A group exemption affords the opportunity for a nonprofit organization to share the tax-exemption of another 501(c)(3) without having to apply to the IRS for their own status. There’s a lot to it, so let’s take a closer look.
A group exemption is simply 501(c) status* conferred by the IRS on a group of organizations, instead of a single nonprofit. This avoids the need for each entity to seek their own tax-exemption. In order for this to work, several circumstances must all be present:
- There must be a parent, or central, organization that will be considered the umbrella holder;
- There must be 2 or more subordinate nonprofits that will make up the group members;
- Each subordinate organization must be affiliated with the parent organization;
- Each subordinate must be subject to the central organization’s general supervision or control;
- Each subordinate must be exempt under the same paragraph of IRC (Internal Revenue Code) 501(c), though not necessarily the paragraph under which the central organization is exempt;
- Each subordinate must be an independent entity with regard to corporate structure and governance, i.e., it is a separate legal entity with its own board of directors.
Group exemptions are often seen with church denominations, fraternities and sororities, and other groups of nonprofits that have affiliation with each other and with a central hub.
They are not to be confused with organizations that have a chapter system. In a true chapter-based nonprofit, each chapter is an outpost of the main organization. It’s only one entity with multiple locations, and usually centralized finances. By contrast, a group exemption is made up of several (or many) legally independent nonprofits who share common purpose and one IRS letter of 501(c) determination. Even though the subordinates are subject to oversight by the parent, they are liable for their own operations, governance, and finances. Most file their own IRS Form 990 each year, though some group exemptions have the parent organization file a consolidated return.
Again, common purpose is usually the key reason why a group of nonprofits would collectively share a single tax-exempt status. The primary advantage is that each subordinate does not have to submit to the IRS Form 1023 application and review process to receive tax-exempt status. Once they are legally formed, usually by incorporation, a parent entity that already has group status can simply add them to their list of oversight subordinates, and report that addition to the IRS.
As stated above, there must be at least 2 subordinates, plus the parent, for a group to exist. Assuming the minimum circumstances are satisfied, there are two ways a nonprofit can join a group.
- The subordinate is part of the parent nonprofit’s request for initial group status. Although the parent must have their own 501(c) status, it isn’t necessary to get that status prior to getting group exemption. They can be applied for at the same time. During the application process, at least two subordinates must be included with the group application. Those nonprofits will make up the initial group.
- Once a group is formed and approved, subsequent members can be added anytime during a tax year. The parent will update the IRS every year as to any new additions to the group.
Because each subordinate is its own legal entity, most accountability concerns rest with that organization. But, the parent is still charged with general oversight. Typically, this means there should be some mechanism of annual review of the subordinate by the parent to ensure each one is operating within the bounds of 501(c) compliance and in concert with whatever affiliate agreement is in place with regard to programs and operations.
Sometimes a subordinate finds that being a member of the group exemption just doesn’t work for them. It could be that they no longer desire the affiliation. When that happens, it’s not too difficult to come out from under the group.
First, it’s important to reemphasize that each subordinate is already its own separate, legal corporate entity. That means there is no need to go through a formation process again at the state level. Once the parent has been notified of the subordinate’s intent to leave the group, the IRS requires the parent to make that update known on its next IRS group report.
As for the subordinate, they are no longer tax-exempt once they leave the group. They will have to formally apply to the IRS via Form 1023 to seek their own 501(c) status.
Group exemptions are a great way for similar organizations to affiliate under a common tax-exemption, and save the member nonprofits from having to seek their own 501(c) status. And while it doesn’t work for every group to have a common bond like that, it often proves to be exactly what’s needed for many others.
For more information, see IRS Publication 4573.
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