The US Tax Court has allowed¹ an entity seeking declaratory judgment that it qualifies as a tax-exempt organization under IRC Section 7428 to withdraw its petition without prejudice via a motion for voluntary dismissal, because such a case does not address a deficiency and was not brought under IRC Section 6213.

Background

Students and Academics for Free Expression, Speech, and Political Action in Campus Education, Inc. (SAFE SPACE), an advocacy organization, electronically submitted Form 1023, Application for Recognition of Exemption, on June 13, 2023. After 270 days with no response from the IRS, SAFE SPACE petitioned the Tax Court on March 18, 2024 for declaratory relief under IRC Section 7428 regarding its initial qualification as an IRC Section 501(c)(3) tax-exempt organization and as an organization described in IRC Section 170(c)(2), donations to which are considered charitable contributions.

On May 3, 2024, SAFE SPACE and the IRS filed a joint motion to dismiss the case on the grounds that the original application was incomplete and not processed by the IRS. Both parties expressed an intent for SAFE SPACE to file a complete application for IRS recognition of tax exemption and thereby create a full and complete administrative record to enable the IRS to make an exemption determination.

Law and analysis

The Tax Court differentiated the case at hand from the majority of similar cases it reviews, which request a redetermination under IRC Section 6213 of deficiencies listed in a deficiency notice issued by the IRS. In those cases, IRC Section 7459(d) generally requires the court to sustain the Commissioner's determination, so the taxpayer may not withdraw a petition. IRC Section 7459(d), however, does not apply to SAFE SPACE's petition, which requests a declaratory judgment under IRC Section 7428 on an application for tax exemption that has been pending over 270 days.

The Tax Court held that a voluntary dismissal is appropriate in a non-deficiency case when the opposing party will not lose any substantial rights as a result or otherwise be prejudiced by the dismissal.

After determining the Tax Court had jurisdiction under IRC Section 7428(a)(2) and noting the parties agreed SAFE SPACE had exhausted all administrative remedies, the court granted plaintiff's motion to dismiss, noting that the IRS joining the motion confirmed a lack of prejudice.

Implications

The SAFE SPACE case reflects the Tax Court's willingness to permit the voluntary dismissal of petitions for declaratory judgment on applications for IRS recognition of exemption that have been pending over 270 days, especially when the IRS does not object to the dismissal. It also reflects the need to verify that Forms 1023 or 1024 are complete and accurate when applying for recognition of exemption. If SAFE SPACE had submitted a complete application, it is more likely the IRS or Tax Court would have recognized its exemption under IRC Section 501(c)(3). After dismissal of the petition by the Tax Court, SAFE SPACE will now need to start the application process anew, thereby adding additional time and cost to the application process.

Experienced tax advisors can promote the facilitation of efficient IRS processing of an application for recognition of exemption, thereby reducing the risk of IRS delay and/or denial on the grounds an application is incomplete or insufficient to demonstrate IRC Section 501(c)(3) qualification. Historically, when the IRS delays ruling on a Form 1023 application, working directly with the IRS can lead to sufficient resolution of any issues with an entity's application. This approach is generally more efficient and effective than petitioning the Tax Court for a declaratory judgment under IRC Section 7428. However, if the IRS is not responsive and does not rule on a Form 1023 or 1024 application within 270 days of filing, petitioning the Tax Court for a declaratory judgment is an option applicants can consider after consulting with counsel. Ironically, filing such a petition is unlikely to expedite resolution, given the deliberate, multi-step nature of Tax Court litigation. Once an applicant files a petition, however, they can either wait for a ruling by the court or attempt to negotiate a settlement with the IRS. If the applicant settles with the IRS or otherwise requests dismissal of the petition, the Tax Court generally will grant the motion to dismiss without prejudice.

EY member firms do not practice law where prohibited by local law or regulation. Ernst & Young LLP (US) does not practice law or offer legal advice.

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