The IRS has published a proposed revenue procedure (Notice 2020-36) that would update conditions for obtaining, maintaining, and qualifying as a subordinate of a group exemption letter (group exemption), under which a group of organizations, affiliated with and subordinate to the general supervision or control of a central organization, may obtain tax-exempt status under IRC Section 501(c). The proposed revenue procedure updates Revenue Procedure 80-27, the IRS's primary authority on group exemptions, which has been in effect since January 1980.

The IRS also announced in Notice 2020-36 that it will not accept any requests for group exemptions beginning on June 17, 2020, until final guidance on group exemptions is published in the Internal Revenue Bulletin.

Background

The IRS states in the proposed revenue procedure that it oversees more than 4,000 group exemptions, which includes more than 440,000 subordinates and imposes a significant administrative burden. Its goals in updating Revenue Procedure 80-27 are to reduce that burden, increase efficiency, improve the integrity of data collected, increase transparency, and increase compliance by central and subordinate organizations.

Proposed changes

Because the proposed revenue procedure will serve as "a comprehensive resource regarding group exemption letters," the IRS notes, it incorporates information that already exists in other guidance, as well as adding new requirements and modifying existing requirements.

In addition to providing amended rules for group exemptions going forward, the proposed revenue procedure provides a transition rule and a grandfather rule to address how the changes would apply to preexisting group exemptions.

Central organization requirements to obtain and maintain a group exemption

Under Revenue Procedure 80-27, a central organization must either be described in IRC Section 501(c) or be an instrumentality or agency of a political subdivision.

The proposed revenue procedure would add two requirements that a central organization would need to meet (subject to the transition period — see later) to obtain and maintain a group exemption: (1) have at least five subordinate organizations to obtain a group exemption and at least one subordinate organization thereafter; and (2) maintain only one group exemption.

Central organization's relationship with subordinate organizations

Consistent with Revenue Procedure 80-27, the proposed revenue procedure would require a central organization to establish that each subordinate organization included in the group exemption be affiliated with the central organization and subject to its general supervision or control. Unlike Revenue Procedure 80-27, however, the proposed revenue procedure defines, and would require subordinates to meet (subject to the grandfather rule — see later) the conditions of affiliation, general supervision, and control.

1. Affiliation: A subordinate organization's affiliation with the central organization is demonstrated by the information required to be submitted when requesting a group exemption letter from the IRS, including information on the central organization's general supervision or control and the subordinate's purposes and activities.
2. General supervision: A subordinate organization is subject to the central organization's general supervision if the central organization (a) annually obtains, reviews, and retains information on the subordinate organization's finances, activities, and compliance with annual filing requirements; and (b) transmits written information to (or otherwise educates) the subordinate organization about the requirements to maintain tax-exempt status under the appropriate paragraph of IRC Section 501(c), including annual filing requirements.
3. Control: A subordinate organization is subject to the central organization's control if (a) the central organization appoints a majority of the subordinate organization's officers, directors, or trustees; or (b) a majority of the subordinate organization's officers, directors, or trustees are officers, directors, or trustees of the central organization.

Additional requirements for subordinate organizations

The proposed regulations would add to Revenue Procedure 80-27 four requirements that subordinate organizations would need to meet (subject to the grandfather rule — see later):

1. Matching requirement: Under Revenue Procedure 80-27, all subordinate organizations included in a group exemption request must be described in the same paragraph of IRC Section 501(c) (e.g., 501(c)(3), 501(c)(4), 501(c)(6)), but the central organization may be described under a different paragraph of IRC Section 501(c). In contrast, the proposed revenue procedure would require all the subordinate organizations to be described under the same IRC Section 501(c) paragraph as their central organization, unless the central organization is an instrumentality or agency of a political subdivision (e.g., a state college may obtain and maintain a group exemption with subordinates described in IRC Section 501(c)(3)).
2. Foundation classification requirement: Revenue Procedure 80-27 does not require that subordinate organizations described in IRC Section 501(c)(3) have any particular foundation classification under IRC Section 509(a), although private foundations cannot be subordinate organizations.

The proposed revenue procedure would require any IRC Section 501(c)(3) subordinate organizations to be classified as public charities under the same paragraph of IRC Section 509(a), except that a group exemption can include both 509(a)(1) and 509(a)(2) organizations. Also, subordinates classified under IRC Section 509(a)(1) do not need to be classified under the same paragraph of IRC Section 170(b)(1)(A). This would allow, for example, subordinate organizations under one central organization to include a church (IRC Section 170(b)(1)(A)(i)), educational organization (IRC Section 170(b)(1)(A)(ii)), hospital (IRC Section 170(b)(1)(A)(iii), and/or publicly supported organization (IRC Section 170(b)(1)(A)(vi)).

If this flexibility adversely affects a central organization's ability to generally supervise or control its subordinate organizations, the IRS notes that it "eventually might require" all IRC Section 509(a)(1) subordinate organizations in a group exemption to be classified under the same paragraph of IRC Section 170(b)(1)(A).

3. Similar purpose requirement: The proposed revenue procedure would add the requirement (subject to the grandfather rule — see later) that IRC Section 501(c) subordinate organizations included in a group exemption, other than those described in IRC Section 501(c)(3), would need to be described by the same National Taxonomy of Exempt Entities (NTEE) code. Central organizations may visit the Urban Institute's National Center for Charitable Statistics website (nccs.urban.org) for a list of NTEE codes.
4. Uniform governing instrument requirement: Revenue Procedure 80-27 requires a central organization to either include a sample copy of the governing instrument adopted by its subordinate organizations with its group exemption request, or to submit copies of representative instruments if no uniform governing instrument exists. In contrast, the proposed revenue procedure would require all subordinates in a group exemption to adopt a uniform governing instrument, with the exception of IRC Section 501(c)(3) subordinates with different exempt purposes (e.g., religious, charitable, educational). The proposed regulations would require a uniform governing instrument to be used for all subordinate organizations with the same charitable purpose (e.g., churches grouped together, schools grouped together, etc.).

Organizations not eligible to be included in a group exemption as subordinate organizations

The proposed revenue procedure would modify the rule from Revenue Procedure 80-27 providing that a group exemption may not include a subordinate organization that is (1) organized and operated in a foreign country or (2) classified as a private foundation under IRC Section 509(a). The new rule would permit a subordinate organization to operate in a foreign country if it is organized in the United States.

Further, the proposed revenue procedure would prohibit certain types of organizations from being subordinates because the rules governing them are too complex. Specifically, neither an organization described in IRC Section 501(c)(3) that is classified as a Type III supporting organization under IRC Section 509(a)(3), nor a qualified nonprofit health insurance issuer (QNHII) described in IRC Section 501(c)(29), could be a subordinate organization.

Finally, if an organization's exemption was automatically revoked and has not yet been reinstated, the organization could not be a subordinate organization in a group exemption.

Authorization for initial inclusion in or subsequent addition to a group exemption

A subordinate organization must consent to being included in a group exemption. The proposed revenue procedure adds that the central organization may remove a supporting organization from the group exemption if the supporting organization fails to comply with the requirements of the revenue procedure. The new rules clarify that the central organization would need to retain the authorization provided by a subordinate as long as the subordinate is included in the group exemption.

Information required to maintain a group exemption

The proposed revenue procedure would require a central organization to submit its annual supplemental group ruling information (SGRI) that describes any changes in its subordinates' identities, purposes, or activities at least 30 days before the close of its accounting period. Revenue Procedure 80-27 had required the SGRI to be submitted at least 90 days before the close of the accounting period. The central organization could update the annual submission at any time.

The SGRI would need to include separate lists of subordinate organizations that (i) have changed their names or mailing addresses during the year, (ii) are no longer included in the group exemption, and (iii) have been added to the group exemption. Each list would need to include the name, mailing address, EIN, and date of formation or incorporation of the affected subordinate organizations. The central organization would also need to describe any changes in the purposes or activities of any of its subordinate organizations. If there have not been any changes in the purposes, activities, or identities of any subordinate organization, the central organization must submit a statement in the SGRI stating there are no changes.

An exception to the SGRI filing requirement applies to churches or conventions or associations of churches, which are not required to submit an SGRI.

When a central organization adds a subordinate organization to its group exemption, the proposed revenue procedure would require the central organization to submit the following in its SGRI:

1. A statement that the information on which the group exemption was based applies in all material respects to the subordinates being added to the group exemption
2. A written authorization from the new subordinate for inclusion in the group exemption
3. A statement regarding the accounting period of new subordinate organizations on behalf of which the central organization will file group returns
4. A list of new subordinate organizations with determination letters

If a central organization intends to terminate its group exemption, the proposed revenue procedure would require the central organization to submit a statement in its SGRI to that effect and notify each subordinate of the termination. The central organization would also be required to provide each subordinate organization with information on how the subordinate organization(s) may apply for or obtain recognition of exemption.

Declaratory judgment provisions of IRC Section 7428

IRC Section 7428 permits organizations described in IRC Section 501(c) to file declaratory judgment actions if they have an actual controversy involving IRS determinations. The proposed revenue procedure explains when IRC Section 7428 applies to group exemption subordinate determinations:

• When the IRS makes a final determination that a subordinate organization is no longer described in IRC Section 501(c)
• When the IRS makes a final determination that a subordinate organization is not eligible for initial inclusion in, or subsequent addition to, a group exemption

A subordinate organization must file its own declaratory judgment action under IRC Section 7428 — the central organization may not file on the subordinate's behalf, or vice versa.

Automatic revocation

IRC Section 6033(j) states that an organization's exempt status will be automatically revoked if it fails to file required Form 990-series returns or notices for three consecutive years.

Clarifying how IRC Section 6033(j) applies to subordinate organizations, the proposed revenue procedure states that a subordinate organization that has had its exemption automatically revoked and not yet reinstated could not be included in or subsequently added to a group exemption. The proposed revenue procedure would require a central organization to notify the IRS, when submitting its annual SGRI, of any subordinate organizations that have had their exemptions automatically revoked. If more than half of the subordinate organizations have automatically lost their exempt status, the IRS may then terminate the entire group exemption.

Notification of intent to operate as an organization described in IRC Section 501(c)(4)

IRC Section 506 requires any entity operating as an IRC Section 501(c)(4) organization to notify the IRS that it is operating as an IRC Section 501(c)(4) organization within 60 days of being established.

The proposed revenue procedure notes that any subordinate organization described in IRC Section 501(c)(4) must submit an electronic Form 8976, Notice of Intent to Operate Under Section 501(c)(4), or authorize the central organization to submit Form 8976 on the subordinate organization's behalf and receive any communications relating to the submission.

Applicability

Transition Period. Revenue Procedure 80-27 remains in effect until the revenue procedure proposed in Notice 2020-36 is published in final form. When a final revenue procedure is published, it will apply to preexisting group exemptions, although there would be a one-year transition period to comply with the requirements that a central organization (1) have at least one subordinate organization, and (2) maintain only one group exemption.

Grandfather Rule. The following definitions and rules would not apply to preexisting subordinate organizations that were in group exemptions before the date the final revenue procedure is published:

• The definitions of "general supervision" or "control"
• The matching, foundation classification, similar purpose, and uniform governing instrument requirements
• The prohibition against including Type III supporting organizations in group exemptions

In place of these definitions and rules, the following rules in Revenue Procedure 80-27 would apply for preexisting subordinate organizations:

• All preexisting subordinate organizations must all be described in the same paragraph of IRC Section 501(c), but their central organization may be described under a different paragraph of IRC Section 501(c).
• Preexisting subordinate organizations described in IRC Section 501(c)(3) may be classified in any paragraph of IRC Section 509(a).
• Each preexisting subordinate organization may have a different primary purpose and governing instruments that are not uniform with one another.

Request for comments

Public comments on the proposed revenue procedure should be submitted to the IRS by August 16, 2020. The IRS is particularly interested in receiving comments on:

• The administrative burdens imposed by proposed requirements on the central organization to collect:
• Annual information from subordinate organizations in exercising general supervision over them
• Authorizations for inclusion in or addition to a group exemption
• SGRI information
• Factors indicating that a subordinate is affiliated with a central organization
• Whether central organizations with more than one group exemption would benefit from procedures permitting consolidation or transfer of those group exemptions

Implications

Capping a group exemption review project that has spanned more than a decade, the proposed revenue procedure reflects the IRS's intent to make the group exemption process more streamlined and uniform, and to reduce administrative burden on the IRS. For many central organizations, the new rules would have very little impact, due to the extensive grandfather rule. But the revenue procedure would create additional administrative burdens for many other central organizations, limit the types of organizations that would qualify as new subordinate organizations, and consequently would likely reduce the total number of group exemptions and subordinates.

Because the proposed revenue procedure would impose more specifically defined obligations and limitations on group exemptions, the costs to be counted when an organization considers whether to apply for, or whether to maintain, a group exemption would be greater. For instance, with the expanded definition of general supervision or control, a central organization would need to annually obtain, review and retain information on new subordinate organizations' finances, activities, and compliance with annual filing requirements, or appoint a majority of its officers, directors and trustees. Although the general supervision or control requirement is not new, central organizations previously had more flexibility in how they met the requirement because "supervision or control" wasn't defined. The proposed revenue procedure would also require central organizations to more carefully scrutinize prospective group exemption subordinates to ensure they meet the new qualification requirements.

Although the proposed revenue procedure would permit a Type III supporting organization to continue qualifying as a central organization, it could no longer qualify as a subordinate organization. Nor could a qualified nonprofit health insurer qualify as a subordinate. The IRS explained that the complexity of the rules governing these organizations outweighs the benefit of allowing them to qualify as subordinate organizations, reflecting its intention to reduce its administrative burden.

After the final revenue procedure has been issued, a central organization would have a one-year transition period to ensure it has at least one subordinate organization and maintains only one group exemption letter. Thereafter, it could lose its group exemption. The IRS estimates these new rules would affect approximately 300 central organizations that report having no subordinates. The proposed grandfather rule would have even wider applicability, exempting all existing central organizations from the more specific supervision or control requirements and stricter subordinate qualification criteria.

One significant benefit of group exemptions that is not affected by the proposed revenue procedure is the ability of a central organization to file a group Form 990 return for two or more of its subordinates. Although the revenue procedure references the existing group return regulations, it does not propose to modify them.

The IRS will not accept any new group exemption letter requests from June 17, 2020, until publication of the final revenue procedure. It will be accepting comments through August 16, 2020. In general, the IRS values real-life examples of how its proposed guidance would affect exempt organizations and seriously considers such comments in revising that guidance. Thus, central organizations have an opportunity to educate the IRS on the administrability of the proposed revenue procedure, and possibly to minimize the administrative burden it imposes.

Please contact your Ernst & Young LLP professional for further information.

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