IRS ELIMINATES ADVANCE RULING PROCESS FOR PUBLIC CHARITY STATUS

Barbara Schwartz Bromberg, Esq, Dinsmore & Shohl

INTRODUCTION

The IRS on September 9, 2008, issued temporary Income Tax  Regulations which surprised and astonished the tax professionals community by eliminating the advance ruling process for a Section 501(c)(3) organization’s public charity (or private foundation) status.  This procedure had been in effect for almost forty years and required a Section 501(c)(3) organization, at the end of its first five tax years, to submit information to the Service establishing its public support level and therefore, its public charity status as opposed to private foundation status.  As background, you will recall that a Section 501(c)(3) charitable organization may be classified as a public charity or as a private foundation, depending upon the level of public support that it receives.

The new regulations, which are effective immediately, provide that a new Section 501(c)(3) organization will be classified as a public charity for its first five years if it can show in its Form 1023 Application that it can reasonably be expected to be publicly supported.  After the first five years, the IRS will use the information that the organization reports on its Form 990, Schedule A, about its public support to determine if the organization is meeting the public charity requirements.  (The public support test is based on a five year computation period consisting of the current year and the four years immediately preceding the current year.)

As part of its announcement of these new rules, the IRS issued “Frequently Asked Questions” about the new procedures and much of this article is based on the answers to those questions.

WHAT ORGANIZATIONS ARE AFFECTED BY THE NEW RULES?

As stated above, only Section 501(c)(3) organizations that anticipate being classified as public charities are affected by the new rules.  Most fraternal foundations and local fraternal foundations do seek public charity status and most do qualify for same, since contributions from a wide variety of fraternity members are generally deemed to be qualifying public support.  The new rules affect organizations whose advance ruling periods have not yet expired, or whose advance ruling periods expired on or after June 9, 2008 – i.e., ninety days before the announcement of the new rules.  Those organizations will automatically be classified as a public charity for their first five years of existence regardless of the amount of public support actually received.  Such organizations no longer need to file Form 8734 with the IRS at the end of their advance ruling period in order to establish their public charity classification.  However, they must file Form 990, and beginning with their sixth taxable and all succeeding years, must meet the public support test as shown on Schedule A of Form 990.  Again, it must be emphasized that the new rules affect only an organization’s classification as a public charity or private foundation – once the IRS has issued a favorable determination letter as to Section 501(c)(3) status to an organization, it remains tax exempt, whether it is classified as a public charity or a private foundation, unless the IRS takes action to revoke such status.

WHAT IS THE EFFECT OF THE NEW RULES ON THE FILING REQUIREMENTS CONCERNING FORM 990?

Even if an organization is covered by the new rules, if it is required to file Form 990 or Form 990-EZ because of its gross receipts level, then the organization must comply with the normal annual return filing requirements.  If the organization’s annual gross receipts are less than $25,000, it may file the new electronic postcard – Form 990-N.

WHAT IS THE EFFECT OF THE NEW RULES ON THE FILING OF FORM 8734 WITH THE IRS?

As indicated above, if an organization is covered by the new rules, the organization need not submit Form 8734 to the Service.  However, if an organization was required to file Form 8734 with the IRS but neglected to do so, and its advance ruling period has expired, the IRS may have changed its status from a public charity to a private foundation.  If it believes itself to be a public charity, the organization should submit Form 8734, even if it is late;  the IRS will review the Form and change the organization’s status back to a public charity if the information on the Form establishes that it met the public support requirements.  If an organization submitted Form 8734 to the IRS, and it received a proposed adverse determination letter indicating that the organization did not meet the public support test, the new rules do not apply to such an organization.  The organization will be reclassified as a private foundation unless it appeals the initial IRS decision as described in the letter from the IRS.

WHAT IS THE EFFECT OF THE NEW RULES ON OTHER DOCUMENTATION?

Note that the new rules apply to all organizations with Form 1023 Applications currently pending before the IRS regardless of when the organization submitted the Form 1023 Application and there is no need to submit a new Form.  The IRS will automatically apply the new procedures to the pending Application.  Also, if your organization received a definitive public charity ruling from the IRS, the letter remains effective, and the new rules do not apply to the organization.  The organization should continue to report its public support information annually on Schedule A of Form 990.

CONTINUAL MONITORING.

As has always been the case, an organization will lose its public charity status if it cannot meet the public charity support test for two consecutive years.  This resulting classification as a private foundation can be devastating to an organization as it can affect the amount of donors’ charitable tax deductions, requires filing of a Form 990-PF and subjects the organization to much more stringent tax rules in its operations.  Therefore, all organizations classified as public charities should constantly monitor their level of public support during every fiscal year to make sure that they do not inadvertently lose this status.  This is especially true if a very large gift is being received, as the organization may need to either classify it as an “unusual grant” if possible, or arrange for the gift to be paid over a number of years.  Organizations should not wait until after their tax year is closed and the Form 990 is being prepared to conduct this monitoring activity, as it may then be too late to take proper corrective action.

CONCLUSION.

In short, the IRS’ action in issuing these new procedures is one of the most groundbreaking actions it could have taken.  It will definitely be a boon to those organizations who have trouble raising much public support during their early years and will allow them more “breathing room” to establish their public charity status.  However, organizations should consult with their tax advisors as to how these rules may affect them and should not wait until their sixth taxable year to gather the necessary support needed to retain the valuable public charity organization status.