Contributing Author: William A Raabe
Although the application process to become a tax exempt entity is lengthy, it is not difficult. Over 90% of applications are approved. Each year, there are approximately 80,000 new exempt entities.
Tax exemption is a valuable asset that an organization has, such as the ability to allow charitable income and estate/gift tax deductions. It should be kept in all circumstances. About 6,000 entities lose their exemption each year. This is usually due to an automated process by the IRS where the exemption is terminated because the entity has not filed the required Forms.
Most automatic revocations or cancellations of exempt status can be attributed to an entity’s failure for three consecutive years to file the required Form 990/990EZ/990N or other information returns. The exemption is lost on the due date for the third consecutive missing returns, likely allowing for an automatic six-month extension.
The language in Rev. is the reason for loss of exemption. Rul. Rul. According to the IRS, this failure to comply prevented the agency from establishing that the entity was fulfilling “the conditions required for the continuation or exempt status.”
There are very few exceptions to the current codification of this rule [SS6033j(1)(B)]. The exempt status will be revoked if the required returns aren’t filed for three consecutive year. The IRS has some responsibility to prevent such revocations [SS6033(j(1)(A)] after 2019. After the second consecutive year of nonfiling, the Service must notify the entity:
It has not received a return from the organization in two consecutive years.
If no return is received for the third year, exempt status will be revoked.
However, this notice procedure does NOT convert the default filing requirements to “just file once every three year then.” Each year, however, the Form 990 due dates will apply.
The three-year rule applies regardless of whether the entity’s classification changes over the period. For example, if the entity grows from an e–postcard entity to a Formula 990-EZ filer. The three-year test applies to years 1-2-3, 2-3-4, and so on. The clock does not reset by changing the required form.
The IRS maintains an online list of organizations whose exemptions were removed under the three-year rule [SS6033 (j)(1)(B). The list is linked to the resource that compiles data on all exempt entities. The entity is not removed from the list by the reinstatement of a revoked exemption, but the date of reinstatement is noted [Rev. Proc. 2018-32, P3]. These lists are generally updated monthly.
It is possible that the entity missed its 990 due dates due to it ceasing operations. However, if it is still active and wants to re-obtain exemption, possibly retroactively to the date it revocationed, it must follow Rev. Proc. 2014-11. This usually involves a re-filing the Form 1023 exemption application, usually with a fee and a statement of reasonable cause for the exemption being lost. It may be difficult to prove reasonable cause for the exemption being lost, since three consecutive missed filing dates cannot be easily justified. This can be used by smaller entities using a simplified process. SS6033(j),(2),(3).
The entity is still responsible for any penalties for failure to file, such as those under SS6652. This penalty is usually $20 per day for each missing return up to a maximum $10,000 or five percent of gross receipts of the entity, whichever is lower. These amounts are $100 to $50,000 for large entities [SS6652 (c)(1)(A). These monetary penalties are not applicable to small entities that are subject to the e–postcard rules [SS6652 (c)(1)(E).] Managers of entities may be subject to a separate penalty for failing to comply with the Service’s demand that missing returns be filed [SS6652 (c)(1)(B).
Many of your students are members or exempt from tax on-campus entities. This rule does not have any de minimis exceptions so it should be of interest for many of your students.
CLASS ASSIGNMENTS
Tax Policy
What is the limit of what is considered “too much” when it comes to filing requirements for tax-exempt entities? Many exempt organizations are small and run by volunteers who often change their roles. Are there any other exceptions to the three year rule for small entities? You might suggest one or two of these possibilities.
Is the IRS shaming entities that have revoked exemptions by listing them? Is there another way to inform the public about the ability of an entity to accept deductible contributions? What?
Tax Research
Identify two tax-exempt entities you know. One on campus, one off. Check the IRS website to determine if they are exempt. Check that the exemption has not expired.
