The Internal Revenue Service (IRS) issued a proposed revenue procedure on group rulings that includes significant changes to the existing procedures under Rev. Proc. 80-27 and substantially restricts eligibility for group ruling letters.
The IRS issued Notice 2020-36 on May 1, 2020, providing new guidance on group ruling procedures in the form of a proposed revenue procedure that, when finalized, will supersede the prior revenue procedure, Rev. Proc. 80- 27. The proposed revenue procedure integrates updates to the ruling procedures that were previously contained in separate IRS guidance issued since Rev. Proc. 80-27, and adds new requirements. The IRS explains that the updated revenue procedure is intended to be a one-stop-shop on group ruling procedures.
Additionally, the IRS explains that these changes are intended to reduce the administrative burden on the IRS and increase the efficiency and transparency of the group exemption letter program. This suggests that the IRS believes that the current group ruling procedures do not fulfill the original goals of the group ruling program, which were to relieve administrative burdens of reviewing the initial and continuing qualification for exemption of subordinate organizations. The administrative burden of central organizations and subordinate organizations with group exemption letters, as well as prospective group exemptions, however, should also be considered.
The new rules make substantial changes to the existing procedures that restrict the eligibility for group rulings, thereby increasing the administrative burden on central organizations with preexisting group exemption letters and prospective central organizations. The proposed revenue procedure does, however, provide transition rules and other relief for central organizations with preexisting group exemption letters and preexisting subordinate organizations. The public has the opportunity to comment on these procedures before they become effective. Comments are due by August 16, 2020.
Importantly, the IRS will not accept new group exemption requests while it is finalizing these new procedures. The IRS will not accept any requests for group exemption letters from June 17, 2020, until the final revenue procedure is published in the Internal Revenue Bulletin.
The proposed revenue procedure revises the requirements for obtaining and maintaining group exemption letters in the following key ways.
Minimum Number of Subordinate Organizations
The proposed revenue procedure requires a central organization to have at least five subordinate organizations in order to apply for and obtain a group exemption letter. However, central organizations must have at least one subordinate organization to maintain the group exemption letter thereafter.
When the IRS conducted research on existing group ruling letters, it concluded that over 300 existing group letters listed no subordinate organizations. Such central organizations will have one year from the date the final revenue procedure is published in order to add at least one qualifying subordinate organization to maintain the preexisting group ruling letter. These requirements will apply to all new group ruling letters.
Organizations Ineligible to Be Subordinate Organizations
The proposed revenue procedure modifies the rules regarding organizations that are not eligible to be initially included or subsequently added to a group exemption letter as a subordinate organization. In addition to organizations classified as private foundations, the proposed revenue procedure adds organizations classified as Type III supporting organizations and qualified nonprofit health insurance issuers described in Section 501(c)(29). In addition, a group ruling may not include an organization that has had its exempt status automatically revoked due to failure to file three consecutive annual returns or notices, which prevents an organization from avoiding the requirement to apply for reinstatement of exempt status. The proposed revenue procedure also revises the ineligibility of foreign organizations by clarifying that an organization organized under the laws of a foreign country is not eligible to be a subordinate organization, but a US organization that merely operates in a foreign country is eligible.
Only One Group Exemption Letter
The proposed revenue procedure provides that a central organization may maintain only one group exemption letter. Currently, many central organizations maintain more than one group exemption letter, such as one group exemption letter for section 501(c)(3) subordinate organizations and one group exemption letter for section 501(c)(4) subordinate organizations. The transition rules provide that such organizations have one year from the date the final revenue procedure is published to inform the IRS which group letter the central organization will maintain and which other ruling(s) it will terminate.
Matching Section 501(c) Paragraph Requirement
The proposed revenue procedure imposes more restrictive matching requirements than any previous group ruling procedure. In addition to the longstanding requirement that all subordinate organizations must be described in the same paragraph of Section 501(c), subordinate organizations must also be described in the same paragraph of Section 501(c) as the central organization, unless the central organization is an instrumentality or agency of a political subdivision and is not described in Section 501(c). This suggests that instrumentalities that have applied for and received recognition of exemption under Section 501(a) will nonetheless be subject to the matching requirement and subordinate organizations must also be described in the same paragraph of Section 501(c). Presumably, an instrumentality may relinquish exempt status under the procedures described in Rev. Proc. 2020-5 and continue to have subordinate organizations with different 501(c) determinations.
These requirements apply in full to all new group rulings and new subordinate organizations. Although central organizations are not required to remove preexisting subordinate organizations that are described in a different paragraph of Section 501(c) from the central organization, the central organization may not add any new subordinate organizations to the preexisting group ruling because the new organization would violate the requirement of matching the same paragraph of Section 501(c) as the central organization or of all the other subordinate organizations under the ruling. For organizations that have to choose which group ruling to remain in effect due to the requirement to maintain only one group ruling, the inability to add new subordinate organizations may be a deciding factor.
Matching Foundation Classification Requirement
For Section 501(c)(3) organizations, the proposed revenue procedure requires all subordinate organizations to be classified under the same paragraph of Section 509(a), except that it treats publicly supported organizations under Section 509(a)(1) and 170(b)(1)(A)(vi) as described in the same section of 509(a) and publicly supported organizations under Section 509(a)(2). Subordinate organizations are not required to be described in the same paragraph of section 170(b)(1)(A), so a group ruling may have, for example, subordinate organizations classified as churches (Section 170(b)(1)(A)(i)), educational organizations (Section 170(b)(1)(A)(ii)), and hospitals (Section 170(b)(1)(A)(iii)).
Effectively, this rule merely prevents a group ruling from having subordinate organizations that are publicly supported organizations described in Section 509(a)(1) or 509(a)(ii) along with Type I or Type II supporting organizations.
Similar Purpose Requirement
The proposed revenue procedure requires subordinate organizations other than Section 501(c)(3) organizations to have the same primary purpose, as classified by three-character National Taxonomy of Exempt Entities (NTEE) Code, as the other subordinate organization included in a group ruling letter. Thus, for example, a group ruling letter may have subordinate organizations that are all Section 501(c)(4) advocacy organizations focused on women’s rights (R24), but not any subordinate organizations focused on reproductive rights (R61) or minority rights (R22).
Uniform Governing Instrument
The proposed revenue procedure requires all subordinate organizations to have uniform governing instruments. Where subordinate organizations are section 501(c)(3) organizations that have different purposes, the subordinate organizations must have a governing instrument that is uniform among the subordinate organizations with that purpose. For example, if a group exemption letter includes groups that are schools and hospitals, the schools must all adopt a uniform governing instrument describing educational purposes, and the hospitals must all adopt a separate uniform governing instrument describing the charitable purpose of promoting health.
Definition of General Supervision or Control
As a continuation of existing rules, a central organization must meet one of two tests with respect to its subordinate organizations, either the “general supervision” test or “control” test. A central organization exercises general supervision if it (1) annually obtains, reviews, and retains information on the subordinate organization’s finances, activities, and compliance with annual requirements to file a Form 990 series information return or notice; and (2) if it educates, in writing or otherwise, the subordinate organization about the requirements to maintain tax-exempt status, including annual filing requirements. A central organization exercises control if either (1) the central organization appoints a majority of the subordinate organization’s officers, directors, or trustees; or (2) a majority of the subordinate organization’s officers, directors, or trustees are officers, directors, or trustees of the central organization. Note that this definition of control is less expansive than the definition of control under Section 512(c)(13) and the Form 990 because it covers the central organization’s officers, directors, and trustees, but not employees.
Annual Update Deadline
The proposed revenue procedure extends the deadline to provide the IRS with a mandatory annual update on the subordinate organizations included in a group ruling letter to at least 30 days before the close of the central organization’s annual accounting period. The IRS explains that allowing central organizations to provide the information closer to the end of their taxable year improves the accuracy of the information reported.
Termination of the Group Exemption Letter
The proposed revenue procedure clarifies the situations in which the IRS may terminate a group exemption letter with respect to all subordinate organizations. Importantly, the IRS proposes to terminate a group exemption letter if the central organization fails to timely submit a single annual update, and if more than half of the subordinate organizations on the group letter ruling have had their exemption automatically revoked, regardless of whether their exemption is later reinstated.
Declaratory Judgment Rights
In general, a declaratory judgment proceeding under Section 7428 can be filed in the US Tax Court, the US Court of Federal Claims, or the US District Court with respect to an actual controversy involving a determination by the IRS or a failure of the IRS to make a determination with respect to the initial or continuing qualification for exempt status. The proposed revenue procedure describes IRS actions that it considers not subject to Section 7428, meaning that an organization would not have a right to challenge the IRS’s action in court. Importantly, the proposed revenue procedure provides that the IRS’s non-issuance, or declination, of a group exemption letter request that presents complex facts and circumstances in the interest of sound tax administration is not a failure to issue a determination within the meaning of Section 7428. The position on group ruling declinations notably conflicts with the IRS’s generally applicable rule under Rev. Proc. 2020-5, Section 10.03 that if the IRS declines to issue a determination letter, the organization may be able to pursue a declaratory judgment under § 7428, provided that it has exhausted its administrative remedies.
In 2011, the Advisory Committee on Tax-Exempt and Government Entities (ACT) completed a study of group ruling procedures and issued a number of recommended revisions to the group ruling procedures in a report to the IRS (ACT Report). The proposed revenue procedure adopts some of these recommendations, such as by making Type III supporting organizations ineligible to be subordinate organizations. However, the proposed revenue procedure does not substantively address any of the procedures on group returns. The proposed revenue procedure does not make any updates to the Form 990 requirements, including the ACT report recommendation to disclose additional information on Schedule O regarding the subordinate organizations covered under a group return. Similarly, the proposed revenue procedure does not adopt the ACT report recommendation to eliminate group returns.