Over the past decade, the Internal Revenue Service (IRS) has grappled with imposing changes for nonprofits with group tax exemptions. The latest and most substantial changes were proposed in Notice 2020-36, which would update and supersede the current procedures in effect. The proposed revenue procedure was issued in May 2020 and currently remains pending with the IRS, leaving nonprofits questioning when these changes may become final.
New Requirements for Central and Subordinate Organizations
A group tax exemption may be obtained by a "central organization" for a group of "subordinate" organizations if the central organization declares that it exercises "general supervision or control" over the subordinate organizations in the group. The group exemption has been used over the years by a number of large national nonprofit organizations that have multiple state or local chapters or affiliates. The IRS maintains more than 4,000 group exemptions providing exemption to more than 400,000 subordinate organizations.
The proposed revenue procedure adds new requirements for central and subordinate organizations seeking to obtain and maintain group exemption letters. Of note, these requirements are subject to certain transition and grandfather rules that would help protect preexisting group exemption letters.
Central Organizations: The proposed procedure would add two new requirements that central organizations would need to meet. Currently, a central organization must be described in Section 501(c) or be an instrumentality or agency of a political subdivision. Under the new requirements, central organizations would also need (i) to have at least five subordinate organizations to obtain a group exemption and at least one subordinate to maintain the exemption, and (ii) to maintain only one group exemption.
Subordinate Organizations: The proposed revenue procedure would also modify the requirements for a central organization's relationship with subordinate organizations by adding four new requirements that must be satisfied for subordinate organizations to be included in or added to a group exemption letter. Revenue Procedure 80-27 requires subordinate organizations to be affiliated with the central organization and subject to its general supervision or control; however, these terms are not currently defined. The proposed revenue procedure adds definitions for "affiliation," "general supervision," and "control," which impose conditions that central organizations would need to satisfy to establish sufficient affiliation with, supervision of, and control over the subordinate organization. These definitions will require central organizations either to have certain control over the subordinate organizations' boards or to meet requirements for review over the subordinate organizations' finances and activities.
To qualify as a subordinate organization, organizations would also need to satisfy the following new requirements:
- Matching requirement: All subordinate organizations would need to be described in the same Section 501(c) paragraph as the central organization unless the central organization is either an instrumentality or agency of a political subdivision. This differs from the current procedure, which allows subordinates to be exempt under a paragraph of 501(c) that is different from the one that applies to the central organization.
- Foundation classification requirement: All 501(c)(3) subordinate organizations would need to be classified as public charities under the same paragraph of Section 509(a), and subordinates could no longer be classified as Type III supporting organizations under Section 509(a)(3). Subordinate organizations would not need to be classified under the same paragraph of Section 509(a) as the central organization. Private foundations continue to be ineligible for group exemptions, as either a central organization or a subordinate organization.
- Similar purpose requirement: Except for subordinates recognized as exempt under Section 501(c)(3), all other Section 501(c) subordinate organizations would need to be described by the same National Taxonomy of Exempt Entities (NTEE) Code. In other words, they must all fit into the same one of roughly 400 purpose categories.
- Uniform governing instrument requirement: All subordinate organizations would be required to adopt a uniform governing instrument that must be submitted with the request for a group exemption letter; the group could no longer submit copies of representative instruments. This requirement does not apply to subordinates recognized as exempt under Section 501(c)(3) unless the subordinates have a similar charitable purpose, in which case the procedure would require a uniform governing instrument for those subordinate organizations.
Required Notifications for 501(c)(4) Subordinates
The proposed procedure adds a requirement that subordinate organizations described in Section 501(c)(4) must submit a completed Form 8976, Notice of Intent to Operate Under Section 501(c)(4).
Authorization for Inclusion
The proposed procedure adds a new requirement that the central organization must be authorized not only to add the subordinate in the group exemption letter but also to remove the subordinate organization if it fails to comply with the procedure's requirements. Central organizations would need to retain this authorization only while the subordinate is included in the group exemption instead of for the entire duration of the group exemption.
Transition and Grandfather Rules for Preexisting Group Exemptions
The proposed procedure would apply to both new and preexisting group exemptions once it becomes final. To aid with the transition, the IRS would provide a one-year transition period for existing central organizations to comply with the new requirements that central organizations must have at least one subordinate organization to maintain the group exemption and can have only one group exemption letter.
The IRS has also proposed very broad grandfather rules exempting certain requirements for preexisting subordinate organizations. Preexisting subordinate organizations would not be required to comply with the following:
- The new matching,1 foundation classification, similar purpose, and uniform governing instrument requirements;
- The definitions of "general supervision" and "control"; and
- The prohibition against including Type III supporting organizations in group exemptions.
Therefore, preexisting subordinates would remain subject to the current rules and definitions set forth in Revenue Procedure 80-27 and would not have to comply with the more restrictive requirements for subordinates described in the proposed procedure. Note, however, that new subordinates added by an existing central organization would need to comply with the new requirements.
Filing Deadlines and Automatic Revocation
The proposed revenue procedure also proposes new requirements for annual group exemption information updates and revocation procedures. A central organization is currently required to file its annual group information update at least 90 days before the end of the organization's fiscal year. The proposed revenue procedure would provide nonprofits with additional time to prepare this information by requiring them to submit this information at least 30 days before the close of the fiscal year. Central organizations could also provide additional updates at any time.
The update would continue to include a separate list for: (1) subordinate organizations that have changed their names or mailing addresses during the year; (2) subordinate organizations no longer to be included in the group exemption letter; and (3) subordinate organizations to be added to the group exemption letter.
Under the proposed procedure, a subordinate organization that has had its exemption automatically revoked and has not been reinstated would no longer be eligible for inclusion in or addition to a group exemption letter, and the IRS can terminate the group exemption letter if more than half of the subordinate organizations have had their tax-exempt status revoked. Accordingly, these new requirements would impose more of an administrative burden on central organizations to supervise subordinate organizations to protect the status of their group exemption.
What Now?
As of June 17, 2020, the IRS is not accepting any requests for group exemption letters until it issues final regulations or other guidance. The Notice did not impact applications that were submitted prior to this date. The IRS accepted comments on the proposed Notice through August 16, 2020, and received a sizeable number of comments, which will be considered in issuing final guidance. In the meantime, nonprofits maintaining group exemption letters should continue to follow the requirements in Revenue Procedure 80-27. For more information on the current procedure, our latest group exemption update can be found here.
[1] While preexisting subordinate organizations would not need to be exempt under the same paragraph of Section 501(c) as the central organization, preexisting subordinate organizations would all need to be described under the same paragraph of Section 501(c). Thus, central organizations that have preexisting subordinates exempt under different Sections of 501(c) would need to remove certain subordinate organizations to comply with the new requirements.