TaxNewsFlash-Exempt Organizations

July 21, 2008
No. 2008-64
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IRS Provides Details of Changes to Public Support Test and Elimination of Advance Ruling Period

The IRS subsequently pulled the FAQs and Errata Sheet discussed below, indicating that the information was a "work in progress."

The IRS recently posted on its Web site an "advance copy" of a set of Frequently Asked Questions (FAQs), and an Errata Sheet for Form 1023, describing the proposed changes to the public support test and the elimination of the advance ruling period for publicly supported section 501(c)(3) organizations. The changes will not take effect until the issuance of implementing regulations.

Background

A tax-exempt organization described in section 501(c)(3) can avoid private foundation status if it satisfies one of the public support tests under sections 509(a)(1) and 170(b)(1)(A)(vi) or section 509(a)(2).

Under current regulations, an organization generally qualifies as publicly supported for its current tax year and the following tax year if it satisfies the applicable public support test in the aggregate for the four tax years immediately preceding the current tax year, unless there is a substantial and material change in the organization's sources of support—in which case the computation period includes the four preceding years plus the current year.

A newly formed organization that wants to be classified as a publicly supported organization may request an advance determination that it will qualify as such for its first five tax years. Grantors and contributors are entitled to rely on an organization's non-private foundation status during its advance determination period, subject to certain limitations. At the end of the five-year advance ruling period, the organization must file Form 8734 to provide financial information supporting its qualification as a publicly supported organization. If the organization adequately demonstrates its publicly supported status on the basis of its financial support during the five-year advance ruling period, the IRS issues a definitive ruling as to the organization’s non-private foundation status.

New Regulations

In connection with the redesigned Form 990, the IRS announced that it planned to eliminate the advance ruling procedure some time in 2008.

The draft instructions to the 2008 Form 990 Schedule A (released in April 2008) indicate that under the new rules, the IRS will make a determination as to a newly formed organization's public charity classification at the same time it makes a determination of the organization's exempt status (based on financial information submitted with Form 1023). The FAQs state that donors and contributors will be entitled to rely on the organization's public charity classification until the IRS publishes notice of a change in such classification. Rather than filing Form 8734 within 90 days after the end of its fifth year, the organization will be required to demonstrate on the Schedule A to the Form 990 (or Form 990-EZ) for its sixth year that it satisfies the applicable public support test on the basis of the current year and the preceding four years.

Accordingly, it appears that new organizations will effectively have six years in which to meet the public support test, except that the first tax year will be disregarded. In addition, existing organizations will use the same five-year computation period that includes the current year and the four preceding years. These changes necessitate amendment of the regulations discussed above.

FAQs and Errata Sheet

The recently released FAQs and Errata Sheet provide the following additional details and clarifications regarding the new regulations to be issued:

  • Organizations that are currently in their advance ruling periods and organizations whose advance ruling periods expired less than 90 days prior to the issuance of the new regulations will not be required to file Form 8734. These organizations will not receive final determination letters and may use their advance ruling determination letters as evidence of a final determination by the IRS that they are public charities.

  • Organizations whose advance ruling periods expired more than 90 days prior to the issuance of the new regulations and that have not filed a Form 8734 will be classified as private foundations by the IRS. These organizations must file Form 8734 to be reclassified as public charities.

  • The new procedures do not apply to an organization that has received a proposed adverse determination letter indicating that it does not qualify as publicly supported. Such an organization will be reclassified as a private foundation unless it successfully protests the proposed adverse determination.

  • Organizations that have obtained final determination letters from the IRS must comply with the new five-year computation period for determining continuing qualification as a public charity.

  • Organizations that file Form 990-N (e-postcard) because their annual gross receipts are less than $25,000 are not required to file Schedule A to demonstrate that they qualify as public charities. However, if such an organization in fact does not qualify as a public charity, it must file Form 990-PF as a private foundation.

  • The Errata Sheet indicates that the instructions at the top of Part IX on page 9 the Form 1023 (Statement of Revenue and Expenses) will be changed to address the longer five-year public support test period after the issuance of the new regulations. The Errata Sheet also states that organizations must not complete Line 6a on page 11 of Form 1023, Request for Advance Ruling, or sign below at “Consent Fixing Period of Limitations Upon Assessment of Tax Under Section 4940 of the Internal Revenue Code.” Organizations are to complete line 6b or 7 on page 11 of Form 1023 (definitive ruling and unusual grants) only if in existence more than five years.

KPMG Observation

The changes discussed above require implementing regulations to be effective. The FAQs refer to temporary income tax regulations issued on July 14. Although the regulations have not, in fact, been issued, the IRS's posting of the FAQs and Errata Sheet at this time may indicate that temporary regulations are anticipated in the very near future.

For more information, contact Rick Speizman, National Partner-In-Charge, KPMG’s Exempt Organizations Tax Practice (ExoTax), at (202) 533-3084 or rspeizma@kpmg.com
 

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