Group Exemption Letters to Become More Restrictive
Proposed changes to IRS group exemption letters could result in organizations needing to re-structure their operations or seek new exemption rulings from the IRS. In Notice 2020-36 (available here), the IRS announced that as of June 17, 2020, it would no longer accept applications for group rulings under Rev. Proc. 80-27. All applications for group rulings after that date would be decided under a new final revenue procedure or other IRS guidance. Exempt organizations covered under a group letter should review the proposed changes and make plans now to comply with the changes once they become final.
To be eligible for a group exemption letter under the proposed changes, a central organization must have at least five subordinate organizations at the time it submits its exemption application and maintain at least one subordinate organization at all times thereafter. Central organizations will not be allowed to have multiple group exemption letters. Central organizations that do meet these requirements will have a transition period to notify the IRS which, if any, of its pre-existing group letters it will maintain. During the transition period, central organizations may add a subordinate organization necessary for maintaining the group ruling. Group letters will be terminated for organizations that do not meet these requirements at the end of the transition period.
Subordinate organizations will need to meet four new requirements to be included in a group letter. The IRS’s stated purpose for adding these requirements is to improve the central organization’s exercise of supervision and control over the subordinate organizations. The first new requirement is that all subordinate organizations must be described in the same paragraph of Section 501(c). This means that if the central organization is described in Section 501(c)(3) then all subordinate organizations must also be 501(c)(3) organizations. Similar to the first requirement, all subordinate organizations must have the same foundation classification. At this time, the IRS is not requiring all subordinate organizations to be classified under the same paragraph of Section 170(b)(1)(A). This would allow a church and a hospital, for example, to be included as subordinate organizations under the same group exemption if they are publicly-supported organizations. The IRS is still considering if the central organization can exercise general supervision or control over such disparate organizations. The IRS may ultimately not allow them to be included in a group exemption once it issues its final guidance.
Furthermore, the new guidance will require subordinate organizations to have the same or similar purposes. The IRS will allow some leeway in varying the purpose statement, but, at a minimum, all subordinate organizations must be described by the same National Taxonomy of Exempt Entities (NTEE) Code. Finally, all subordinate organizations must have a uniform governing instrument. The IRS takes the position that not using a uniform governing instrument is inconsistent with the same or similar purposes requirement. The IRS previously allowed central organizations to submit copies of representative governing instruments, but now that will no longer be allowed since each subordinate organization must adopt the uniform instrument.
Under current law, subordinate organizations must have an affiliation with the central organization and be subject to its general supervision and control. The proposed new guidance goes into more detail about what it means to be subject to the general supervision and control of the central organization. To exercise general supervision, the central organization must annually obtain, review, and retain information about the finances, activities, and annual filing compliance of all subordinate organizations. The central organization must also inform subordinates of requirements to maintain tax-exempt status. On the issue of control, a majority of the subordinate organization’s directors will need to be appointed by the central organization or overlap with the directors of the central organization.
Most of the proposed changes are more restrictive than current law, but the IRS’s proposal broadens the use of group exemption letters in at least one significant way – by allowing subordinate organizations to operate in foreign countries. The IRS will allow a subordinate organization to operate outside of the United States, provided that it is organized in the United States.
Subordinate organizations that have had their exemptions automatically revoked for failure to file annual information returns will be ineligible to be included in any group exemption. Such organizations must apply for reinstatement under the IRS’s reinstatement procedures. However, once it has been reinstated, the subordinate organization may be added to a group exemption if it meets all other requirements.
We will continue to monitor developments in this area and plan to provide an update once final guidance is published. Please contact us if you would like our assistance determining how the proposed changes affect your group exemption letter and what you need to do to be ready for these changes.
This article is provided for general information and should not be relied upon as legal advice for a specific situation. If you are in need of specific advice or legal representation, please do not hesitate to contact us.
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