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Loss of Exempt Status is One Big Mess

Jul 22nd 2011
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For those of you who missed it, the IRS made its first additions to the list of organizations that had their tax-exempt status revoked. In Ohio, for example, the number of organizations swelled 17 percent. The number of organizations nationwide that have lost their tax-exempt status has likely exceeded 300,000.

Before the first list was released in June, I had one tax-exempt application under IRS review and four in process. As of today, I have received one IRS determination letter and have seven applications in process – and I expect a few more.

I agree that small organizations do get a break while applying for reinstatement IRS Notice 2011-43. A fee of $100 and not having to show reasonable cause are benefits. However, getting a “properly completed and executed” application to the IRS by Dec. 31, 2012 is another matter. Good luck!

Those of you who have filled out a tax-exempt application know what I mean.

I’ll say this. Any organization that has filled out a tax-exempt application understands the challenge of the application process. Frankly, I would be shocked if an organization REALLY WANTS to go through the process again.

Much of the focus has been on the 1023. This form primarily applies to 501(c)(3) organizations. It is fair to say while public charities and private foundations make up the majority of organizations that lost their status; the total is only about 60-65%. Nearly all the other organizations file Form 1024, which has fewer pages and different requirements.

The indirect effect: I am preparing applications for organizations that – I kid you not – never applied to the IRS! These are not-for-corporations in their states. However, their responses to my request for the determination letter were at best unsettling.

“What Letter?”

As you know, the Pension Protection Act of 2006 required nearly all tax-exempt organizations to file an information return for the first time. For organizations with gross receipts that are normally less than $50,000 ($25,000 before 2010), all that was required was the filing of Form 990-N, the e-postcard. This process takes at best 15-20 minutes to complete. In fact, I filed two 990-Ns on the morning of July 1 for nonprofits whose fiscal years ended June 30.

The law also called for organizations to lose their tax-exempt status if they failed to file a 990 for three years in a row.

So how did organizations make the list? Some said they were never informed of the new requirements; though the IRS made an extensive effort to let groups know. Some said that for one reason or another they have multiple EINs. Others have filed returns with the wrong EIN.

These groups are the minority.

It is fair to say the majority of the organizations that lost their exempt status fall into two categories:

• The organization no longer exists. This is an intended consequence of the revocation.
• The organization has a group exemption.

Group exemptions are in place as a convenience for both the IRS and organizations with many affiliates. Known as “subordinates,” the affiliates do not have to file a tax-exempt application, and the IRS does not have to process separate applications. Therefore, subordinates do not receive individual exemption letters.

Example: A national organization wants to start a chapter in your area. The national body has a group exemption, and wants the chapter to handle its own finances and file its own 990. The chapter only has to apply for an EIN; the application is not needed.

To properly understand how Notice 11-43 applies, you have to look at IRS Notice No. 11-44. In the latter, the IRS specifically discusses group exemptions. In other words, the group exemption does not protect an organization from filing a 1023 or 1024.

Case in point: The revised list in July added a large number of subordinates affiliated with two well-known national service organizations.

By making the revocation list; by-laws, articles of incorporation and all the questions on the forms will have to be filled out for the first time. Frankly, I think the easiest section of the application to complete is the financial data. Realistically, an organization needs at least six months to go through the process.

The small groups are the lucky ones. For organizations that failed to file a 990 or 990-EZ for three consecutive years, they have to show reasonable cause to be reinstated retroactively. Chances are many of these groups will only be reinstated based on the postmark date on the application.

Whether small or large, groups in tax-exempt limbo have a real problem. For starters, donors can’t claim a deduction until the status is reinstated. More important: unrelated business income rules no longer apply. All income is now taxable.

How will an organization handle its tax return? File a 990 for part of the year, and an 1120 or 1041 for the remainder? How about the latter for the entire year? These are good questions. … Not to mention state and local income taxes that could kick in.

To say this is a mess is an understatement. Therefore, consider the following:

If you volunteer for or otherwise work with a nonprofit organization, ask to see a copy of the determination letter, and inquire when the last time it filed its 990. If you do not get a satisfactory answer, take action immediately! You don’t want to see your organization’s name on the revocation list, which will next be updated in mid-August.


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