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Tax-exempt organizations that have had their tax-exempt status automatically revoked because of failure to file required annual returns for three consecutive years can follow new procedures for seeking reinstatement of their tax exemptions.  The IRS released these procedures in Revenue Procedure 2014-11 on January 2, 2014.  The Revenue Procedure, which is the first IRS guidance on this topic since 2011, outlines three procedures that organizations may use to apply for reinstatement.

First, under a “Streamlined Retroactive Reinstatement Process,” small organizations eligible to file a short form (Form 990-EZ) or postcard return (Form 990-N) may have their tax-exempt status retroactively reinstated to the date of revocation, provided that they have not previously had their exemptions automatically revoked.  Under this procedure, organizations must complete and submit Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3)) or Form 1024 (Application for Recognition of Exemption Under Section 501(a)) not more than 15 months after revocation.

Earlier this year the IRS issued drafts of the 2013 Form 990, Return of Organization Exempt From Income Tax, and 2013 Form 990 Instructions.   Although there were no major changes to the Form 990, there were several changes and clarifications in the draft instructions, including:

  • Short Period Returns.  The draft instructions clarify that a short period return cannot be filed electronically unless it is appropriately designated as an initial return or final return.
  • Change in Accounting Method.  The draft instructions provide that an organization that files Form 990-N (electronic postcard) must report its accounting changes on Form 990, Form 990-EZ or Form 1128.
  • Documentation.  The draft instructions clarify what documentation must be attached to Form 990 to support a name change, or by an organization that has terminated, dissolved, merged or had its exemption revoked by the IRS.
  • Public Support Test.  The draft instructions clarify when an organization can exclude from Schedule B contributors that fall below the greater-than-$5,000/2% threshold.  In order to limit the contributors an organization reports on Schedule B, an organization must complete the “support tests” in Schedule A, Part II.

The Advisory Committee on Tax Exempt and Government Entities (ACT) has released its annual report and recommendations to the IRS on selected issues concerning exempt organizations, employee benefit plans, tax-exempt financing, and state and local governmental entities. See our post about last year’s report here. The annual ACT report is always an important indicator and focus group of IRS trends. This year’s Exempt Organizations (EO) report, “Leveraging Limited IRS Resources in the Tax Administration of Small Tax-Exempt Organizations,” is particularly interesting.  The development of the Report and recommendations preceded the so-called “IRS TEGE scandal” involving alleged targeting of certain (c)(3) and (c)(4) applications for review, the exodus of Lois Lerner, and the consequent infusion of long-needed resources for eliminating or reducing EO application and review bureaucratic delays, due to pure and simple overload, and limited resources, exacerbated by the Sequester.

The Report also reflects a serious effort by all the players to figure out how to leverage limited administrative, educational and enforcement resources in the interest of providing more public information, transparency and accountability for the “small” and “very small” EOs (in part because the Attorney-General offices (AGOs) often see these EOs being an easy target for fraudsters at the local level, an arena AGOs are charged with policing and which they have far more incentives to monitor than the IRS), expanding the availability of education and technical assistance for these EOs through leveraging a range of private/public vehicles, plus the IRS website itself, and enhanced information sharing for all these purposes with state charity regulators.

The IRS released its Final Report on its five year study of the audit results of colleges and universities.  Lois G. Lerner, Director of the Exempt Organizations division of the IRS announced the “long awaited” posting of the report.

In 2008, the IRS sent a 33 page questionnaire to 400 randomly selected colleges and universities.  In 2010, the IRS released an Interim Report.  Following review of the responses and Forms 990 and 990-T, the IRS selected 34 schools for audit.  The audits were limited to two specific areas, unrelated business income tax (UBIT) and executive compensation.

The Final report was released on April 25, 2013.  The IRS points out that because the 34 organizations that were audited were not randomly selected, the schools do not represent a statistical sample.

Correction of Plan Errors

Final Internal Revenue Code Section 403(b) regulations which became effective January 1, 2009 require that plan sponsors adopt written 403(b) Plan documents.  A 403(b) Plan is a form of defined contribution retirement plan that may only be offered by employers that are tax-exempt entities under Section 501(c)(3) of the Internal Revenue Code or that are public educational organizations and for the benefit of certain clergy members.  If a 403(b) Plan sponsor did not adopt a written plan document by December 31, 2009, the sponsor’s 403(b) plan is technically no longer considered to be a qualified tax-deferred retirement plan as of January 1, 2009.  The benefit of correcting the written document failure is that all money that has been contributed to the 403(b) Plan will remain tax-deferred and that all investments under the 403(b) Plan will retain their tax-favored status.

To help 403(b) Plan sponsors voluntarily correct any plan document errors, the IRS recently updated its Employee Plans Compliance Resolutions System (referred to as EPCRS).  Plan document errors are cured through the voluntary correction program (referred to as VCP) by having the 403(b) Plan sponsor adopt a written plan document that complies with the final regulations, make a VCP submission, and pay a compliance fee based on the number of employees eligible to participate in the 403(b) Plan.  To simplify this procedure, the IRS has made available a 403(b) VCP Submission Kit, and to encourage 403(b) Plan sponsors to take advantage of this program, the IRS has reduced the compliance fee by 50% if the VCP filing is made by December 31, 2013.

IRS Exempt Organizations group has sent out more than 1,300 questionnaires to self-declared Section 501(c)(4) social welfare organizations; 501(c)(5) labor, agricultural or horticultural organizations; or 501(c)(6) business leagues.  The questionnaires are part of IRS efforts to increase voluntary compliance, learn more about self-declared exempt organizations, and determine whether self-declared exempt organizations are complying with applicable tax-exempt law.  The questionnaires are directed to organizations that are not recognized by the IRS as tax-exempt, but claim exemption under Section 501(c)(4), (5) or (6) and filed a Form 990 for tax years beginning in 2010 or 2011.  Unlike most Section 501(c)(3) organizations, these types of exempt organizations are not required to apply to the IRS for recognition of exemption.

At the end of January, 2013, the IRS Exempt Organizations Group (“EO”) released its annual report, highlighting EO’s 2012 accomplishments and outlining its priorities for 2013.  This year’s report was significantly more detailed and informative than last year’s report and workplan.  Some accomplishments and priorities of interest are described below, with something for nearly everyone in the tax-exempt sector.

2012 Highlights:

  • Exchange of Information with States.  EO continued to see an increase in the number of referrals from state charity regulators and tax agencies regarding potential exempt organization tax law violations.  In FY 2011, EO received 104 referrals from 19 different states.  Some of the most common issues that are referred to the IRS from the charity regulators involve private benefits and inurement, nonfilers, political activities by § 501(c)(3) organizations, employment tax issues and organizations not operated as required by their exempt status.  Conversely, under recently expanded authority, the IRS is allowed to disclose to certain state charity regulators significantly more information about exempt organizations, including proposed and final revocations of tax exemption for § 501(c)(3) organizations, proposed and final notices of deficiency for Chapter 42 excise taxes, § 501(c)(3) exempt organizations applications in process and proposed or final denials of these applications.  At present, only eight state tax and charity agencies in seven states have met the requirements to receive these disclosures; nonetheless, these agencies received approximately 27,000 disclosures in FY 2011.
  • Hospital Community Benefit Reviews.  As we have previously noted, EO is required under the Affordable Care Act to review the community benefit activities of all tax-exempt hospitals every three years.  This work continued in the past year.  EO will use the information from the reviews for research, reporting and compliance purposes, as well as to identify areas where additional guidance, education or Form 990 changes are needed.

The IRS continues to implement the “three years and you’re out” rule for Form 990 non-filers added by the Pension Protection Act of 2006 (the “PPA”).  That legislation amended Section 6033 of the Internal Revenue Code to provide that exempt organizations required to file a Form 990-series return (i.e., a Form 990, Form 990-EZ or Form 990-N) that do not file the return for three consecutive years will have their tax-exempt status automatically revoked going forward.  Organizations subject to automatic revocation are required to file exemption applications with the IRS to regain exempt status, even if they were not originally required to file an application for recognition of exempt status.  Further, exempt status will not be restored retroactively unless the IRS finds there was reasonable cause for the failure to file.

Many practitioners have been anxious to leaf through regulations to confidently determine whether an organization is a “functionally integrated” or “non-functionally integrated” Type III supporting organization, and the implications of either classification.

On December 28, 2012, the Internal Revenue Service released the long-awaited final regulations for Type III supporting organizations, as well as temporary regulations addressing annual distribution requirements.  The text of the temporary regulations also serves as the text of the proposed regulations.  The final regulations describe all of the other requirements (outside of the annual distribution requirement explained below) of a Type III supporting organization’s relationship with its supported organization.

The IRS and Treasury Department have released their annual Priority Guidance Plan (the “Plan”) for the 2012-2013 fiscal year.  The 35-page Plan is available here and includes thirteen projects directly related to Exempt Organizations.  At least five other projects, such as final regulations under Section 170 regarding charitable contributions and guidance on Section 403(b) plans, are also likely to be of interest to Exempt Organizations.