
practitioners and private practitioners in that area.
    Then you might also see joint ventures between for-profit 
entities, public charities through a joint venture entity. The 
limited liability corporation, or LLC, is probably the most 
common vehicle for joint ventures today. It could still be a 
taxable corporation. It could even be another tax exempt 
organization. But commonly you are doing that for one of three 
reasons. You are trying to get access to capital that you 
wouldn't otherwise be able to obtain. You are trying to get 
access to expertise. That for-profit enterprise knows a lot 
about this business. You need to get them to help you manage 
that so you can do it more effectively. Or, you are trying to 
get access to a neighborhood, an area market where it is 
difficult because of barriers to entry economically to get in, 
logistically to get in, so you get the help of others to run 
that joint venture.
    So as you can imagine, this is the basic form of complex. 
There can certainly be a lot more boxes under it. The key 
there--and I think this is where the Service has done a good 
job and can continue to do a good job--is transparency. And 
keep in mind that the Form 990 is a public record document. And 
the IRS, while it is the regulator, is but one constituency for 
that document. Because it is public record, you can see it 
online on guidestar.org, look at these 990s of organizations. 
You want to make sure that regulators, donors, funders, staffs, 
patients, Members of Congress understand what each of these 
boxes are and it is very clearly reported and transparent. And 
I think that is where we can continue to see progress in that 
direction.
    Chairman BOUSTANY. Thank you very much, Mr. Hyatt. That is 
a very helpful description to get the committee focused on some 
of the complexities of these organizations.
    With that, I am happy to yield to the ranking member, Mr. 
Lewis.
    Mr. LEWIS. Thank you very much, Mr. Chairman.
    I want to thank each of you for being here, for your 
testimony. Thank you so much.
    Professor Tobin, since you have been so quiet and you 
haven't had an opportunity to respond, is there anything that 
you want to say, to just get it off your chest? You have been 
waiting so patiently.
    Mr. TOBIN. I think on UBIT and associated entities my 
colleagues have done quite well. So I am happy to answer your 
questions regarding the tax exempt entities and the way that 
they affiliate.
    Mr. LEWIS. Professor Tobin, Schedule R of the new Form 990 
asks for information about organizations related to a public 
charity. This includes for-profit subsidiaries and affiliated 
tax exempt organizations. Why is this information so important 
and so necessary for the IRS and the public to know?
    Mr. TOBIN. So in the tax exempt situation it is very, very 
important, and that is because the public charities get a 
significant subsidy from the public. Donations to public 
charities are deductible by donors. And we see these 
organizations as special, as ones that serve some type of 
government function. When they affiliate with other 
organizations there is a serious risk that that subsidy that we 
provide to them gets pushed off to those other affiliates. And 
what we really want to make sure of is that public charities 
are doing public charity work and that these other 
organizations are doing what they are designed to do. So if 
they are lobbying, if they are engaged in political campaigns, 
we want to make sure that is not being done by the public 
charity. It is separated off. And the Form 990, without it, it 
is very hard to figure out who the different affiliated 
organizations are and what role they are playing.
    So the Form 990, Schedule R serves a very important public 
function of letting us know who those organizations are and 
what they are doing.
    Mr. LEWIS. Could you really elaborate and make it simple 
and plain to this Member? Are there activities that an 
affiliated tax-exempt organization may engage in that a public 
charity may not?
    Mr. TOBIN. Sure. So public charities are only allowed to 
engage in an insubstantial amount of lobbying. And there is 
section 501(h), which helps determine how much that is. So a 
(c)(3), a public charity, can engage in some little amount of 
lobbying, but not a lot. And the idea here is they are doing 
their normal functions and they may doing some little thing 
that may be considered lobbying, and we want to let them do 
that. But if they are going to be a lobbying organization, they 
are supposed to be a 501(c)(4) organization, a social welfare 
organization. Because lobbying is considered a social welfare 
function.
    So it is perfectly fine for a 501(c)(4) to be a lobbying 
organization, and a (c)(3) can form a 501(c)(4). And it happens 
all the time.
    Now a charity, a public charity, is not allowed to engage 
in a political campaign for or against a candidate for public 
office, 501(c)(3) makes that very clear. We do not want the 
subsidy that goes to public charities to be going into campaign 
organizations. So a 501(c)(3) is prohibited from engaging in 
political activity. They should do that through an affiliated 
(c)(4). Actually, they are not allowed to create an affiliated 
527, but they are allowed to create an affiliated (c)(4), which 
is allowed to create an affiliated 527. So that is how they get 
that done.
    Mr. LEWIS. In your testimony, you noted that there are 
serious enforcement problems. Some big issues. I know the 
chairman and others do not want us to move into this political 
climate that we are in right now, but it seems like each time 
we pick up the newspaper, hear something on television or the 
radio, that there are real problems out there.
    Do you think the IRS is having a major problem in 
enforcment with limited resources, limited staff? Who is 
watching? Who is policing?
    Mr. TOBIN. This interrelated affiliation is a mess. And it 
is a mess for a lot of reasons that are the faults of a lot of 
us and a lot of reasons that are not anyone's fault. The IRS is 
not set up to be a campaign watchdog. They are not good at it 
and it doesn't serve their primary purpose. And so when they 
are placed in the position of having to get involved in these 
kind of political debates, it is very difficult for them to 
make these kind of determinations. But in addition, we have 
seen really, really aggressive pushing by organizations and 
what they claim their activities are. So the more aggressive 
organizations push, the more it creates problems for the IRS in 
enforcement. If we talk about a public charity not being 
allowed to intervene in a political campaign, and the public 
charity starts doing it but claims they are not from some weird 
definition, it creates this enforcement burden on the IRS; have 
the engaged, have they not.
    We have seen in the social welfare context where the 
definition that organizations seem to be using appears to be 
the election law definition, not the Tax Code definition. So 
you have a whole set of (c)(4) social welfare organizations who 
in my view are absolutely 527s. Now who is supposed to police 
that, right? If a social welfare organization says this 
political campaign activity is social welfare, who comes in and 
checks that? And the answer is it has got to be the IRS. And it 
is just very difficult for them to do that.
    Mr. LEWIS. Thank you. I notice my time has expired. And the 
chairman has been so liberal here. Thank you very much. Thank 
you, Mr. Chairman.
    Chairman BOUSTANY. Thank you.
    Ms. Jenkins, you are recognized.
    Ms. JENKINS. Thank you, Mr. Chairman. Thank you all for 
being here.
    Ms. Borenstein, in your testimony you discuss the extensive 
changes to the Form 990 and note that some problems still 
exist. Can you talk more about what challenges still exist for 
tax exempt organizations, preparers, and the IRS, and also 
maybe what recommendations might solve them?
    Ms. BORENSTEIN. Yes. At basic ground level the difficulty 
with the form vests in a couple of places that have been vexing 
to preparers. Again, I stress that there is many people who are 
doing a good job preparing their own form, especially when 
filing organizations do them on their own.
    My first suggestion is that the IRS should do more 
educational efforts to explain that some of the terminology 
used is not inherently value-laden as we are finding a fear in 
the exempt sector: ``That I should not have a board member 
whose company is providing us a good deal because then I have 
one less independent director and there is something inherently 
wrong with that director's capacity to serve,''--which is 
certainly not the case. Folks like myself can say that as much 
as we want. Hearing it directly from the IRS would be helpful. 
So I am asking for more educational outreach on the part of the 
Service to express that they are just asking the question, 
rather than saying there is anything inherently bad about 
disclosure of favorable transactions with insiders.
    The Schedule L, colloquially we refer to it as ``lose your 
mind.'' The Schedule L has four separate parts. One deals with 
a statutory regime regarding excess benefit transactions that 
there is to ensure public charities cannot be taken advantage 
of unfairly by people who have been in substantial influence at 
any point in the last 5 years. You turn someone in if that has 
been the case. So one part of the Schedule L filers have a 
definition of and disclosure asking ``has that happened with a 
certain group of people?'' Another part asks, ``are there loans 
outstanding at year end with a different group of certain 
people?'' A third part asks, ``have there been grants or 
assistance provided to yet another group of certain people?'' 
And then finally, one last part asks, ``are there business 
transactions with certain people?''
    I have strongly recommended that the IRS create some sort 
of educational materials or flow chart in the instructions to 
the end of simplifying the definitions, trying to make them 
easier to handle. Standalone they all make sense as bright 
lines in the sand, but paired together their combined weight 
creates a very daunting task for the sector.
    Past there: The Schedule F. I think there is much concern 
about the utility of the information being provided to the IRS 
about activities outside the borders of the United and 
widespread evidence that the info asks are burdensome (and 
potentially of questionable value). So I am recommending that 
that schedule be either extremely streamlined or eliminated.
    And then there was a vestigial part of the old 990 that I 
think there was huge agreement had very value to the IRS. It is 
there at the behest of States and requires groups to 
functionalize their expenses between program and fundraising 
and management. There was an old-school belief that I would 
give a dollar to a charity first who was going to spend 90 
cents of that dollar on program, but I know that I might want 
to give a group a dollar who is going to spend only 60 cents on 
program because that is where they are in their lifecycle and 
they need to build up management or need to put some efforts 
into fundraising, et cetera. That part/statement that has 
groups functionalize expenses should not be on the form. It is 
subjective. It doesn't work, and it continues longstanding 
mythology in favor of giving money to groups who say more 
dollars are going to program.
    And then finally, it is clear that in spite of my saying 
groups can do their own Form 990, that small organizations 
can't. They are being very burdened. We had a transition period 
in which small organizations did not have to file the full 
redesigned 990 for a period of years. That finally ratcheted 
down to gross receipts of $200,000 as the level at which one 
must fill out the Form 990, or gross receipts at any level but 
owning assets of more than a half million dollars (requires the 
whole 990). I am suggesting that those thresholds rise back to 
the first transition year of a million dollars of gross 
receipts or perhaps on average a million dollars of gross 
revenues a year or having assets of $3 million. We have amateur 
athletic associations who have built a hockey and sports 
facility arena. They own $3 million worth of real estate. Well, 
$3 million might be the point at which they are filling out the 
full 990. But if they own a million dollars or $2 million worth 
of real estate, I and many others think they are still a small 
organization if their budget is less than a million dollars a 
year. On top of those increased thresholds by which groups 
could still fill out the Form 990-EZ, I am suggesting that the 
IRS come up with a third way to find ways in which that Form 
can be bettered in order to let more small organizations fill 
out a less comprehensive form. In sum total, that was my last 
recommendation.
    Ms. JENKINS. Thank you.
    Mr. Chairman, I yield back.
    Chairman BOUSTANY. Thank you.
    Mr. Becerra.
    Mr. BECERRA. Mr. Chairman, thank you. Thank you all for 
your testimony. Each of you has to some degree focused some of 
your testimony on the growing complexity in this area and also 
the need for more transparency, a greater degree of disclosure, 
and so forth. I know that Mr. Miller put the best light or best 
face he could on the capacities of the IRS to try to oversee 
the numerous organizations that are now popping up under the 
tax-exempt structure, but it seems like what we are doing is 
losing ground every day on the ability to seek transparency and 
reduce the complexity. And so we thank you for your guidance 
and some of your ideas of how to try to make that better.
    I think, Mr. Tobin, you have also suggested some ways to 
try to enhance the ability for us to pursue the bad apples, 
those who make the rest of the nonprofit world look bad because 
they have done things that don't conform with what we consider 
to be good mode of procedure for a nonprofit, the kind of 
things that we think of when we think of that charitable 
hospital or the cancer society or those organizations that are 
out there to do good for a lot of Americans.
    Can you tell us a little bit with more detail from what you 
say in your written testimony about how we can go about 
enforcing some compliance in the tax-exempt area where, for 
example, we deal with lobbying, political campaigning, and 
other activities that seem to go beyond what we typically think 
of the work of a charitable or a not-for-profit entity?
    Mr. TOBIN. So one of the problems in this area is that we 
have put the IRS in charge of policing and we haven't really 
given them the tools that we would normally give an agency that 
is required to police in this way. For example, the Federal 
Election Commission, you can make a complaint to the Federal 
Election Commission. But the IRS, it runs, it does its audits. 
You don't complain that your neighbor has not been audited and 
have them all of a sudden audit your neighbor. There are 
whistleblower statutes. But for the most part the IRS does 
their audit and then they keep it all secret, because that is 
what they are supposed to do. They are not supposed to disclose 
my tax return to anyone else, and we expect that kind of 
privacy.
    Well, that is happening in the tax exempt area, and I think 
there is a real question whether we need it to happen in the 
tax exempt area. Tax exempt organizations are public charities. 
They are public organizations. They are receiving this public 
subsidy. So I think that there are ways in which we can have a 
public complaint process, where the public are looking at what 
is going on, they find that there is a problem. Right now they 
can send a letter to the IRS, but they don't have any idea what 
is going to happen. There is no requirement the IRS look at it. 
There is certainly no requirement that the IRS tell you what 
happened in that process. And they can't, in most cases.
    And so I advocate that you have a public complaint process 
that you set up and that we have some transparency in that 
process because I think both sides of the aisle--in my history, 
I have been a professor for 11 years, and before that have at 
DOJ for 4 years, and then I was a judge, and I was on the Hill 
for 7 years, so there is a good 20 years of this stuff--and 
both sides of the aisle, when these things happen, you want to 
have some certainty that it is not political and that it very 
objective. My experience is the IRS handles this in an 
objective way. And the more we can be transparent in that, the 
better.
    Mr. BECERRA. Are there any existing complaint processes 
that we could use to guide us in how you would form such a 
complaint process?
    Mr. TOBIN. It is nice when you are a professor and somebody 
asks you about something you wrote, you just have to remember 
what you said. But I did an article on that in Georgetown's Law 
Review on the process. And I think having a panel of 
nonpartisan, of career service employees that could rotate 
through so that you weren't doing something like the FEC, where 
you had three and three, which creates a possibility for 
deadlock, where you had transparency in the decisionmaking 
process so that you could have some sense of what was actually 
happening, is the best way to go forward.
    Mr. BECERRA. Thank you. Thank you all for your testimony.
    Yield back, Mr. Chairman.
    Chairman BOUSTANY. I thank the gentleman.
    Mr. Marchant.
    Mr. MARCHANT. Professor Colombo, it is easy to imagine an 
instance where a tax exempt organization would participate in a 
soup kitchen kind of scenario and then everybody liked the soup 
and so started canning the soup and then selling it and made 
that. But can you describe in better detail how one analyzes a 
for-profit activity and at what point the activity jeopardizes 
their tax exempt status?
    Mr. COLOMBO. Well, I think in my world a commercial 
activity is one that competes in the private market with 
products and services available widely in the private market. 
So I will use my example of selling soup. I don't know whether 
selling soup is related or unrelated to operating a soup 
kitchen, but I am quite certain that it is a commercial 
activity. It competes in the private market with other soup 
makers.
    How about tuition charged by a private school? Well, that 
one I would say is not a commercial activity because we have 
not yet reached the point where educational services are widely 
available in the private market. There are a couple. There is 
the University of Phoenix. But we are not there yet. So my view 
about that one is that tuition charged is not.
    So I would look to the private market and I would say that 
if what the charity is doing is selling a good or service that 
is widely available in the private market, that is a commercial 
activity.
    Where would I draw the line? I actually wouldn't draw the 
line. I would say to charities, You can engage in as much 
commercial activity as you want, provided that all of it is 
taxed and that you show us that that commercial activity is 
generating revenue that is expanding your charitable outputs. 
If it is not doing that, then why are you doing it? Do 
something else. Go sell your business and invest it in a 
diversified portfolio and use the money from the portfolio to 
operate the soup kitchen rather than selling soup. You may not 
be good at selling soup.
    Mr. MARCHANT. So in my State and many States are now 
experiencing expiration leasing income on the land that they 
own. So that someone comes to a local university, simple, that 
first box up there. They have never really even thought about 
getting out of that box. And all of a sudden they discovered 
oil and gas on their campus or a piece of land that they have 
always considered to be their campus. That income, is it 
clearly not taxable?
    Mr. COLOMBO. I think under current law it is pretty clearly 
a royalty, if that is the way that it is structured. I come 
from southern Illinois. We have oil and gas in southern 
Illinois, too, but I forget how the oil and gas leasing is done 
in that situation. But I think it is pretty clear that it would 
be passive income either as rental income from real estate or 
as a royalty arrangement.
    Mr. MARCHANT. If they chose not to lease the royalty out 
and chose to drill, actually hire a rig and start drilling and 
producing their gas and oil, is that----
    Mr. COLOMBO. In my world, that is a commercial activity. 
Now you are Shell Oil.
    Mr. MARCHANT. And then, in your opinion, you would have an 
unrelated----
    Mr. COLOMBO. Yes.
    Mr. MARCHANT. Ms. Borenstein.
    Ms. BORENSTEIN. If it were a school and you were teaching 
your students how to do that drilling and operate a business, 
you would be able to, under the current UBIT regime, talk about 
a substantial relationship to the conduct or accomplishment of 
your exempt purpose.
    Mr. MARCHANT. Mr. Tobin, would you feel like that that fell 
outside the actual participation in the drilling and becoming 
the consumer, not just the royalty owner?
    Mr. TOBIN. I agree with both examples. In the first example 
I think if you actually engaged in the commercial activity and 
you became the driller, it would be much more problematic. If 
you were able to make it part of your teaching process, then it 
would be less. We are talking about a hypothetical here, but it 
would be less problematic.
    Mr. MARCHANT. Thank you, Mr. Chairman.
    Chairman BOUSTANY. Thank you, Mr. Marchant.
    Mr. Paulsen.
    Mr. PAULSEN. Thank you, Mr. Chairman. As you know, one of 
the issues that has come up at prior hearings actually deals 
with our learning about tax exempts and the ability of exempt 
entities to enter into partnerships, whether it is with another 
exempt entity or with a for-profit entity. Can you just explain 
maybe, Mr. Hyatt, in a little bit greater detail how a public 
charity would actually enter into a partnership or a joint 
venture with another organization and what are the specific 
issues in particular that have to be dealt with to ensure that 
an exempt organization actually remains exempt?
    Mr. HYATT. Certainly. Thank you, Mr. Paulsen. Joint 
ventures are really one of the areas of substantial corporate 
growth certainly in the last 20 years, since about the late 
seventies or early eighties, for the reasons I described. 
Typically, what would happen is the exempt organization would 
look to this outside for-profit party, look for a way of 
sharing mutual abilities and enter into a joint venture through 
a limited or general partnership. A limited liability company, 
as I say, is the most common model these days.
    If you look back historically prior to about 1980, the IRS 
took the position that you couldn't as a public charity engage 
in limited partnership joint ventures, for example, that it was 
too much of sharing of your activities with the for-profit side 
and that was inconsistent with the tax exempt status. The Tax 
Court overruled that position. The IRS subsequently pulled back 
from that line and over the years has come up with a series of 
guidance that approved certain structures for entering into 
joint ventures.
    The essence of it is no matter how you do it, no matter how 
you structure that joint venture, your participation in it has 
to further a charitable purpose and you have to ensure that you 
haven't unduly ceded control over the organization to for-
profit parties.
    So if you look back into the 1980s, for example, we were 
starting to see hospitals cede the entire operation of the 
hospital to a joint venture with a for-profit party, what is 
sometimes called a whole hospital joint venture. The IRS took a 
look at that and used a fact pattern that is not uncommon in 
these sorts of situations in a revenue ruling, the good 
situation and the bad situation. And in essence, they said as 
long as you ensure that you haven't unduly conceded control to 
the for-profit parties, as long as you are doing this for a 
legitimate charitable purpose, perhaps you are, as many 
hospitals are, particularly academic medical centers, 
struggling to make ends meet, this is the way to remain as a 
charitable entity, you got a legitimate reason for doing that, 
and as long as you are not improperly benefiting private 
parties under IRS rules, that is an acceptable way to go. But 
if you ceded so much control to the for-profit party that they 
in effect are really operating the charity now, it no longer 
continues to qualify as a charity and the IRS has indicated we 
would take that away.
    Another version of that is what is sometimes called an 
ancillary joint venture. The example in the most recent revenue 
ruling by the IRS in this circumstance was a college or 
university that wanted to do distance learning. They wanted to 
ensure that teachers in the summertime could come and take 
courses without actually having to be on campus. They said 
there are for-profit companies out there who can do a better 
job at figuring out what cameras to choose, how to get the 
mikes set up, what halls should we rent, how do we go about 
doing that. What we do very well is figuring out what our 
curriculum is, who our best teachers are, what the standards 
are for passing that test.
    So we will approve that kind of ancillary joint venture as 
long as you haven't ceded control over to this for-profit party 
and the for-profit party is dealing with the business aspects, 
the charity continues to deal with the charity aspects of it. 
If you break it up in that fashion, otherwise share risks and 
rewards, have shared governance of that organization, in the 
IRS's view back in 2004, that is a legitimate way to do an 
ancillary joint venture as well for a public charity.
    Mr. PAULSEN. That is helpful. Thank you. Let me just 
dovetail into something real quick, Ms. Borenstein, if I can 
ask you a question. Because in your testimony you noted that 
the changes have occurred for the Form 990 and entirely new 
information now is required and existing requirements have 
changed substantially. What were the deficiencies of the old 
Form 990 and what particular concerns actually prompted all 
these substantial changes with 990
    Ms. BORENSTEIN. Well, where should we start? I mean, the 
director of the exempt organization division referred to the 
prior iteration of the Form 990 as a disaster, and it was 
perhaps the one time that the entire exempt organization 
community completely agreed with the IRS.
    The old form was built out very, very poorly. Questions 
were asked as the topic du jour rose through hearings in this 
august body and through law changes. There was no rhyme or 
reason to how it was structured. And as I earlier stated, it 
was perceived as a financial statement because you largely saw 
numbers, but there were questions all over the place that said 
attach a schedule, and you had to read the instructions to know 
what to attach in the schedule. The software providers for 990 
preparation all had a different inclination as to what the 
schedules should provide. You couldn't find the data. You would 
go to Guide Star and find a 300-page return, and be endlessly 
searching for the list of directors, officers and key 
employees, or other common attachments without so much as a 
clue where that information was going to be.
    It was widely understood that it was time to start over, 
which is why the IRS, starting in 2005 and 2006, went through 
what I thought was a very thoughtful process of engaging the 
entire sector to say if we have to ask questions about who you 
are and what you are doing and why you continue to be an exempt 
entity in terms of qualifying, ``what would you want to see us 
put on the form?'' And there was a fair amount of back and 
forth. The IRS proposals I am sure included items that they 
were ready to negotiate on, and they did jettison some 
completely. They took a lot of suggestions. The architecture of 
the form was agreed to for the most part by the sector. The 
instructions are relatively plain English. They worked very, 
very hard on that. They continue to make corrections each year, 
resulting in improvements to the form. But again, the notion is 
that we want an environment of transparency and accountability, 
particularly for public charities. And so to annually report on 
the sum total of who they are, under whose watch are things 
being performed, what compensation is being paid particularly 
to those in charge--a full view--is what the new 990 affords. 
The old 990 attempted to ask a lot of that information but only 
someone like myself understood those questions.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    Chairman BOUSTANY. Thank you.
    And Ms. Borenstein, just in follow up on what Mr. Paulsen 
asked, in your testimony, you had discussion of eight 
completely new areas on the revised Form 990. For example, any 
information required on authority and management practices, 
related parties on Schedule R is one example. Explain what 
specific information is now required there. How the IRS or 
other interested parties may use that information to examine 
the organization. And how have these requirements prompted 
public charities to make changes for compliance purposes?
    Ms. BORENSTEIN. Well, I am sorry, Mr. Chairman, are you 
asking about the Schedule R?
    Chairman BOUSTANY. Yes.
    Ms. BORENSTEIN. I think the chief imperative behind the 
Schedule R was to afford a view into the linkages between the 
filing organization and organizations over which control 
existed in one direction or the other. Also, in addition to 
noting where the linkages are, it gives the opportunity for the 
IRS and the public--the court of public opinion in my eyes is 
the third regulatory body to the States and the IRS--to see 
answers to the IRS' asking the right questions, depending on 
whether the related organization is for profit and taxable 
versus exempt or a partnership--in each of those instances, 
there is different contextual information asked of. So you and 
I as readers of the return see who those entities are with much 
more detail than that afforded by the prior 990.
    One of the things I don't note in my testimony that is 
important to understand that the Schedule R serves to inform 
the compensation picture, too. The very important people, the 
in-charge people for the filer, for these individuals the 
Schedule R triggers visibility for what compensation they are 
paid by, and what hours they are providing to, the filer's 
``related organizations.'' In the good old days, before the 
current 990, if I had a complex organization that was comprised 
of a (c)(3) with a related (c)(4), I would not know from 
reading the 990 of either if an important person for the (c)(3) 
was also being compensated by or providing services to the 
(c)(4) or vice versa. I would have had to read both returns 
together but now it is in one place on each organization's 
return.
    Chairman BOUSTANY. Okay. Thank you. That was very helpful.
    And finally, Professor Colombo, in your testimony, after 
discussing the many problems with the commerciality doctrine 
compliance IRS enforcement, you provide several suggestions for 
reform. And I want to just focus on two of those options you 
had laid out. First is to return to the commensurate in scope 
doctrine. Explain to me in more detail what that proposal is 
and how it would actually work.
    Mr. COLOMBO. Well, this is actually part of this question 
of how much commercial activity should a charity engage in. In 
1964, actually, the Internal Revenue Service took a look at 
this problem and wrote a ruling and basically said that you 
could engage in--there was no limit on the amount of commercial 
activity you could engage in as long as your charitable 
activities were commensurate in scope with your investment in 
commercial activity.
    So this was the IRS's check on making sure that the 
commercial activity was providing resources to the charitable 
side as opposed to just becoming, as I point out, empire 
building.
    I would resurrect that test. I probably would resurrect it. 
The IRS has sort of let it lie, and then they resurrected it in 
other areas, and now I am not exactly sure anymore what----
    Chairman BOUSTANY. It is inconsistent.
    Mr. COLOMBO. Yeah. I don't know what it means anymore. I am 
not sure they know what it means anymore, frankly. So I would 
resurrect it for its original purpose.
    I might even add some kind of safe harbor rule, that if you 
earn a rate of return that is equal to the current Federal 
rate, medium-term Federal rate or something like that, that you 
then redeploy on the charitable side, you are okay, it is fine, 
you go and you can engage in as much commercial activity as you 
want. So that is the piece of it that I refer to as 
resurrecting the commensurate in scope doctrine.
    Chairman BOUSTANY. Okay.
    And finally, second is to no longer use the relatedness 
test for UBIT and impose tax on all commercial activities by 
charities. You kind of talked a little bit about that in our 
previous back and forth. How would that work? Would it make 
oversight easier? And what kind of impact would this have on 
the tax-exempt sector overall?
    Mr. COLOMBO. Well, I think, first of all, if you just tell 
charities that all of your commercial activities are taxable--
you could actually I think do it either way, tell them they are 
all taxable or tell them they are all not taxable; I think that 
it happens to be not a good idea to tell them that they are all 
not taxable--hen again, you eliminate this, as Mr. Miller 
pointed out, very difficult to enforce line between what is 
related and unrelated.
    Now, there is still a definitional question, no doubt about 
that, there is a definitional question about what is 
commercial. But my own view about that one is that is a pretty 
easy definitional line to meet, certainly much easier in my 
view than related or unrelated. I am not sure at the end of the 
day that that will have much effect on charities other than 
giving them clarity that they can engage in commercial 
activities. It will not cause them to lose their tax exemption. 
They can then set up the corporate structure or the business 
structure that makes sense from a business perspective as 
opposed to worrying about, well, do I have to drop this thing 
into a corporate container because if I don't, then someone 
from the IRS might come along and say, well, that affects your 
tax exemption. No. You know, let them make those decisions 
based upon issues that are not tax issues, that are issues of 
business issues. So my own view is that that would in fact 
simplify oversight. How much? I don't know. But I think the 
system we have got, sort of anywhere is up.
    Chairman BOUSTANY. Thank you.
    Mr. Lewis, do you have any follow up.
    Mr. LEWIS. No, Mr. Chairman.
    Chairman BOUSTANY. Mr. Paulsen is gone.
    Well, that concludes our hearing. Thank you very much. Your 
testimony was very, very helpful to us. Keep in mind that 
members may have some additional questions that may come up, 
and they would submit those to you directly for answers. Both 
questions and answers will be made part of the official record. 
And with that, I will now conclude the hearing.
    [Whereupon, at 11:38 a.m., the Subcommittee was adjourned.]

    [Submissions for the Record follow:]

                      American Bankers Association

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                        Center for Fiscal Equity

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                      Economic Research Institute

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