Tax Law Insights

Many individuals and business entities create charitable organizations to serve the needs of a specific group of persons or a specific community with a need for a type of service. Most charitable organizations undertake the arduous task of applying for tax-exempt status with the Internal Revenue Service in order to be exempt from paying corporate income taxes and to solicit charitable donations from public and private patrons. In June of 2011, the IRS revoked the tax-exempt status of approximately 275,000 organizations because these organizations failed to file the required annual reports for 2007, 2008 and 2009. Prior to revoking the tax-exempt status of these organizations, the IRS attempted to inform over 1 million organizations that failed to file the annual information returns as required by law. Additionally, in 2010, the IRS published a list of at-risk organizations and gave such organizations additional time to file the information returns in conjunction with its voluntary compliance program.

The Internal Revenue Code (the "Code") requires all organizations exempt from taxation under Section 501 to file an annual information return such as IRS Form 990, Return of Organization Exempt from Income Tax, IRS Form 990-EZ, Short Form Return of Organization Exempt from Income Tax, or IRS Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation. However, organizations whose annual gross receipts are not more than $50,000 (or $25,000 for taxable years beginning before January 1, 2010) are not required to file an annual information return. In 2006, Congress passed the Pension Protection Act of 2006 which now requires tax-exempt organizations not required to file one of the annual information returns to file an annual notification to the IRS. These tax-exempt organizations will satisfy the annual notification requirement when the organization files an annual electronic notice using IRS Form 990-N (e-Postcard). The IRS will automatically revoke the tax-exempt status of any organization that fails to file a required annual information return or IRS Form 990-N e-Postcard for three consecutive years. The automatic revocation date will be the filing date for the third annual return or notice.

Reinstatement Process for Organizations other than Small Organizations

An organization seeking to have its tax-exempt status reinstated from the date of automatic revocation must submit a request for retroactive reinstatement with either IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) or IRS Form 1024, Application for Recognition of Exemption under Section 501(a). Further, if the tax-exempt status of a subordinate organization included in a group exemption letter is automatically revoked, the subordinate organization must apply for reinstatement on its own behalf. All organizations seeking reinstatement must pay the appropriate user fee of either $400 if the organization's annual average gross receipts were less than $10,000 during the preceding four years or $850 if the organization's annual average gross receipts were greater than $10,000.

Along with the application for reinstatement, the organization must include:

1. A written statement (a) setting forth all of the facts that support its claims for reasonable cause for failing to file a required return or notice in each of the three consecutive years and over the consecutive three-year period and (b) describing the safeguards the organization has put in place to ensure it will not fail to file returns or notices in the future;
2. Any evidence to substantiate all material aspects of the written statement;
3. Properly completed and executed paper annual information returns (i.e., Form 990, Form 990-EZ, or Form 990-PF) for all tax years during and after the consecutive three-year period that the organization was required, but failed, to file an annual information return;
4. Properly completed and executed Form 990-EZ for all tax years during and after the consecutive three-year period that the organization was required to file a Form 990-N e-Postcard but failed to file either a Form 990-N e-Postcard or an annual information return; and
5. An original declaration dated and signed under penalties of perjury by an officer, director, trustee or other official who is authorized to sign for the organization.

Moreover, an organization seeking retroactive reinstatement must demonstrate that it had reasonable cause for failing to file a return or notice not only for each of the three years but also over the entire three-year period. An organization may establish reasonable cause by providing facts and circumstances showing it exercised ordinary business care and prudence in determining and attempting to comply with its reporting requirements for each of the three years and over the entire three-year period, but was nonetheless unable to file the required returns or notices for three consecutive years.

The IRS will consider a request for retroactive reinstatement from an organization other than a small organization only if the organization submits a request for reinstatement with a properly completed and executed application for reinstatement within 15 months of the later of the date of the IRS revocation letter or the date the IRS posted the organization's name on its revocation list available on the IRS website.

Reinstatement Process for Small Organizations

The IRS defines a small organization as one who has annual gross receipts of not more than $50,000 in its most recently completed tax year. A small organization who had its tax-exempt status revoked may establish reasonable cause for failing to file the required information returns and have its tax-exempt status retroactively reinstated to the date it was automatically revoked if it meets each of the following conditions:

1. The small organization was not required to file annual information returns for tax years prior to 2007;
2. The small organization was eligible to file IRS Form 990-N e-Postcard for tax years 2007, 2008, and 2009; and
3. The small organization submits an application for reinstatement to the IRS on or before December 31, 2012.

A small organization who is not a private foundation or a supporting organization and whose annual gross receipts were less than $25,000 would have been eligible to file IRS Form 990-N e-Postcard in those tax years.

A small organization seeking to have its tax-exempt status reinstated must also file IRS Form 1023 or IRS Form 1024. The small organization must submit the appropriate form regardless of whether the organization was originally required to apply with the IRS for tax-exempt status. Finally, a small organization seeking relief must write "Notice 2011-43" on the appropriate form and provide a statement that the small organization meets the conditions for relief. The IRS offers a reduced user fees of $100 for small organizations seeking reinstatement who meet the conditions described above.

Taxpayer Impact

An organization that loses its tax-exempt status by automatic revocation will be required to file IRS Form 1120, U.S. Corporation Income Tax Return or IRS Form 1041, U.S. Income Tax Return for Estates and Trusts for that particular tax year. All 501(c)(3) organizations that lose exempt status will no longer be eligible to receive tax-deductible contributions. Under state law, these organizations may also then be subject to sales taxes, taxation on the sale of real property or other assets, and other taxes which would have been exempt prior to the automatic revocation.