about Tax-Exempt Organizations at
Lisa M. Chessare
Todd R. Eskelsen
Louise M. Fitzsimons
Andrew M. Grumet
P. Gregory Hess
Michael J. Huft
Katherine J. Levy
Stephen A. Marcus
Christine R. W. Quigley
Thomas P. White
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The IRS and the Treasury Department issued new temporary regulations on September 8 this year that streamline the application process for new organizations seeking tax exemption as publicly supported charities and also make certain procedural and computational modifications to the application of the public support tests for existing publicly supported charities.
Previously, a new organization applying for exemption that showed it was likely to qualify as a publicly supported charity would receive an advance ruling recognizing its public charity status for an initial period (the "advance ruling period") ending with the end of the organization's fifth tax year, whereupon a definitive ruling would be issued, provided that the organization successfully showed, by filing Form 8734 after the end of the advance ruling period, that it had met one of the applicable public support tests during the advance ruling period. If the charity failed to meet a public support test for the advance ruling period, it would be reclassified as a private foundation, and the 2% excise tax (1% in some circumstances) imposed on the investment income of private foundations (Section 4940 tax) would then be assessed retroactively for the entire advance ruling period. The other excise taxes applicable to private foundations would not apply to the advance ruling period, regardless of whether the charity had complied with the private foundation rules giving rise to those excise taxes, but the organization would be subject to all such taxes beginning with its sixth tax year.
Once a definitive ruling was issued to a new publicly supported charity, it still had to continue to meet a public support test on a rolling four-year basis, or it would be reclassified as a private foundation. That is, a charity would be recognized as publicly supported for a given tax year if it met a public support test, in the aggregate, for the previous four years, not including the tax year in question. Furthermore, a charity that qualified as a public charity for a given tax year by reason of having met a public test for the immediately previous four years would automatically be treated as a publicly supported charity for the following tax year, regardless of whether it met a public support test for the four years immediately prior to that tax year. Thus, a charity would have to fail to meet a public-support test for two years in a row before it would lose its public charity status.
Because the IRS believed that the burden on both the IRS and taxpayers imposed by the advance ruling period substantially outweighs the tax administration or compliance benefit, it has issued these new regulations in order to deploy its compliance resources more effectively. The following changes are effective as of September 9, 2008 and apply to taxable years beginning on or after January 1, 2008:
- The advance ruling period for new organizations is eliminated. A new organization seeking classification as a publicly supported charity will receive a definitive ruling if its application for exemption shows to the satisfaction of the IRS that it can reasonably be expected to meet a public-support test for its first five years. The organization will be treated as a public charity for all purposes during its first five years. Thus, even if it fails to meet the public support test for that period, its reclassification as a private foundation will be effective only beginning with its sixth year. No Section 4940 tax will be assessed with respect to its first five years.
- Form 8734 is eliminated. There is no longer any requirement for a special showing of public support at the end of first five years other than a continuation of the requirement that organizations filing Form 990 or 990-EZ must report its support on Schedule A each year and complete the public support calculations provided on that form.
- For all publicly supported organizations, the computation period for public support is changed from a four-year period ending immediately before the applicable tax year to a five-year period that includes the tax year being tested as well as the immediately prior four-year period. As a result of including the current tax year in the public support calculation, a charity may not know until some time into the following year that it has lost its status as a public charity. Consequently, the IRS will not assert excise taxes and penalties for all or part of a year in which the charity has been reclassified as a private foundation in situations where the imposition of such taxes would be unfair or inequitable, especially in situations where the failure to meet a public-support test was unforeseeable or due to circumstances beyond the charity's control. In addition, an organization that believes the imposition of such taxes to be unfair or inequitable may seek relief by submitting the relevant facts and circumstances to the IRS. The rule that a charity must fail to meet a public support for two years in a row before it can lose its status as a public charity remains unchanged.
PRACTICE TIP: Organizations whose qualifications as a publicly supported charity are "borderline" may need to monitor their revenue more closely than before to determine whether their qualification will fail so as to mitigate the effects of being reclassified as a private foundation. This may be especially important for organizations that enter into transactions that are permitted for public charities but would constitute self-dealing if the organization were classified as a private foundation.
- Under the prior regulations, a publicly supported charity was required to use the cash method of accounting in calculating its public support, even if the organization kept its books under the accrual method. Under the new regulations, an organization must use the same method of accounting in calculating its public support as it uses to keep its books. Charities following the accrual method will therefore not be able to use the information reported in its recent Form 990s for this purpose, but will have to compute their public support on the accrual method even with respect to years included in the calculation that ended prior to the effective date of the new regulations.
- A transition rule is provided whereby a charity that cannot meet a public-support test for its first tax year beginning on or after January 1, 2008 will qualify as a publicly supported charity if it met a public support test for its 2007 taxable year based on the prior four-year calculation.
- Organizations that have received advance rulings that expire on or after June 9, 2008 will now be subject to the new regulations in all regards. They will be treated as new public charities for all purposes, without regard to the actual public support received during their first five years, and will not have to file Form 8734 after the end of their fifth year. Their advance ruling will be treated for all purposes as a definitive ruling. However, an organization whose advance ruling expired before June 9, 2008 and did not timely file Form 8734 must still file the information required by Form 8734 and establish that it has met a public support test during its first five years in order to qualify as a publicly-supported charity.
- Organizations that filed Form 1023 prior to the effective date of the new regulations will be treated under the new regulations, and the IRS will issue definitive rulings as to their status as public charities or private foundations.
Although the advance ruling period has been eliminated for new organizations, it continues to be an option for private foundations that convert to public charity status by operation as a public charity. As before, a private foundation can make such a conversion by notifying the IRS of its intention to do so (in accordance with the procedures set forth in the applicable regulations), whereupon it must operate as a public charity for a continuous period of 60 months. Upon a showing that the private foundation met a public-support test during the entire 60-month period, it will receive a definitive ruling as a public charity. The converting charity may, but need not, request an advance ruling that, if granted in the discretion of the IRS and upon a showing that the organization can reasonably be expected to meet a public-support test, can be relied upon by donors that grants and contributions to the organization during the 60-month period will be treated as having been made to a public charity. Although the private foundation itself cannot rely on the advance ruling, if it successfully completes the 60-month conversion, it will be treated in retrospect for all purposes as if it had been a public charity during the 60-month conversion period.
"Spotlight On: Cherkin Preston Foundation," Philanthropic Spotlight (September 2008)
"Embezzlement and Nonprofits," Non-Profit News (September 2008)
"IRS Releases Thoroughly Redesigned Form 990 for 2008,"
Tax-Exempt Organizations Update (August 2008)
"Alternative Pledge Payment Options," Non-Profit News (August 2008)
"Pledge Payment Options," Non-Profit News (July 2008)
"Hiring Related Parties," Non-Profit News (June 2008)
"Paying for the Gala," Non-Profit News (May 2008)
Schiff Hardin LLP is enthusiastically committed to serving the legal needs of tax-exempt organizations, matched by significant experience and practice capabilities in this area. Our attorneys provide comprehensive counsel to a wide array of public and private philanthropic, health care, medical and scientific research, housing, neighborhood redevelopment, cultural, artistic, civic, college and educational, and religious organizations, as well as social welfare organizations, trade associations and business leagues, business and housing cooperatives, and professional fundraisers. For more information about the services Schiff Hardin LLP provides to tax-exempt organizations, please feel free to contact us.