By: Robert G. Tweel, Lindsay D. Petrosky, and Brontë G. Arreola
Does your company have any dormant tax-exempt entities in your organizational chart? If so, read on.
In recent Private Letter Ruling (PLR) 202437007[1], the Internal Revenue Service (IRS) revoked the tax-exempt status of an organization. The organization had qualified as a tax-exempt supporting organization under Section 501(c)(3) and Section 509(a)(3) of the Internal Revenue Code (Code), and subsequently did not engage in any tax-exempt activities nor provide any support to its supported organization. As a result, the IRS determined that the organization did not meet the operational test required under 509(a)-4(e) and, therefore, did not perform any tax-exempt activity under Section 501(c)(3). Accordingly, the organization failed to qualify for Section 501(c)(3) tax-exempt status. PLR 202437007 serves as a reminder for all companies to analyze the operational functions of their tax-exempt affiliates and evaluate whether any dormant entities still fulfill an exempt role in their organization.
To be exempt under Section 501(c)(3) of the Code, an organization must be both “organized and operated” exclusively for one or more of the specified exempt purposes. If an organization fails to meet either the organizational test or the operational test, it is not exempt. For supporting organizations under Section 509(a), the entity must be both organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one specified publicly supported organization. In PLR 202437007, the IRS’s analysis focused on the organization’s Form 990-EZ, which reported that the organization’s exempt activities had no expenses. Further, in response to an Information Data Request, the organization confirmed that it had no activities to further the exempt purposes of its supported organizations. The IRS determined that the organization failed its operational test because it had no operations furthering its charitable purpose and therefore no longer qualified for tax-exempt status.
Traditionally, many organizations have chosen to maintain their dormant tax-exempt entities rather than voluntarily relinquishing its tax-exempt status and dissolving the entity. When appropriate, an organization would have the option to either repurpose the dormant entity with a similar charitable purpose or update the entity’s purpose by filing a request for Miscellaneous Determination as opposed to filing a Form 1023 Application for Recognition of Exemption under Section 501(c)(3) to update the purpose, which is a much longer process.
The recent Ruling provides insight into how the IRS may view dormant tax-exempt entities. It may no longer be sufficient to simply file an annual informational return if the organization is not engaging in activities that would satisfy the applicable operational tests. Organizations should take the following steps to review the tax-exempt entities in their organizational chart:
- Review organizational chart and annual returns to determine whether any tax-exempt entities are dormant. If so, confirm if these entities can be repurposed. If not, confirm appropriate next steps for the organization within the corporate structure.
- Review current activities for all tax-exempt entities to ensure that such organizations are only participating in activities that are within the scope of what is permitted for tax-exempt entities.
- Review the identified tax-exempt purposes for all exempt organizations and confirm whether any updates are needed.