New IRS Procedures for Reinstating Revoked Tax-Exempt Status of Organizations. Molly Hayes Sharbaugh Reed Smith LLP Pittsburgh, PA

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FEBRUARY 2014 EXECUTIVE SUMMARY TAX AND FINANCE PRACTICE GROUP New IRS Procedures for Reinstating Revoked Tax-Exempt Status of Organizations Molly Hayes Sharbaugh Reed Smith LLP Pittsburgh, PA The

1 FEBRUARY 2014 EXECUTIVE SUMMARY TAX AND FINANCE PRACTICE GROUP New IRS Procedures for Reinstating Revoked Tax-Exempt Status of Organizations Molly Hayes Sharbaugh Reed Smith LLP Pittsburgh, PA The Internal Revenue Service (IRS) has issued new guidelines for reinstating taxexempt status to those organizations that have had their tax-exempt status automatically revoked for failure to file annual IRS information returns or notices for three consecutive years. 1 Revenue Procedure outlines a more-streamlined reinstatement process for revoked organizations, provides for retroactive reinstatement, and offers penalty relief under certain criteria. 3 These new processes may be helpful for health care-related organizations that have inactive affiliates, subsidiaries, or auxiliary organizations that need to reinstate their tax-exempt status. This summary discusses the background of the automatic revocation of the tax-exempt status of an organization; prior IRS guidance for reinstatement of an organization s taxexempt status; the new, streamlined reinstatement processes provided in Revenue Procedure ; how Revenue Procedure may be useful for health care organizations and their affiliates; and the beneficial changes resulting from the new guidance. Background Under the Pension Protection Act of 2006, the tax-exempt status of an organization is automatically revoked if the organization fails to file the required annual return, IRS Form 990 Return of Organization Exempt from Income Tax (Form 990) or IRS Form 1 See IRS Revenue Procedure issued on January 2, Available at 3 Effective for applications submitted after January 2,

2 990-EZ Short Form Return of Organization Exempt from Income Tax (Form 990-EZ), or the required notice, IRS Form 990-N e-postcard (Form 990-N), for three consecutive years. 4 The IRS is required to maintain and publish monthly a revocation list of all organizations that have had their tax-exempt status revoked. 5 In addition, an organization will receive a revocation letter from the IRS in the mail sent to its lastknown address to notify the organization that its tax-exempt status has been revoked. An organization that has had its tax-exempt status automatically revoked may apply to the IRS to obtain reinstatement of its tax-exempt status on IRS Form 1023 Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code (Form 1023), or IRS Form 1024 Application for Recognition of Exemption Under Section 501(a) (Form 1024). 6 If approved, the organization s reinstated tax-exempt status will be effective to the post-mark date of the application and will not be retroactive to the date on which the organization s exempt status was revoked. Further, if an organization can show to the IRS satisfaction evidence of reasonable cause for the failure to file, the organization's tax-exempt status may be reinstated effective from the date of the revocation at the discretion of the IRS. 7 Prior IRS Guidance on Reinstatement Procedures When the IRS revoked the status of more than 275,000 organizations in 2011, it simultaneously issued guidance setting forth procedures for reinstatement, including retroactive reinstatement, of the tax-exempt status of organizations whose exempt status was automatically revoked. IRS Notice (Notice ) detailed instructions for organizations seeking retroactive reinstatement other than certain small organizations covered by IRS Notice (Notice ), described below. Notice indicated that organizations seeking reinstatement of their tax-exempt status, regardless of whether they were originally required to file an application for exemption, had to complete Form 1023 or 4 26 U.S.C. 6033(j)(1). 5 Id U.S.C. 6033(j)(2) U.S.C. 6033(j)(3). 2

3 Form 1024 and submit the user fee. The organization was further required to demonstrate reasonable cause for failure to file its annual returns to receive retroactive reinstatement. Notice provided relief for certain small tax-exempt organizations. Given its specific relevance to small organizations, Notice provided more-generous relief than Notice Notice indicated that the IRS would treat a small organization as having reasonable cause for failing to file Form 990-N or an annual return for its taxable years beginning in 2007, 2008, and 2009 if it: (1) was not required to file annual returns before 2007; (2) was eligible in 2007, 2008, and 2009 to file Form 990-N; and (3) the organization submitted to the IRS a properly completed and executed application for reinstatement of tax-exempt status on or before December 31, Notice also reduced the application fee for eligible small organizations to $100 rather than the $400 or $850 fee. This relief has now expired. New IRS Guidance Revenue Procedure Revenue Procedure supersedes the prior guidance under Notice and Notice It updates the prior guidance with the provision of clear instructions as to what exactly is required to be submitted with applications for retroactive reinstatement and updates procedures for making reinstatement requests both with retroactive effect and without. Unlike prior guidance, Revenue Procedure addresses procedural questions regarding how and when an organization must file Form 990 and Form 990-EZ for those years in which it did not file previously. The processes described in Revenue Procedure through which an organization may apply for retroactive reinstatement of its tax-exempt status are as follows. Streamlined Retroactive Reinstatement for Form 990-EZ or Form 990-N Filing Organizations An organization that is eligible to file either Form 990-EZ or Form 990-N for each of the three consecutive years that it failed to file and has not previously had its tax-exempt 3

4 status automatically revoked may apply for retroactive reinstatement on Form 1023 or Form 1024 within 15 months of the date of revocation. Under this process, Form 1023 or Form 1024 must be submitted no later than 15 months after the later of the date of the organization s revocation letter, or the date the organization s name was posted on the IRS auto-revocation list. Retroactive Reinstatement for Form 990 Filing Organizations An organization that was required to file Form 990 for any of the three consecutive years that it failed to make a Form 990 series filing may apply for retroactive reinstatement on Form 1023 or Form 1024 within 15 months of the date of revocation. Under this process, the organization must submit statements that it had reasonable cause with respect to its failure to file a required annual return or notice for at least one of the three consecutive years in which it failed to file and has since filed completed paper returns for all tax years in the consecutive three-year period (and for any other tax years after such period) for which the organization was required, and failed, to file. To establish reasonable cause, the organization must demonstrate that it exercised ordinary business care and prudence in determining and attempting to comply with its reporting requirements. The IRS will take into account all relevant facts and circumstances in establishing reasonable cause and will look favorably on the following factors: The organization's failure was due to its reasonable, good-faith reliance on erroneous written information from the IRS, stating that the organization was not required to file a return, provided the IRS was made aware of all relevant facts; The failure to file the return or notice arose from events beyond the organization's control that made it impossible for the organization to file a return or notice for the year; 4

5 The organization acted in a responsible manner by undertaking significant steps to avoid or mitigate the failure to file the required return or notice and to prevent similar failures in the future; and The organization indicates a past pattern of complying with its federal tax return reporting requirements. An officer, director, trustee, or other official authorized to sign for the organization must sign an original declaration, dated and signed under penalties of perjury, that the request for retroactive reinstatement, including the written explanation of all the facts of the claim for reasonable cause, is true, correct, and complete to the best of his or her knowledge. Under the process described above, Form 1023 or Form 1024 must be submitted no later than 15 months after the later of the date of the organization s revocation letter, or the date the organization s name was posted on the IRS auto-revocation list. Retroactive Reinstatement for an Organization More Than 15 Months After Revocation An organization may apply for retroactive reinstatement more than 15 months after revocation under the process described above for Form 990 filing organizations; however, the organization must establish that it had reasonable cause with respect to its failure to file a required annual return or notice for each of the three years that it failed to file, as opposed to just for at least one of the three consecutive years in which it failed to file. Penalties For each of the processes described above: If the application is approved, the organization can avoid imposition of the failure to file penalties 8 if it files paper Forms 990 or 990-EZ for those reinstated years that a 8 See Section 6652(c)(1) of the Internal Revenue Code of 1986, as amended (Code) for a description of the failure to file penalties. 5

6 Form 990 or 990-EZ was due. Forms 990-N for those years in which the organization was qualified to file the e-postcard are not required; and The organization must include Revenue Procedure , Streamlined Retroactive Reinstatement written on the top of the Form 1023 or Form In addition, the organization should include Retroactive Reinstatement written on the Forms 990 or 990-EZ filed. Reinstatement from Post-Mark Date of New Application for Exemption An organization that does not qualify under any of the processes outlined above may apply for reinstatement of its tax-exempt status effective as of the post-mark date of its new Form 1023 or Form 1024 filed with the IRS. As such, the exemption will be retroactive to the date on which the new application is filed, as opposed to the date of revocation. In this case, the organization must include Revenue Procedure , Reinstatement Post-Mark Date written on the top of the Form 1023 or Form 1024 Application. Subsequent Actions The IRS will apply the streamlined rules to existing applications for retroactive reinstatement and all future applications; however, an organization can be automatically revoked again if it fails to file required returns for three consecutive years beginning with the year in which the IRS approves the application for reinstatement. Organizations seeking reinstatement of tax-exempt status after a subsequent revocation are not eligible to use the Streamlined Retroactive Reinstatement Process. Application of New Procedures to Health Care Organizations Various types of health care organizations are considered charitable organizations exempt from taxation under Section 501(c)(3) of the Code such as nonprofit hospitals, cooperative hospital service organizations, medical research organizations, clinics, 6

7 medical societies, and professional boards. The procedures of Revenue Procedure provide important guidance for any health care organization that may have had its tax-exempt status automatically revoked for failure to file annual information returns or notices for three consecutive years. Tax-exempt hospital systems may contain active or inactive affiliates, subsidiaries, or auxiliary organizations that, depending on their size, may follow one of the procedures outlined above to reinstate their tax-exempt status. In a complex hospital system, it is important to ensure each component of the system maintains its tax-exempt status so the tax-exempt status of the whole system or parent organization is not jeopardized. Once the organization receives reinstatement, it will again be eligible to receive taxdeductible donations from donors, provide support, and conduct non-taxable activities. Benefits of New Procedures for Reinstatement Revenue Procedure has simplified prior procedure for reinstating an organization s tax-exempt status and should assist in addressing the bottleneck of exemption applications at the IRS. It provides clarity to the reinstatement process and will contend with the overwhelming problem faced by the IRS in processing requests for reinstatement of tax-exempt status and addressing missing Forms 990 and 990-EZ. The approval of streamlined processes may indicate a commitment on the part of the IRS to efficiently reinstate such qualified organizations. Revenue Procedure particularly offers the following new benefits: Concrete definitions of factors the IRS will weigh as reasonable cause ; Organizations filing in the 15-month window must only show reasonable cause for one year; and Organizations that have already been reinstated effective as of the post-mark date of their application may be granted retroactive reinstatement. 7

8 For organizations that would have satisfied the Revenue Procedure s Streamlined Retroactive Reinstatement requirements, retroactivity will be automatic if the organization keeps a copy of the Revenue Procedure with its reinstatement letter. All other organizations must re-submit their application, at no fee, on or before May 2, 2014 to obtain a retroactive effective date for their tax-exempt status. These options illustrate the IRS willingness to approve retroactivity where it was not previously available. Revenue Procedure generally makes it more straightforward for both small and large organizations to achieve retroactive reinstatement of their tax-exempt status. Under the prior guidance, the reasonable-cause requirement was challenging to demonstrate for three consecutive years, and without a showing of reasonable cause, reinstatement could only be obtained from the date of the filing of the application for exemption. In contrast, Revenue Procedure presumes reasonable cause for small organizations and large organizations only need to show it for one year. Ideally, IRS application of the new Revenue Procedure will demonstrate a relaxed reasonablecause standard and result in effectual reinstatement for a greater number of revoked tax-exempt organizations. New IRS Procedures for Reinstating Revoked Tax-Exempt Status of Organizations 2014 is published by the American Health Lawyers Association. All rights reserved. No part of this publication may be reproduced in any form except by prior written permission from the publisher. Printed in the United States of America. Any views or advice offered in this publication are those of its authors and should not be construed as the position of the American Health Lawyers Association. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought from a declaration of the American Bar Association 8

Applicable Sections: Revenue Procedure SECTION 1. PURPOSE

Applicable Sections: Revenue Procedure SECTION 1. PURPOSE Applicable Sections: 26 CFR 1.6033-2. Returns by exempt organizations (taxable years beginning after December 31, 1969) and returns by certain nonexempt organizations (taxable years beginning after December