Exemption Reinstatement for nonprofit organizations is something I have been doing since 2010. In that time, I have spoken to hundreds of organization leaders who wish to have their tax-exemption reinstated, but are confused by the process. Below are some of the questions that I have been asked many times.
- Can’t I just file the returns (990-N, 990-EZ, 990, or 990-PF) that I didn’t file and get the Exemption Reinstatement?
Answer: No. The only way to get the organization’s tax-exempt status reinstated after automatic revocation is to apply again with the IRS to have your organization recognized as tax-exempt. If, for example, you try to just send in a Form 990-EZ, the IRS will reject it, since your organization is no longer tax-exempt, and Form 990-EZ is a return for a tax-exempt entity. Note: To check your organization tax exempt’s status, you can go to the Tax Exempt Organization Search tool.
- But I paid my $20 (or $25 or $50) faithfully every year. I have a record of those payments. So the IRS must have made a mistake, right?
Answer: The minute someone says that they paid something with their filing, I know that they are confusing their state’s filing requirement with the IRS’s informational return filing requirement. I know that because there is no fee to file an informational return with the IRS. However, most states require an annual filing with a state agency, such as a secretary of state, and many charge an annual filing fee along with that filing. For example, Michigan requires that Michigan nonprofit corporations file an annual report and pay a $25 annual filing fee. Very often people confuse the state and IRS filings. So if the only reports you filed required a fee, you did not file your annual informational return with the IRS, leading to automatic revocation when you failed to file the third consecutive return.
- We haven’t even been in existence for three years, so how can we have failed to file returns for three consecutive years?
Answer: I have seen this happen often. The thing that you have to understand is that the IRS starts the “clock” on your filing requirement as soon as your organization obtains a Tax ID number (also called an EIN). As part of the process of obtaining that number, you have to provide certain information to the IRS. That information is used to classify your organization, and to determine what return the IRS should expect from your organization. As soon as that determination is made, your filing obligation begins. The other thing to remember is that a partial year counts the same as a full year in calculating whether you have failed to file for three consecutive years. For example, if you incorporated your organization on December 15, 2016 and obtained a Tax ID number that same day, then your first return would cover the period December 15, 2016 to December 31, 2016 (assuming your accounting year ends December 31). In this scenario, if you did not file in 2017 and 2018, then your organization’s exemption would be automatically revoked on May 15, 2019—the due date of the third return you did not file. So in this example, the tax exemption of an organization that had been in existence for only two years and six months would be revoked for failure to file informational returns for three consecutive years.
- But I just got my determination letter from the IRS saying that the organization is a 501(c)(3), and a week later, we got a letter revoking the status. How can that be?
Answer: The answer to this question is related to the preceding one. Depending on when your organization obtained its Tax ID number, and when you applied for exempt status, the revocation letter might follow very quickly after the favorable determination letter. I have even heard of cases where the organization receives the revocation letter before the determination letter! As an example, let’s say your organization obtained its Tax ID number December 15, 2014. It then filed Form 1023 (the application to be recognized as a 501(c)(3)) in August, 2016. There was some back and forth between the organization’s leaders and the IRS, but on April 26, 2017 the IRS issued a favorable determination letter recognizing your organization as a tax-exempt 501(c)(3). However, you failed to file a return for the organization’s first year of existence (the short year from December 15, 2014 – December 31, 2014). You also failed to file in 2015 and 2016. That being the case, the organization’s tax-exempt status would be automatically revoked on May 15, 2017, which was the due date for the third consecutive return you did not file. In this scenario, you might receive your favorable determination letter from the IRS not long before receiving your notice of revocation.
- The office where we had all the organization’s records was destroyed in a fire, and all the records were lost. That is why we didn’t file. Can I just write a letter to the IRS and explain why we didn’t file and have them reinstate the exemption?
Answer: Even if the failure to file was due to a tragedy beyond your control, this approach will not work. The organization’s tax-exempt status is revoked automatically on the due date of the third consecutive return that was not filed. The IRS has no discretion to undo that revocation. The best that you can do is to get retroactively reinstated to the date on which you lost the exemption. In many ways, that result makes it as if the revocation never happened because there will be no “gap” in your tax-exempt status.
- How is retroactive reinstatement of tax-exemption different than if the organization’s exemption had never been revoked?
Answer: For one thing, some donors might be concerned that the organization has had its tax-exemption revoked because they consider that to be negligent, and it undermines their confidence in the board’s ability to run the organization responsibly. However, I have found that most donors just want to know that the organization is tax-exempt at the time they make their donation or grant. The other effect that a revocation has, even if the exemption is retroactively reinstated, is that it makes it harder to get reinstated if there is ever a second loss of exemption (this is more common than you might think).
- What do we tell our donors while we’re in the process of trying to get our organization’s exemption reinstated?
Answer: First of all, you must be honest with them. The fact that your organization’s tax exemption was revoked is public knowledge; it appears on a searchable database on the IRS’s website. If someone makes a donation expecting that it will be deductible, you should tell them that you are in the process of getting the exemption reinstated, and you believe that it will be reinstated retroactively (if that is the case). However, you cannot guarantee that it will be; that decision is up to the IRS. One good thing is that the donor probably will not need a definite answer until he or she files a personal tax return, which might be many months after the donation is made. For example, a donor makes a donation in August, 2018 and wants to claim a deduction for it. However, your organization’s exemption has been revoked, effective May 15, 2018, and it has not yet been reinstated. Therefore, at the time the donor gives you the donation, it is not tax-deductible. You discovered the revocation at the time the donor wished to make the donation. The donor wishes to know if the donation is deductible. Remember that the donor will not need to know definitely if the donation is deductible until he or she files a personal tax return for the year in which the donation was made. In this case, the return covering 2018, the year in which the donation was made, will not be due until April 15, 2019. If the organization acts promptly to get reinstated after it learns in August, 2018 of the loss of exemption, its leaders should know well before April 15, 2019 if its exempt status has been retroactively reinstated. If it has been, then the retroactive reinstatement covers the period when the donor made the donation, and there is no problem—the donation is deductible. If it has not been retroactively reinstated by April 15, 2019, then the donor will not be able to claim the deduction. If you find out after April 15, 2019 that the exemption has been retroactively reinstated, you can inform the donor. The donor will then have to decide if it is worthwhile to file an amended return to claim the deduction.
- Can I do nothing, and just let the corporation go away?
Answer: Of course you can decide to not reinstate the organization’s tax exemption, and just ignore it. However, that might not be the best course of action, and it could cause you a big headache later. Let me explain. Here I will assume that the organization is a nonprofit corporation (rather than a trust or an unincorporated association). Since losing its exempt status, the organization is now considered a nonexempt corporation. Such a corporation will normally have to file Form 1120. This is the same return that a for-profit corporation has to file. The instructions for the 2018 Form 1120, under “Who Must File”, state the following:
Unless exempt under section 501, all domestic corporations (including corporations in bankruptcy) must file an income tax return whether or not they have taxable income. Domestic corporations must file Form 1120, unless they are required, or elect to file a special return.
Your corporation acquired a new filing obligation that began the day it lost its tax-exempt status. What if you don’t file Form 1120? The IRS can charge various types of penalties when a corporation does not file a return, files late, or files but pays the tax due late. In addition to the penalties, interest may be charged as well. For example, for filing a return late, the organization may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. Even if no tax is due, the minimum penalty for a Form 1120 that is over 60 days late is the smaller of the tax due or $210.
Generally the IRS has three years to audit a filed return. This can be extended in certain circumstances. However, when a return is not filed, this three year limitations period never begins to run. Consequently, failing to file Form 1120 means that the IRS can audit the missing tax year at any time, even years down the road when you might have misplaced the relevant records.
State filing obligations for non-exempt corporations vary from state to state, and your corporation might be liable for late penalties and interest at the state level as well. Even if you do not plan to continue operating your organization, it makes sense to reinstate it and then dissolve it properly. If its exemption is reinstated retroactively to the date it was revoked, there will be no non-exempt period you have to worry about. You can then dissolve it properly and bring a definite and documented end to its filing obligation.
Here is a list of FAQ’s from the IRS on Exemption Reinstatement if you need more information.