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In PLR 202405011, the IRS revoked the exempt status of an organization under examination for failing to meet the operational test for exemption under IRC Section 501(c)(3), as the organization had become inactive and ceased operations.

Background

IRC Section 501(c)(3) allows entities organized and operated exclusively for charitable purposes to qualify for federal income tax exemption. Treas. Reg. 1.501(c)(3)-1(c)(1), which the IRS cited in its revocation letter, regards an organization as "operated exclusively" for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes in IRC Section 501(c)(3).

Ruling

In response to an information request from the IRS seeking to verify that the organization's operations complied with IRC Section 501(c)(3), a representative from the organization informed the agency it had not conducted any activities during the tax year under examination, other than wrapping up the organization and distributing its assets. The representative also noted that the organization didn't officially exist during that year because it had previously terminated its operations and been administratively dissolved by the Secretary of State. The organization had marked its most recently filed Form 990-EZ, Short Form Return of Organization Exempt from Income Tax, as final.

The IRS determined that the organization didn't qualify for exemption under IRC Section 501(c)(3) because it existed during the year but didn't conduct any tax-exempt activities during that year. The IRS challenged the organization's claim that it no longer existed during the year due to the state's administrative dissolution of the organization in a prior year. The IRS countered that, according to the state, administrative dissolution by the Secretary of State did not terminate the organization's legal existence. Rather, the organization was required to file articles of dissolution to cease its existence under state law, then submit those articles of dissolution with its final Form 990-series return.

Implications

This revocation highlights the need for exempt organizations to continue engaging in charitable activity throughout their lives. If an IRC Section 501(c)(3) entity becomes dormant in a particular tax year, it will fail the IRC Section 501(c)(3) operational test for subsequent years unless it reengages in charitable activity. Accordingly, an organization that ceases operations in one year, but doesn't dissolve under state law until a subsequent year, risks revocation of its exemption for that subsequent year, and puts the deductibility of its donors' contributions at risk. If an organization has ceased or plans to cease operations, it should review the applicable laws within its state of incorporation and promptly take action to dissolve under state law. It should then attach its articles of dissolution (or equivalent document certified by its state) with its final Form 990-series return.