The Tax Court recently delivered some sound advice – do not play “cat and mouse” with the IRS.  In Ohio Disability Association v. Commissioner, a Tax Court Memo filed November 12, 2009, the Tax Court rejected the petitioner’s request for a declaratory judgment that it qualified as a public charity.  The court’s rejection was based on its inability to conclude that the organization would operate exclusively for exempt purposes.

The opinion is instructive on how not to deal with the IRS in the exemption process.  Organizations seeking IRS recognition of tax exemption (which is required of almost all charities, except for churches) must file a 26-page Form 1023, which is explained in 38 pages of instructions.  The IRS also has extensive questions and answers further explaining Form 1023.

Notwithstanding the broad scope of the questions on the Form 1023, it is quite typical to receive further extensive questions from the IRS following its review of the Form 1023 submission package.  These questions usually seek elaboration on the current and proposed activities of the organization, compensation structure, information about the Board members, copies of documents referred to in the application (e.g., bond offering, leases, and employment agreements).  Some practitioners sometimes treat these supplemental IRS questions in a cavalier manner, considering them a nuisance.  This type of response is a mistake, as the petitioner in Ohio Disability Association v. Commissioner learned.  At a minimum, responding to IRS questions in this manner often leads to extensive delay in obtaining an IRS exemption letter.

In denying the petitioner tax exemption, here are some of the faux pas that the court pointed to:

1. In the numerous letters that were exchanged between the organization and the IRS, the organization’s answers were “often curt and, for the most part, referred [the IRS] back to prior letters and the initial application.”  (Interestingly, the court notes that, at times, the IRS inquiries “were not coherent.”)

2. The organization’s letters included conclusory statements that the requirements for tax exempt status were satisfied.

3. In response to a question on how the conflict of interest policy would be implemented, the organization said that it copied the policy from the instructions.

4. Most of the organization responses were general and conclusory.

5. The organization supplied a sample pooled trust agreement when requested to supply the actual agreement that would be used by the organization. 

The lesson of the case is to fully and timely respond to all questions, even if the organization or its representative believes that the IRS is asking questions that are unnecessary or repetitive.

We have seen situations where playing games has resulted in inordinate delay and extensive additional legal fees.  If the IRS unduly delays in issuing a determination of exemption, try filing a Form 911, a form not commonly known among practitioners, with the National Taxpayer Advocate Office.  For an interesting annual report by that office, see the National Taxpayer Advocate’s 2009 Annual Report to Congress, which discusses, among other things, how targeted research and increased collaboration are needed to meet the needs of exempt organizations.