275,000 Nonprofits Lose Tax Exempt Status

Well, it’s official.  We’ve known this day was coming since the Pension Protection Act was passed into law in almost 5 years ago.  On the afternoon of June 8, 2011, the IRS released the initial list of nonprofits that have automatically lost 501(c) tax exemption due to non-filing of Form 990 for 3 consecutive years, 2007-2009.  The numbers, while expected, are still staggering:

275,000 Nonprofits Are No Longer Tax Exempt!

Estimates are that as many as 2/3rds of this list may be functionally dormant.  Even if that’s true, that leaves nearly 100,000 active charities and other nonprofits in a very critical situation.

Let’s take a look at exactly what the ramifications are for an organization on the list:

  • 501(c) status is revoked retroactively with an effective date of May 15, 2010 (the due date of the 2009 Form 990).
  • Donations are no longer tax deductible to the donor effective the date of the list publication…in this case, June 8, 2011.  You’ll notice that while no grace is afforded the nonprofit, the unaware donor is catching a break.
  • A for-profit corporate tax return is likely due.
  • There may be serious (and expensive!) consequences at the state level including, but not limited to, sales and property taxes, payroll and unemployment taxes and workers’ compensation, as well as thorny issues with the state Department of Charitable Solicitations.

This list only scratches the surface of the problems facing these nonprofits.

So, how does such an organization go about restoring its 501(c) status?

For starters, it must file a new Form 1023 (or 1024) with the IRS, as well as pay the filing fee.  The process will be a lot like the first time the nonprofit went through it, though I expect there will be additional scrutiny placed on these “do-overs”.  I also expect enormous backlogs at the IRS.  Assuming the organization still qualifies (and some will not) and the application is prepared by someone who knows what they are doing (a shameless plug for us), the IRS will issue a new determination letter effective the date of the new Form 1023’s receipt at the IRS.

A retroactive effective date is possible, but very tricky.  First off, a letter requesting retroactivity back to the revocation date is required.  In addition, all of the Form 990s that were not filed must be prepared and included with the Form 1023.  Here’s where it gets even messier…even if the organization qualified to file the Form 990-N e-postcard for any of the years in question, a Form 990-EZ or Form 990 must be prepared instead.

Why is retroactivity desirable?

It seems easier to just forget about the past 990s and just accept IRS determination from the date of the application, right?  Not so fast.  While that may work for some, keep in mind that the nonprofit will have a period exceeding one year where it was operating as a for-profit organization. As such, it will likely be required to file a for-profit corporate tax return, Form 1120. That’s a big mess.  Also, getting renewed status retroactively will help eliminate the many potential problems at the state level.

We honestly did our best to warn people about this.  So did many others.  Now that the list has been published, it will be interesting to see the fallout.  I expect it will be epic.

To see the list for yourself, visit http://www.irs.gov/charities/article/0,,id=239696,00.html

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

This Post Has 4 Comments

  1. Denise

    My status was taken and when I went to retrieve my proof it was gone. But a message was on the paper work that said that the 990N/99ez and 990 information was lost through the IRS. So what they did was to make sure people lose their status and pay another $400.00 so they can make money. Then what do you do with your donations? What if you started and then stopped due to funding but you filed your taxes, why should you pay out more money to the IRS just because they need money. This is not the American way and is the worst thing I have ever heard of to do to people. I am toast and have no choice but to let it go, will call granters and ask for all proposals back. This is why people are working off the books and paying nothing to the IRS.

    1. Greg McRay

      I certainly understand your frustration. This may not make you feel any better, but this has nothing to do with either the IRS or the government needing money. Congress passed legislation in 2006 designed to increase the accountability and transparency of nonprofits…a needed thing. Part of the law change introduced the Form 990-N for small nonprofits, including the new rule that failure to file Form 990 for 3 straight years would result in automatic loss of tax exemption. The IRS is simply tasked with administering the law. For what it’s worth, I’ve spoken with a number of IRS agents in the Exempt Organization’s division and most of them were dreading this law taking effect. Most would have preferred some sort of suspension/reinstatement scheme as opposed to the death penalty. Us, too. If anyone is to blame, it’s Congress.

  2. Chuck

    Our group filed for a 501c(4) status for the 2010 tax year. We have not herad back from the IRS. However we have determiend that we do not want to remain a 501c(4). We wish to return to just a Non-Profit Corporation status. I have only found two ways to make that happen. One would be to not file a 990 for 3 years and let the IRS revoke our status. the other would be to file a 990 for tax year 2011 and annotate “Terminated” on the 990.
    Neither is attractive to us becaues we do not want to file as a 501c(4) for 2011. Nor do we want to desolve our group.

    Do you have any suggestion on how we can manually revoke our status ourselves without desolving our group?

    1. Greg McRay

      If you haven’t been approved by the IRS yet, you can simply write to your case reviewer at the IRS and withdraw your application…case closed. If indeed you have already been approved as a 501c4, you can simply file Form 990 and mark “final” return. That will effectively end your tax exempt status as of the end of the fiscal year of the return, but will have no impact on your corporation.

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