There has been much news related to group exemptions for tax-exempt organizations in recent months, from an influential advisory committee suggesting last summer that group returns be jettisoned to an announcement from the Internal Revenue Service (“IRS”) early this year that it plans to send out questionnaires to group exemption holders to see how they are complying with applicable law while maintaining their group exemptions.
When one considers that approximately 500,000 organizations have tax-exempt status by virtue of inclusion on a group exemption letter, it becomes clear just how broad an impact any tinkering with the rules or heightened enforcement may have on associations and other nonprofits. In light of the recent focus, now is a good time for associations that hold group exemptions or wish to obtain a group exemption to take a close look at the existing requirements.
The IRS’s group exemption process allows a “central” tax-exempt organization to have more than one “subordinate” organization to be considered an exempt organization without the need for each subordinate to file for and obtain recognition of exempt status from the IRS. In the association community, a group exemption is frequently used by a national organization to permit its chapters to have the benefits of exempt status without need for the completion and filing of multiple application forms. Historically, the IRS began allowing such group exemptions as far back as 1940, although no formal procedures were established for obtaining group exemption until 1968.
At present, the rules of the road for obtaining and maintaining group exemption recognition are set forth in a 1980 Revenue Procedure (Rev. Proc. 80-27, 1980-1 C.B. 677). According to the requirements of this Revenue Procedure, at the outset, it is necessary for a central organization to first have its own exempt status recognized by the IRS. Note that associations which are exempt under Internal Revenue Code § 501(c)(6) are permitted to “self-certify” as exempt without obtaining specific recognition. Those self-certifiers would not, however, qualify to serve as central organizations.
Other threshold matters for consideration by organizations that would seek to obtain a group ruling are: no subordinates that are organized and operated in a foreign country may be included in a group exemption letter and no IRC § 501(c)(3) private foundation may be included as a subordinate. Finally, subordinates that are included in a group exemption letter should not apply separately for recognition of exempt status.
In general, the structure envisioned by the group exemption process is one in which the central organization is putting itself in the place of the IRS when it comes to a determination of whether its subordinates are operating consistent with tax-exempt status. In this role, the central organization will essentially take on the legal duty of ensuring that its chapters/subordinates are operating consistent with the exempt status being sought. Thus, oversight should be exerted by the central organization over the subordinates to ensure ongoing compliance.
In order to obtain group exemption recognition, the central organization must establish that the subordinates that it wishes to include in the letter are: (1) affiliated with it; (2) subject to its general supervision or control; (3) all exempt under the same section of the IRC; (4) not private foundations (in the case of § 501(c)(3) group exemptions); (5) all on the same accounting period as the central organization if they are to be included in a group return; and (6) organizations that have been formed within the 15-month period prior to the date of the submission of the group exemption application (in the case of § 501(c)(3) organizations).
As part of the group exemption application process, each subordinate is required to authorize the central organization to include it in the application for the letter. The authorization must be signed by a duly authorized officer of the subordinate and retained by the central organization while the group exemption letter is in effect.
According to the Revenue Procedure, the application should set forth information that verifies the relationship between the central organization and its subordinates, a sample copy of a subordinate’s governing instruments, a detailed description of the purposes and activities of the subordinates (including sources of receipts and nature of expenditures); a list of the subordinates to be included in the list; and certain signed affirmations. It should be noted that in practice the IRS recently has sought more detail than what one might expect is necessary based on the wording of the Revenue Procedure. For instance, the IRS will usually request not just a “sample” copy of a subordinate’s governing instruments, but rather copies of all subordinate governing instruments.
To maintain the group exemption, the central organization must submit an annual report to the IRS (at least 90 days before the close of its fiscal year) confirming that the subordinates are still active and included in the group exemption, adding or deleting any affiliates as appropriate, and detailing any significant changes in the purposes, character, or method of operation of the subordinates.
Finally, separate and apart from the annual reporting required by the group exemption rules, both the central organization and its covered affiliates must comply with the IRS’s annual Form 990 filing requirements. In this regard, the central organization may (but is not required to) file a group Form 990 for its covered subordinates on a consolidated basis. Because the central organization must file its own Form 990, this process results in two federal returns—one for the parent and one for all affiliates under the group exemption that elect to be included in the group return.
It is possible that the above-described regime will be in for some changes in the near future. Practitioners have noted anecdotal instances of increased hesitancy on the part of IRS to approve group exemption applications; further, the ACT Report included a number of suggestions for changes, and one of the IRS’s own officials stated publicly in reaction to that report that the group exemption option may no longer make sense.
The ACT Report specifically recommended that the group return option may no longer be consistent with the IRS’s stated goals of enhancing transparency, accountability, and responsibility in the exempt organization arena. Specifically, group returns are not able to reflect, for example, an individual subordinate organization’s compensation levels.
While the ACT Report recommended removal of the group return option, it came out in support overall of retaining the group exemption option—citing the tremendous burden of requiring a separate application for recognition of exempt status for the hundreds of thousands of subordinates and pointing out the unique and virtually insurmountable transition issues that would arise. The ACT Report does recommend some changes to the process, though. Specifically, it suggests that the IRS update its 32-year-old Revenue Procedure so that it: (1) better defines what is meant by “supervision or control”; (2) excludes certain types of supporting organizations; and (3) allows for retroactive recognition for any subordinate that was formed within 27 months of its application (rather than the current 15-month lookback period). In addition, the ACT Report recommends that the IRS find a way to include on its master list of § 501(c)(3) organizations that are eligible to receive tax-deductible contributions those subordinates that have been identified in a group exemption.
While officials at the IRS have not made any further remarks calling into question the continued existence of the group exemption option, there was an announcement in the IRS 2012 work plan indicating that the IRS is preparing a questionnaire for completion by group exemption holders. The IRS has in the past used the compliance questionnaire as a means of determining whether a more comprehensive enforcement regime should be conducted. The IRS ties this focus not just to the recently released ACT Report, but also to the automatic revocations that have only recently begun to come to light as a result of the 2006-enacted IRC § 6033(j). That section of the IRC mandates that organizations which fail to file annual Forms 990 for three consecutive years will have their tax-exempt status automatically revoked. The initial wave of automatic revocations shows that a large number of group exemption subordinates were among those that were revoked.
In light of the current focus on group exemptions, those associations with group exemptions in place should take a close look at their current procedures to ensure they will stand up to scrutiny. Those procedures should include some form of annual reporting from the subordinates/chapters to ensure that activities are consistent with exemption. The annual reporting might include a brief description of program achievements from the previous year, information regarding receipts and expenditures, and information about directors and officers. In addition, the national organization should take affirmative steps to ensure that Form 990, corporate reporting, and other administrative compliance steps are being taken by each chapter.
For more information, please contact George Constantine at geconstantine@Venable.com.
The author is an attorney in the law firm of Venable LLP. This article is not intended to provide legal advice or opinion and should not be relied on as such. Legal advice can only be provided in response to specific fact situations.
1 Advisory Committee on Tax Exempt and Government Entities. “Exempt Organizations: Group Exemptions—Creating a Higher Degree of Transparency, Accountability, and Responsibility,” June 15, 2011. Available at: http://www.irs.gov/pub/irs-tege/tege_act_rpt10.pdf. This report includes an in-depth and informative look at both the history of the group exemption process and the current implementation by the IRS. (This report will hereinafter be referred to as the “ACT Report.”)
2 Note that the subordinates could all be exempt under a different set of the IRC than the central organization. For instance, a § 501(c)(3) central organization may obtain group exemption recognition under § 501(c)(6) for its chapters.
3 If the application is for a § 501(c)(3) group exemption and the chapters/subordinates have been in existence for longer than 15 months, a group exemption letter still may be issued, but only if all subordinates are willing to be recognized as exempt from the date of the application.
4 “IRS Considers Changes in Disclosure Rules for Many Groups,” Chronicle of Philanthropy, June 15, 2011, citing a statement by IRS’s Holly Paz. Available at: http://philanthropy.com/article/IRS-Considers-Changes-in/127922/.
5 ASAE has taken an active role in connection with the group exemption issue, filing comments to the IRS in response to the ACT Report. In its comments, ASAE favors retention of the group return option. Further, ASAE expresses strong support for the retention of the group exemption option generally. ASAE’s comments are available at: http://www.asaecenter.org/files/Group%20Exemption%20Letter%207-11.pdf
6 See http://www.irs.gov/pub/irs-tege/fy2012_eo_work_plan_2011_annrpt.pdf.