New Rules Reinstating Tax Exempt Status—Retroactively

By:
David A. Shuster, JD, LLM
Published Date:
Feb 1, 2014

Has there been any good news lately for organizations that have had their exempt status automatically revoked for failing to file required annual returns or notices for three consecutive years? Well, 2014 began with a resounding "yes." On Jan. 2, the IRS issued Revenue Procedure 2014-11, which, compared with the prior guidance that had been in place, will make it easier for organizations to regain their exempt status retroactively to the date of revocation so that, in effect, there is no lapse in exempt status.

As has been the rule, automatic revocation of exempt status for failing to file for three consecutive years is generally effective as of the due date of the third year’s return or notice. An organization may obtain reinstatement of exempt status by reapplying, but reinstatement will generally be effective only from the postmark date on the envelope containing the application for reinstatement. Consequently, an organization having its exempt status automatically revoked and subsequently reinstated—but not retroactively—will not have exempt status between the due date of the third year’s return or notice and the relevant postmark date. As a result, the organization will be subject to income taxation during the non-exempt period. Additionally, donations made during the non-exempt period to charitable organizations will have lost their status as deductible charitable contributions.

Although retroactive reinstatement has always been available, the new revenue procedure makes it easier to obtain. Furthermore, the IRS has indicated in this recently issued guidance that it will not impose failure-to-file penalties if the organization’s exempt status is retroactively reinstated. Being able to obtain retroactive reinstatement of exempt status is therefore highly desirable, making the new revenue procedure especially welcome.

Each organization seeking retroactive reinstatement must, among other requirements, establish reasonable cause for its failure to file annual returns or notices for three consecutive years. Under a streamlined process, however, a smaller organization, one that was eligible to file the e-Postcard (Form 990-N) or Form 990-EZ for each of the three consecutive years that it failed to file, need not include with its application for reinstatement a separate statement establishing reasonable cause. Rather, it will be deemed to have reasonable cause for its failures to file.

Further, a larger organization, one that was ineligible to file a Form 990-N or Form 990-EZ for at least one of the three consecutive years that it failed to file, need only include with its application for reinstatement a separate statement establishing reasonable cause for only one of the three years. Any organization, however, whether large or small, that applies for retroactive reinstatement more than 15 months after its status was automatically revoked (measured from the date of the revocation letter from IRS or from the date on which such revocation is posted on the IRS website, whichever is later), will have to include a separate statement establishing reasonable cause for all three years that it failed to file.

Under the new revenue procedure, an organization that has to establish reasonable cause needs to show that it exercised ordinary business care and prudence in determining and attempting to comply with the annual reporting requirements set forth under Internal Revenue Code section 6033. The IRS takes into account a variety of factors, no one of which is all-important. Below is a summary of some of the factors:

  1. The organization’s failure was due to its reasonable, good faith reliance on erroneous written information from the IRS, stating that the organization was not required to file a return or notice under section 6033, provided the IRS was made aware of all relevant facts;
  2. The failure to file the return or notice arose from events beyond the organization’s control that made it impossible for the organization to file a return or notice for the year;
  3. The organization acted in a responsible manner by undertaking significant steps to avoid or mitigate the failure to file the required return or notice and to prevent similar failures in the future; and
  4. The organization has an established history of complying with its reporting requirements (if any) under section 6033 and/or any other applicable reporting or other requirements under the Code.

Change from Previous Retroactive Rules

Under previous guidance, any organization seeking retroactive reinstatement had to establish reasonable cause for all three years that it failed to file. Additionally, that organization’s application for retroactive reinstatement had to be filed within 15 months after the organization’s exempt status was automatically revoked. Although there was a streamlined process similar to the one announced in the recent guidance, it was available to only the smallest of organizations, those that were eligible to file the Form 990-N for all three years that they failed to file, and the deadline for seeking retroactive reinstatement under that streamlined procedure expired at the end of 2012 (except that it was briefly extended for organizations affected by Hurricane Sandy).

In our experience, establishing reasonable cause to the IRS’s satisfaction for all three years proved to be exceedingly difficult. The recent guidance thus appears to be more promising for all organizations seeking retroactive reinstatement. Perhaps in recognition of the new rules being less stringent than the old ones, the IRS has also provided guidance indicating how organizations that sought reinstatement under the old rules may be eligible for retroactive reinstatement under the new rules.

Those who want to know more about the complexities of obtain tax exempt status should review the December 2013 Tax Stringer article, Long Delays on IRS Tax Exemption Applications.


David A. Shuster, JD, LLMDavid A. Shuster JD, LLM, is a tax principal at Grassi & Co., serving as its Director of Tax Controversy Services. His practice focuses on advising, representing, and defending clients in their controversies with the IRS and the state taxing authorities. He has written about major developments in tax law, including judicial decisions and legislative developments. He also conducts seminars for clients, prospects, and other interested folks on various tax issues. Shuster serves as a board member and treasurer for several non-profit organizations. He can be reached at 516-336-2436 or dshuster@grassicpas.com.

 
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