Eleven years after issuing a notice of proposed rulemaking, the IRS has finalized regulations (TD 9964) on the process that states may use to obtain or inspect certain information pertaining to tax-exempt organizations, including information regarding applications for recognition of tax-exempt status, denials of such applications, assessments and proposed assessments of tax, and revocations of tax-exempt status. The final rules amend existing regulations to reflect legislative changes under the Pension Protection Act of 2006 (PPA).

Background

In March 2011, the IRS issued REG-140108-08, proposing changes to IRC Section 6104(c), as amended by the PPA, and received only one comment letter in response. The bulk of these proposed regulations are now reflected in the final regulations.

The PPA amended IRC Section 6104(c) to address circumstances under which the IRS may disclose to state officials certain information about IRC Section 501(c)(3) entities, some other exempt organizations, and taxable entities or persons that had applied for recognition as tax-exempt. Before this change, the IRS could share certain information with appropriate state officers (ASOs) about tax-exempt entities, but the PPA expanded the type of information the IRS may share with ASOs.

IRC Section 6104(c)(1) — which the PPA did not modify — directs the IRS to notify an ASO if (1) the IRS declined to recognize an entity as a charity; (2) a charitable organization is no longer meeting the requirements for exemption; or (3) the IRS has mailed a deficiency notice for any tax imposed under IRC Section 507 (i.e., termination of a private foundation) or IRC chapter 41 or 42 (i.e., requirements for public charities and private foundations).

Changes to disclosure rules in the PPA and final regulations

IRC Section 6104(c)(2) through (6), added by the PPA, expanded the IRS's ability to disclose information to state officials. These changes allow the IRS to disclose the following information to ASOs who meet certain confidentiality and disclosure requirements:

• Proposed refusals to recognize an entity as a charitable entity described in IRC Section 501(c)(3), proposed revocations of charitable status, and proposed excise tax deficiencies under IRC Section 507 (IRC Section 6106(c)(2)(A)(i) and (ii))
• Prior law allowed disclosure only of final decisions on these matters
• Names, addresses, and taxpayer identification numbers of applicants for tax-exempt status under IRC Section 501(c)(3) (IRC Section 6104(c)(2)(A)(iii))
• Prior law limited disclosure to information involving final denials of applications for IRS recognition of tax-exempt status under IRC Section 501(c)(3)
• Returns and return information pertaining to organizations that have applied to the IRS for recognition of exemption under IRC Section 501(c)(3), received letters from the IRS proposing assessment of tax, or received from the IRS notices of proposed revocation of exemption or denial of an exemption application under IRC Section 501(c)(3) (IRC Section 6104(c)(2)(B))
• Prior law permitted disclosure under IRC Section 6104(c) only if the returns and return information pertained to an entity's receipt of a final exemption denial, exemption revocation or tax assessment
• Returns and return information from charitable entities and applicants "if the IRS determines this information may constitute evidence of noncompliance with the laws under the jurisdiction of the ASO," even if an ASO has not requested the information (IRC Section 6104(c)(2)(D))
• No provision under prior law
• Returns and return information from IRC Section 501(c) organizations other than those described in IRC Section 501(c)(1) or (3), if the ASO provides a written request and needs the information for administering state laws regulating solicitation or administration of charitable funds and assets of the affected organizations (IRC Section 6104(c)(3))
• Prior law only allowed, under IRC Section 6104(c), disclosure of information relating to charitable entities and applicants under IRC Section 501(c)(3)

Unless otherwise noted, the IRS may disclose the prior information to an ASO if the ASO submits a written request and needs the information to administer state laws regulating charities (IRC Section 6104(c)(2)(C)).

Other provisions added by the PPA provide the following:

• Returns and return information of organizations and taxable persons disclosed under IRC Section 6104(c) may be disclosed in civil administrative and judicial proceedings pertaining to enforcement of state laws regulating the organizations (IRC Section 6104(c)(4))
• No provision under prior law
• No return or return information may be disclosed under IRC Section 6104(c) if the IRS determines that disclosure would impair federal tax administration (IRC Section 6104(c)(5))
• Prior law provided this disclosure by regulation rather than in the IRC
• Returns and return information may be disclosed to an ASO designee (IRC Sections 6104(c)(2)(C) and (c)(3))
• Prior law restricted disclosure to ASOs
• An ASO is defined as a state attorney general, state tax officer, any state official charged with overseeing charitable organizations, and the head of the state agency that the state attorney general designates as having primary responsibility for overseeing the solicitation of charitable contributions (IRC Section 6104(c)(6)(B))
• Prior law defined an ASO more narrowly as the state attorney general, state tax officer, or any state official charged with overseeing IRC Section 501(c)(3) organizations

In addition, the PPA made IRC Section 6104(c) subject to the security, confidentiality and use restrictions of IRC Section 6103. For example:

• Any state officer or employee who receives returns or return information from the IRS under IRC Section 6104(c) may not disclose the information, except as authorized under the Code (IRC Section 6103(a)(2))
• The IRS must maintain permanent standardized records of all inspection and disclosure requests made under IRC Section 6104(c) and of all information inspected or disclosed as a result (IRC Section 6103(p)(3))
• Any ASO receiving returns or return information under IRC Section 6104(c) must establish and maintain certain safeguards (IRC Section 6103(p)(4))

Civil and criminal penalties for unauthorized disclosure or inspection were also added under IRC Sections 7213, 7213A and 7431.

Before receiving returns or return information from the IRS under IRC Section 6103 or 6104, a federal or state agency must file a report with the IRS detailing the safeguards the agency has implemented to protect the information from unauthorized inspection or disclosure (IRC Section 6103(p)(4)(E)).

Upon considering the comments made by the only commenter on the proposed regulations, and rejecting most of them, the IRS determined that the final regulations needed to "clarify the proper application of the prohibition against disclosure to agents and contractors" by deleting a section in the proposed regulations and "adding definitional clauses … emphasizing that the agent-contractor disclosure prohibition applies both to IRS disclosures and to ASO redisclosures."

Implications

These final regulations may portend greater and/or more focused state scrutiny of tax-exempt organizations. The IRS notes, in the Background to the final regulations, that the IRS currently has Section 6104(c) agreements with only nine states, meaning that only nine states have agreed to comply with the IRS's strict security, confidentiality and use restrictions on Section 6104(c) data and therefore qualify to receive that data. However, the IRS is confident that finalization of the regulations reflects "the potential for increased participation by other ASOs" and will "facilitate the enforcement of State law regarding exempt organizations." It remains to be seen how many additional states will agree to these restrictions as a condition of receiving the additional IRS information described previously. But given increasing state scrutiny of exempt organizations, these final regulations are likely to result in at least some state charity regulators' obtaining additional information from the IRS that will help them focus their enforcement efforts on exempt organizations that are new, newly revoked, or newly scrutinized by the IRS.

These regulations underscore the need for tax-exempt organizations to continuously monitor and take actions to comply with new federal and state regulations, as federal and state authorities typically apply and enforce new regulations soon after they become effective.

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

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