IRS Proposed Group Exemption Rules

Amy Hebbeler, Fraternal Law Partners, Amy.Hebbeler@manleyburke.com

Group exemptions are an efficient tool that tax-exempt organizations utilize, especially national fraternities and sororities, in streamlining the federal exemption process for their subordinates. Under a group exemption, subordinate organizations affiliated with a central organization can be recognized as exempt from federal income tax without filing an individual application for exemption (i.e. a national fraternity or sorority and its chapters).

The way a group exemption works is, first an already exempt central organization submits an application to the IRS for a group exemption. Then, if the central organization obtains a favorable determination from the IRS, the central organization can provide the IRS with a list of subordinates that will be exempt under its group exemption. This eliminates the need for each subordinate to apply for its own individual exemption, saving time and money for the subordinate. However, the central organization is responsible for ensuring that its subordinates qualify, and continue to qualify, to be exempt.^[1]

In order to qualify as a subordinate, the organization must, among other requirements, be affiliated with and under the general supervision orcontrol of a central organization. However, under the IRS’ existing procedures, the IRS did not provide much guidance on the definition of supervision or control.^[2]In order to fill in some of the gaps and provide clearer guidance regarding group exemptions, the IRS has issued a proposed revenue procedure updating the group exemption letter program.^[3]

Some of the provisions of those proposed rules we think are most relevant to national fraternities and sororities and their chapters are the following:

Clarifications^[4]

1. Automatic Revocation– A subordinate organization that has had its exemption automatically revoked for failure to file IRS Form 990 for three consecutive years and has not had its exemption reinstated after filing an application for reinstatement is not eligible for initial inclusion in or subsequent addition to a group exemption letter. Additionally, the IRS may terminate a group exemption letter with respect to all subordinate organizations if more than half of the subordinate organizations have had their exemption automatically revoked.

1. General Supervision Defined – A subordinate organization is subject to the central organization’s general supervision if the central organization –
   1. annually obtains, reviews, and retains information on the subordinate organization’s finances, activities, and compliance with annual filing requirements and
   2. transmits written information to (or otherwise educates) the subordinate organization about the requirements to maintain tax-exempt status under the appropriate paragraph of section 501(c), including annual filing requirements.

1. Control Defined – A subordinate organization is subject to the central organization’s control if—
   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.

New Requirements^[5]

1. Minimum Number of Subordinates– A central organization must have at least five subordinate organizations to obtain a group exemption and at least one subordinate to maintain the group exemption.

1. Matching Requirements – All subordinates initially included or subsequently added to a group exemption letter must be described in the same paragraph of section 501(c) as the central organization (i.e. if the central organization is exempt under section 501(c)(7) then the subordinates must meet the requirements of 501(c)(7) organizations).

1. Same or Similar Purposes – All subordinate organizations described in section 501(c) (other than section 501(c)(3)) initially included in or subsequently added to a group exemption letter must have the same or similar purposes and be described by the same National Taxonomy of Exempt Entities Code.

1. Uniform Governing Instrument – All subordinate organizations must adopt a uniform governing instrument; the organizations can no longer submit copies of representative documents.

1. Initial Authorization –As previously required, a subordinate organization must authorize the central organization in writing to include the subordinate organization on the group exemption and the authorization must be signed by a duly authorized officer of the subordinate organization. However, the proposed rules also require that the authorization acknowledge that the central organization may remove the subordinate organization if the subordinate fails to comply with IRS requirements.

It is important to note, the proposed revenue procedure will apply to group exemption letters requested and issued after the date that the final revenue procedure is published in the Internal Revenue Bulletin as well as to all preexisting group exemption letters, with a few exceptions.

The requirements that the central organization have a least one subordinate to maintain a group exemption letter and that the central organization only have one group exemption letter will apply to pre-existing group exemptions after a one-year transition period. Also, the new general supervision and control definition, the new matching, similar purpose, and uniform governing instrument requirements, as well as the inclusion of the removal authorization for initial inclusion will not apply to preexisting subordinate organization. It is important to note that those requirements WILL apply to all new subordinate organizations added to a preexisting group exemption letter after the final rule is published.

Finally, these rules are proposed, they are not yet finalized. The deadline for comments was August 16, 2020. In the interim, the previous Rev. Proc. 80-27 will continue to apply but the IRS stopped accepting requests for group exemption letters on June 17, 2020. Fraternal Law Partners will keep you updated on the development of these proposed rules and the effects that they will have on new and existing group exemptions.

**Note there are additional requirements and revisions specific to Foundations which are outside the scope of this article**

** Note, the central organization and each subordinate organization must file an annual information return or notice. Though the central organization may file a group return for two or more of its subordinates**

[1]IRS Publication 4573 (Rev. 10-2019) https://www.irs.gov/pub/irs-pdf/p4573.pdf

[2]IRS Rev. Proc. 80-27, 1980-1 C.B. 677 https://www.irs.gov/pub/irs-tege/rp1980-27.pdf

[3]IRS Notice 2020-36 https://www.irs.gov/pub/irs-drop/n-20-36.pdf

[4]IRS Notice 2020-36 https://www.irs.gov/pub/irs-drop/n-20-36.pdf

[5]IRS Notice 2020-36 https://www.irs.gov/pub/irs-drop/n-20-36.pdf