IRS Proposes Changes to Group Exemption Letter Program

| 5/14/2020
IRS Proposes Changes to Group Exemption Letter Program

On May 1, the IRS issued Notice 2020-36, which includes a proposed revenue procedure to update the group exemption rules under Revenue Procedure 80-27. A group exemption letter permits a central organization (an organization that has one or more subordinates under its general supervision or control) to request recognition of tax-exempt status for itself and subordinate organizations. Comments on the proposed revenue procedure are due by Aug. 16, 2020. Following are highlights of the proposed updates:

New requirements for central organizations:

  • Limitations. A central organization must have at least five subordinate organizations to obtain a group exemption and at least one subordinate organization to maintain the group exemption. Also, a central organization can have only one group exemption.
  • Annual reporting. Most central organizations will be required to submit supplemental group ruling information every year at least 30 days before the close of their annual accounting period.

New requirements for subordinate organizations:

  • Matching requirement. All subordinate organizations must be described in the same paragraph of Section 501(c) as the central organization. For example, if the central organization is a Section 501(c)(3) organization, the subordinate organizations must be described in Section 501(c)(3).
  • Foundation classification. Subordinate organizations described in Section 501(c)(3) are not required to have the same foundation classification as the central organization, although generally they must collectively share the same foundation classification under Section 509(a)(1)-(4). The IRS, however, eventually might require all subordinate organizations classified under Section 509(a)(1) to have the same foundation subclassification (such as church, hospital, school). Publicly supported organizations classified under Section 509(a)(1) and described in 170(b)(1)(A)(vi), and those classified under Section 509(a)(2), are considered as having the same foundation classification.
  • Similar purpose. Subordinate organizations other than Section 501(c)(3) organizations included in a group exemption must have the same or similar purposes and the same National Taxonomy of Exempt Entities code.
  • Uniform governing instrument. Generally, all subordinate organizations must adopt a uniform governing instrument and submit a copy with the group exemption letter request. However, Section 501(c)(3) subordinate organizations with different purposes can have different uniform governing instruments as long as all subordinate organizations with the same purpose have the same uniform governing instrument.
  • Domestic organization. An organization organized in a foreign country cannot be a subordinate organization. However, an organization organized in the U.S. can be a subordinate organization even if it operates in a foreign country.
  • Per se ineligible organizations. A Section 501(c)(3) Type III supporting organization, a qualified nonprofit health insurance issuer under Section 501(c)(29), and a private foundation are not eligible to be subordinate organizations.
  • Organization with automatic exemption revocation. An organization that has had its exemption automatically revoked is eligible to become a subordinate organization included in a group exemption letter only after it has filed an application for reinstatement and has had its exemption reinstated.
  • Removal. A subordinate organization must permit the central organization to remove it from the group exemption for failure to comply with the revenue procedure.
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The revenue procedure is proposed to apply to group exemption letters requested and issued after the date the revenue procedure is published and to existing group exemption letters. However, there is a one-year transition period and a grandfather rule under which some requirements will not apply to existing subordinate organizations. These requirements include the matching requirement, foundation classification, similar purpose, and uniform governing instrument rules as well as the limitation applicable to Type III supporting organizations.

Pending publication of the final revenue procedure, Revenue Procedure 80-27 continues to apply. New requests for group exemption under Revenue Procedure 80-27 will not be accepted after June 17, 2020.

Looking ahead

It is not surprising that the 40-year-old group exemption process is being updated, as the IRS has had group exemptions on its radar for some time. The broad grandfather rule is a welcome provision for existing group exemptions, although those planning to add subordinate organizations or to create new group exemptions will have to navigate the seemingly complex new requirements of the revenue procedure.

While a one-year transition period will apply once the revenue procedure is published, following are some actions that existing central organizations can begin to consider and plan for now:

  • Plan to have at least one subordinate organization. The IRS has identified more than 300 group exemption letters that include no subordinate organizations, and it desires to remove them to conserve administrative resources.
  • If a central organization has more than one group exemption, plan to terminate all but one of those group exemptions. Keep in mind that a subordinate organization removed from a group exemption might have to file a new exemption application with the IRS or be added to another group exemption.
  • If a central organization is holding a group exemption that includes subordinate organizations described in different paragraphs of Section 501(c), plan to remove nonconforming subordinates.
  • Carefully consider any future subordinate organizations that might not be covered by the grandfather rule to ensure they meet the new qualification requirements.

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Janice Smith
Janice Smith
Managing Director