20 Percent of All Nonprofits May Have Lost Tax-exempt Status
Revocation and Restoration of Tax-Exempt Status
Nonprofits subject to IRS annual reporting requirements
Until recently, most U.S. nonprofit organizations were not required to file an annual information return with the IRS. Beginning January 2007, all that changed when even the smallest of nonprofits became subject to IRS annual reporting requirements. The only exceptions were state organizations, churches and their affiliated organizations, and certain religious groups. Nearly all others were required to file some version of Form 990, and the failure to do so for three consecutive years would mean automatic loss of the organization’s tax-exempt status.
New nonprofit filing requirements
It has now been three years since the implementation of the new filing requirements, and the IRS estimates that perhaps 20% of all nonprofits may have lost their tax-exempt status on May 17, 2010 (the annual filing deadline for nonprofits with a December 31 fiscal year end), for failure to file an information return for three consecutive years.
When nonprofit tax-exempt status is revoked
Revocation of tax-exempt status is a serious matter for a nonprofit. It means that its income is now subject to tax, and that an income tax return must now be filed. It means that the organization can no longer accept tax-deductible contributions, which could potentially mean a loss of its entire base of support.
IRS list of nonprofits whose tax-exempt status has been revoked mailing
So what does this mean for individual donors and grantmakers? The IRS is apparently waiting until 2011 to send out letters of revocation and to publish a list of nonprofits whose tax-exempt status has been revoked. Until that time, individuals can still deduct charitable contributions and grantmakers can still make qualifying distributions to those charities. Beginning in 2011, however, foundations will need to amend their pre-grant due diligence process to include confirmation that a charity has not lost its tax-exempt status.
Welcome relief for small nonprofits only
In the meantime, a press release issued by the IRS on July 26, 2010 offers welcome relief for small nonprofits only. Small exempt organizations have a one-time opportunity to either (1) file their missing returns by October 15, 2010, or (2) engage in a voluntary compliance program. The first option is for very small organizations that are eligible to file Form 990-N (known as the “e-Postcard”). The second option is for somewhat larger organizations that are eligible to file Form 990-EZ.
Organizations that file Form 990-N can simply go online and complete their filings electronically. Organizations that file Form 990-EZ must both bring their delinquent returns up to date and pay a compliance fee.
Regaining nonprofit tax-exempt status
For charities that receive an IRS revocation letter next year, all is not lost. A nonprofit can regain its tax-exempt status by filing a lengthy application (Form 1023 or Form 1024) with the IRS and paying the applicable user fee. (Unfortunately, this application process applies even to organizations that did not have to apply in order to gain their initial tax-exempt status.) Reinstatement will usually be effective as of the date the application is filed. However, if a nonprofit can demonstrate that it had reasonable cause for failing to file returns for three years, reinstatement will be effective as of the date of revocation.
Donor and Grantmaker Questions
Whether you are a donor with questions about an organization, a grantmaker that needs assistance in revamping its due diligence processes or a charity that fears it may have lost its tax-exempt status, the attorneys at Wright Penning & Beamer stand ready to assist you.
Lee Flaherty