In a memorandum (TEGE-04-0216-0003) to IRS Exempt Organizations (EO) examinations managers and revenue agents, the IRS has updated procedures for handling revocations and modifications of tax-exempt status in light of changes made by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). For a general discussion of PATH Act provisions affecting tax-exempt organizations, see Tax Alert 2016-58.

Background

Among other changes, the PATH Act, enacted December 18, 2015, expanded the availability of the Section 7428 declaratory judgment option to additional types of tax-exempt organizations. In general, Section 7428 allows an eligible organization to seek a declaratory judgment in court regarding certain tax-exempt status issues if the organization disagrees with an IRS finding (or the IRS has failed to make one) and the organization has exhausted its administrative remedies with the IRS.

Prior to amendment by the PATH Act, the opportunity to seek a declaratory judgment in court under Section 7428 was only available to organizations seeking Section 501(c)(3) or Section 170(c)(2) classification, Section 509(a) private foundation classification, Section 4942(j)(3) private operating foundation classification or Section 521(b) cooperative classification. The PATH Act expanded the Section 7428 declaratory judgment option, making it available to organizations seeking classification under any Section 501(c) subsection (not just Section 501(c)(3)), and also to those seeking Section 501(d) classification.

EO memorandum

The memorandum advises all IRS EO examination managers and EO examinations revenue agents on revised procedures resulting from the expansion of Section 7428. The memorandum states that all revocations of Section 501(c) or Section 501(d) organizations will now follow the same procedures as those previously used for Section 501(c)(3) organizations. It adds that, as a result of the changes, modifications of tax-exempt status no longer apply (i.e., the IRS will no longer propose modification, for example, from a Section 501(c)(4) exemption to a Section 501(c)(7) exemption). Instead, the IRS will revoke (or treat asa revocation for declaratory judgment purposes) the tax-exempt status of organizations that no longer qualify under the Code section for which tax exemption was granted or self-declared. Revoked organizations may apply or reapply for tax-exempt status under a different Code section.

The memorandum details specific forms to use, records to keep and other procedures for IRS personnel to follow for these purposes. It specifies that these procedures also apply to disqualifications of tax-exempt status on a year-to-year basis for Section 501(c)(12) and Section 501(c)(15) organizations that fail their respective 85% member income test or gross receipts test for a particular tax year. The memorandum notes that the expansion of declaratory judgment rights applies retroactively to final adverse determinations issued 90 days prior to the enactment of the PATH Act. Agents who issued adverse determination letters in the retroactive time period are instructed to contact their managers with respect to how to notify affected organizations of their rights.

Implications

The PATH Act expanded declaratory judgment rights to all Section 501(c) organizations, regardless of their paragraph, and to Section 501(d) organizations. The PATH Act required the IRS to implement new administrative appeal guidelines for tax-exempt organizations facing an adverse determination. In response, as reflected in the memorandum, the IRS has changed its procedures for handling revocations and modifications of the tax-exempt status of organizations. Specifically, the IRS will now treat all revocations of tax-exempt status under Section 501(a) and Section 501(d) similarly.

The expansion of declaratory judgment rights under the PATH Act provides greater recourse to organizations that have not received final determination letters from the IRS or whose tax-exempt status has been revoked or denied. The EO Examinations memorandum resulting from the expansion may, however, be disadvantageous for tax-exempt organizations in some instances. This is because the newly changed procedures no longer allow the IRS to modify the tax-exempt status of an organization under examination. Instead, the revised procedures instruct the IRS to revoke (or treat asa revocation for declaratory judgment purposes) an organization's tax-exempt status upon determination that the organization no longer qualifies for tax exemption under the particular Code section for which exemption was initially granted or self-declared. Affected organizations wishing to be tax-exempt will now need to seek declaratory judgment on tax-exempt status in court, or formally reapply for tax exemption under a different Code section. This will add an additional administrative burden compared to the prior process under which an organization could simply agree to a modification of a tax-exempt status classification proposed by the IRS.

Please contact your EY tax professional for additional information.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg

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