IRS Announces Comprehensive Bond
Compliance Survey of Charities

The Internal Revenue Service recently announced a second major audit initiative focusing on qualified 501(c)(3) bonds issued on behalf of tax-exempt organizations. Beginning this summer, between 2,000 and 5,000 surveys will be sent to tax-exempt organizations that reported tax-exempt bond financing on Form 990. These surveys are expected to request a broad range of information about post-issuance compliance, private business use, arbitrage, record retention and management practices.

The latest initiative follows a smaller IRS initiative, conducted in 2006, involving audits of qualified 501(c)(3) bonds issued on behalf of approximately 30 nonprofit hospital systems. According to the IRS, these 2006 audits revealed that many borrowers did not maintain records sufficient to substantiate that the actual use of bond proceeds satisfied the rules for maintaining the tax-exemption for such bonds, including allocating bond proceeds to particular investments and expenditures.

It is imperative that issuers and borrowers maintain adequate records substantiating that bond proceeds are used in accordance with the rules for maintaining tax-exemption for such bonds. In addition, these records are used to determine rebate and to demonstrate the lack of private use of bond-financed property. In the event of an audit, the IRS could challenge the tax-exemption of the bonds in the absence of these records. As a rule of thumb, issuers and borrowers should maintain records for at least three years after final maturity or earlier redemption date of the bonds (and, in the event that the bonds are refunded, for at least three years after final maturity or earlier redemption date of the refunding bonds).

Issuers and borrowers that have not maintained adequate records should work with counsel to develop record retention policies and other post-issuance compliance practices. In certain circumstances, it may be possible to recreate records substantiating the appropriate use of bond proceeds. Additionally, issuers and borrowers may be able to correct significant record retention and other post-issuance compliance failures through the IRS Tax Exempt Bond Voluntary Closing Agreement Program.

Should you have any questions about this development, please contact Randall E. Moore at 614.227.2380 or rmoore@bricker.com.

eDiscoTECH — Is Your Company “In-Step” With the
New Electronic Discovery Rules?

Litigants have become all too aware in recent years that their electronically stored information (ESI) may lead to increased costs during the discovery phase of civil lawsuits in federal court. With the recent amendments to the Federal Rules of Civil Procedure, which went into effect in December of 2006, electronic discovery has received a great deal more attention. But specifically, how much do you really know about your obligations under the new rules? What exactly are the consequences for failing to meet these obligations? And what does electronic discovery involve anyway?

These were some of the subjects addressed by Bricker partner Alan Ross and associate Greg Krabacher at the 17th Annual Seminar on Significant Developments in Computer and Cyberspace Law, hosted on June 8 by the University of Dayton School of Law.

“The talk was essentially a survey of recent cases that show how the courts are beginning to address the issues under the new rules,” Ross said.

Questions from the audience brought home the reality of the problem caused by ESI.

“We received several questions related to when a company may be subject to a duty to preserve,” Krabacher said. “In evaluating each unique situation, companies really need guidance on how the courts have reacted under similar circumstances. Otherwise, they are bound to make the same mistakes.”

Summary of the presentation

The case law since the advent of the e-discovery rules has highlighted the importance of acting promptly to preserve both a party’s own evidence and that of its adversary in litigation. The importance of acting promptly to preserve a party’s own evidence was emphasized in Reino De Espana v. American Bureau of Shipping, where the court found the plaintiff to have spoliated evidence by waiting six months after filing the Complaint to send a preservation notice to its agencies. Several cases held that the duty to preserve evidence attaches upon the filing of the Complaint, while Floeter v. City of Orlando held that in the Eleventh Circuit, that is an open question.

The Floeter case illustrates the importance of sending a preservation demand letter with the Complaint, or immediately upon receipt of the Complaint, if a defendant. In a related issue, the court in Griffin v. GMAC Commercial Finance, Inc. held that it was understandable that the defendant had not recognized that certain documents, which had been destroyed, were relevant, given that they were somewhat unrelated to the issues raised in the Complaint. This case points out the importance of notifying the adversary of the potential scope of relevant evidence at the outset of the case, if not before.

Several cases focused on the consequences of spoliation. In Miller v. Holzmann, the court held that the sanction of dismissal requires proof by clear and convincing evidence of flagrant or egregious conduct. In PML North America v. Hartford Underwriters Ins. Co. and Quantum Communs. Corp. v. Star Broad., the courts awarded default judgment for tampering with evidence on hard drives (PML) and for failing to produce “smoking gun” documents (Quantum).

The courts sent mixed messages regarding obtaining mirror images of hard drives. In Balfour Beatty Rail, Inc. v. Vaccarello, the court denied such a request, labeling it a fishing expedition. In Hedenburg v. Aramark American Food Services, the court held that the common thread in cases permitting the inspection of hard drives is the fact that the contents of the computer go to the heart of the case. The court in Cenveo Corp. v. Slater followed the court in Ameriwood Indus., Inc. v. Liberman and authorized a protocol that involved imaging the adversary’s hard disks and recovering anything and everything that was on the disk.

The Cenveo court seemed unaware that the parties in Ameriwood had returned to the court asking for relief for what they correctly perceived as an onerous undertaking. ‘Be careful what you ask for’ was the morale of those two stories, emphasizing the importance of understanding forensic principles.

Finally, in Lorraine v. Markel American Insurance Co., the court set forth the parameters of authentication and admissibility of electronically stored information. For electronic business records, the court adopted a procedure first proposed by Prof. Edward J. Imwinkelried, UC Davis. For email, the court explained every conceivable way in which email can be authenticated. The court also gave substantial treatment hearsay and other evidentiary issues peculiar to ESI.

The foregoing is a brief summary of a lengthy treatment of the post December 2006 e-discovery case law. There is much more available in the full papers as well as in their PowerPoint presentation.

Quick Hits

• The IRS has blessed transactions in which hospitals provide financial assistance or otherwise subsidize electronic health record arrangements with private physicians, so long as the arrangements are consistent with the 2006 Health and Human Services final regulations. Copy of the IRS field directive on this issue and an analysis of this announcement.

• The IRS issued Notice 2007-45 providing guidance on the requirement that all tax-exempt organizations, including churches, disclose their Forms 990-T, regarding unrelated business income. Besides churches, the organizations most affected by this change will be state universities that have received 501(c)(3) designation, because state universities exempt only under section 115 of the Internal Revenue Code are exempt from this disclosure requirement.

• The IRS has published guidance supplementing the instructions for the 2006 Form 990 and clarifying the questions regarding board structure, compensation and other board relationships (lines 75b and 75c). In general, the IRS has simplified the relationships that must be disclosed.

• The IRS has released a discussion draft of a redesigned Form 990 that it hopes to have finalized in time for the 2008 tax year. The draft Form 990 represents a significant change in the format and content of the return. The new Form 990 consists of a 10 page form with 15 schedules, including four new schedules requesting information about foreign activities, hospitals, tax-exempt bonds and contributions of property. An in-depth discussion of the new Form 990 will be included in the July 2007 Nonprofit Advocate.

• The IRS issued Revenue Ruling 2007-41 providing formal advice to churches and other charitable organizations about their ability to engage in political activity. This revenue ruling was apparently issued in response to the large number of complaints of alleged electioneering by exempt organizations received by the IRS in the most recent election cycles.

• The IRS issued Notice 2007-45 requiring charitable organizations to disclose their Forms 990-T, reporting unrelated business income.

• An IRS official said that a recent private letter ruling which found that income generated by professional corporations affiliated with a taxexempt hospital was unrelated business income was “atypical” and limited to its facts. The IRS issued PLR 200716034 on April 23, 2007. The ruling involved six controlled professional corporations owned by physicians employed by the hospital. In reviewing the arrangement, the IRS concluded that the income generated by the controlled professional corporations was taxable unrelated business income because the professional corporations did not serve the hospital’s patients and carried on activities on a larger scale than reasonably necessary for the hospital to carry out its exempt purposes.

  The ruling has generated significant controversy, given the prevalence of the controlled professional corporation structure. As a result, tax-exempt hospitals and other tax-exempt utilizing similar business structures should pay careful attention to further developments.