Contributing Author: William A Raabe
The application to become a tax-exempt entity is time-consuming but not difficult to complete. Most applications (over 90%) eventually are approved, with about 80,000 new exempt organizations created every year.
Tax exemption is such a valuable asset for an organization, such as by allowing charitable income and estate/gift tax deductions for donors, it should be retained under all circumstances. But about 6,000 entities lose their exemption every year, usually under an automated process where the IRS terminates the exemption because the entity failed to file the required Forms 990 over a period of years.
Most of the automatic revocations of exempt status are attributable to the entity’s failure to file the required annual Form 990/990-EZ/990-N or other information returns, for three consecutive years. The exemption is lost as of the due date of the third consecutive missing return, probably allowing for the automatic six-month extension of the filing date.
Loss of exemption is traceable to language in Rev. Rul. 59-95, where the entity’s incomplete financial records kept it from filing required returns. The IRS said that this lack of compliance kept the agency from establishing that the entity was meeting “the conditions required for the continuation of an exempt status.”
The current codification of this rule [§6033(j)(1)(B)] allows for few exceptions. If the required returns are not filed for three consecutive years, the exempt status is revoked. The IRS bears some responsibility for keeping such revocations from occurring [§6033(j)(1)(A)] after 2019. The Service must notify the entity after the second consecutive year of non-filing:
- That it has no record of receiving a return from the organization for two consecutive years, and
- That a revocation of exempt status will occur if no such return is received for the coming (third) year.
This notice procedure does not, though, convert the default filing requirements into “just file once every three years then.” The Form 990 due dates apply for each year independently.
The three-year rule applies even if the entity’s classification changes during the period, such as by growing from an e-postcard entity to a Form 990-EZ filer. If, say, the entity becomes an EZ filer in Year 2, the three-year test applies to the periods of Years 1-2-3, 2-3-4, etc. Changing the required form does not “restart the clock.”
The IRS keeps an online listing of organizations whose exemptions were revoked under the three-year rule [§6033(j)(1)(B)]. The list is associated with the resource that compiles data about all exempt entities. Reinstatement of a revoked exemption does not remove the entity from the list, but the date of reinstatement then is noted [Rev. Proc. 2018-32, ¶3]. These lists generally are updated monthly.
The entity may have missed its 990 due dates because it ceased operations, but if it still is active and wishes to re-obtain the exemption, perhaps retroactively to the date of the revocation, it must follow the steps outlined in Rev. Proc. 2014-11. Generally, this entails a re-filing of the Form 1023 application for exemption, usually accompanied by an application fee and a statement of the reasonable cause by which the exemption was lost. Reasonable cause to explain the loss of the exemption may be difficult to show, however, as three consecutive missed filing dates are not easily justified. Smaller entities can use a streamlined process for this purpose. See §6033(j)(2),(3).
The loss of exemption does not excuse the entity from any failure-to-file penalties, such as under §6652. Usually, this penalty is $20 per day per missing return, to a maximum of $10,000 or five percent of the entity’s gross receipts, whichever is less. These amounts are $100 and $50,000 for large entities [§6652(c)(1)(A)]. Small entities subject to the e-postcard rules are not subject to these monetary penalties [§6652(c)(1)(E)]. Entity managers may be subject to a separate penalty if they do not comply with the Service’s demand that the missing returns be filed [§6652(c)(1)(B)].
Many of your students are members of small on-campus exempt entities. This rule has no de minimis exceptions, so it should be of interest to many of them.
- How much is “too much” as to filing requirements for tax exempt entities? Most exempt organizations are small and managed by volunteers who change roles frequently. Should there be additional exceptions to the three-year rule for small entities? Suggest one or two such possibilities.
- Does the listing of entities with revoked exemptions constitute “shaming” by the IRS? Are there other ways to inform the public about an entity’s ability to accept deductible donations? Like what?
- Identify two tax exempt entities that you know, one on campus and one off. Ascertain their exempt status at the IRS website. Then check there that the exemption has not been revoked. Take a screen grab of all four of these results and send them to your instructor.
- Which exempt entities lose their status under the three-year rule? Use data from org and classify such revocations by the entities’ industry (for example, arts, education) and location.
- Find articles about the automatic revocation process posted by two different exempt entity “industry consultants,” for example, home schools, soup kitchens, labor unions. Write a one-page memo summarizing the planning ideas promoted in these articles, such as the entity’s board should ascertain that the Form 990s have been filed for each tax year. Send the memo to your instructor.
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