EO Attorney Seeks to Reduce Burden for Small Unincorporated Associations

January 1, 2018

Ms. Victoria Judson
Associate Chief Counsel (TE/GE)

Ms. Janine Cook
Deputy Associate Chief Counsel (TE/GE)

Office of Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: 2017-2018 PRIORITY GUIDANCE PLAN (released October 20, 2017)
PART 2. NEAR-TERM BURDEN REDUCTION

Item 19: Update to Revenue Ruling 67-390

Dear Ms. Judson and Ms. Cook:

I am writing regarding your work at the Internal Revenue Service Office of Chief Counsel (TE/GE), Associate Counsel side, along with the Treasury Department's Office of Tax Policy, on guidance for tax preparers and taxpayers concerning the 2017-2018 Priority Guidance Plan Item 19 (captioned above).

My address relates specifically to the issue of whether a new exemption application is required when a tax-exempt unincorporated association alters its form of entity by incorporating as a nonprofit corporation under applicable state (or other available jurisdiction) law.

Not requiring an exemption application in this circumstance would alleviate a highly burdensome regime, detailed below, which is particularly harsh for small unincorporated associations recognized as exempt under Internal Revenue Code section 501(c)(3) or 501(c)(4) who later choose to acquire corporate protection. [For purposes of this communication, “small associations” references entities who are eligible to file Form 990-EZ as of tax years begun in 2008 (i.e., have annual gross receipts each year of less than $200,000 (with yearend assets of less than $500,000)) and/or those not required to file an annual return at all but subject to the electronic 990-N notice (i.e., have annual gross receipts normally not in excess of $50,000).]

1. Background

Pursuant to Example 4 in Revenue Ruling 67-390, it has been the posture of the IRS to effectively treat the creation of a nonprofit corporation by a predecessor tax-exempt unincorporated association as the establishment of a “new” taxpayer who has no right to retain or otherwise be covered by the determinations ruling the predecessor had obtained. That prior-existing, predecessor unincorporated association (hereafter, “PRE-UA”) is effectively treated as demised in spite of the intention of the PRE-UA's managers (and, when appropriate, the association's voting members who have confirmed the move to incorporated status) to avail of corporate protections for the PRE-UA's managers and the organization's operations.

A corollary posture of the IRS Exempt Organizations Division likely “justified” by Revenue Ruling 67-390's Example 4 has been in place throughout the past three decades in which I have practiced in this arena (although I understand it was just challenged the last quarter of this year as noted below). This posture required the “new” taxpayer in the intended recasting of a PRE-UA into incorporated status procure a new employer/taxpayer identification number (“EIN”) when applying for recognition of exemption. In line with that issuance (which would or at least should have occurred at or after the “new” taxpayer's date of incorporation), the corporation (hereafter, the “POST-UA”) also found its dealings with donors, financial institutions, employees and other stake-holders immediately affected by the perception that the POST-UA was a wholly different entity from the PRE-UA group, concomitantly lacking a prior history of banking relationships, donor-donee relationships, employer status, operations, etc. As noted in section 2, below, the “new EIN” mandate (and the resulting relationship impacts therefrom) of the Exempt Organizations Division may have been erroneously required.

2. Countervailing Procedure Relating to Mandate Procurement of “New” EIN Exists in Internal Revenue Manual; and Court Holdings Regarding “Corporate/Association” Separate Taxpayer Characterization under Federal Tax Law

In the past several weeks I was informed by another exempt organizations tax practitioner that she had just recently persuaded the IRS Exempt Organizations Division Determinations Office to recognize the tax-exemption of a newly-created nonprofit corporation (specifically incorporated to continue the operations of a PRE-UA; said taxpayer referenced, again, as a “POST-UA”) utilizing the same EIN as that of the PRE-UA. That result was afforded after the tax practitioner brought to the attention of the Division's Determinations officials the text of Internal Revenue Manual (IRM) 7.20.2.2.2:

7.20.2.2.2 (10-22-2015) Employer Identification Numbers

1. The IRS uses an EIN to identify business entities for federal tax purposes. All organizations applying for exemption must have an EIN that is uniquely theirs (see Rev. Rul. 73-526).

2. If you determine the organization isn't using the correct EIN, research IDRS to determine whether the organization has been assigned an EIN.

[chart redacted]

3. Don't approve or deny an application until the organization provides a valid EIN.

4. If an organization was assigned more than one EIN in error:

a. Research IDRS for all EINs (e.g., INOLES, ENMOD, and BMFOLO).

b. Confirm which EIN the organization wants to continue using. (Recommend using the EIN under which any returns were filed or payments applied.)

c. Prepare Form 14271, EO Determinations EIN Merger Memo, at case closing, attaching the applicable IDRS research prints.

5. A tax-exempt organization that changes legal form may have to secure a new EIN. See Publication 1635, Understanding Your EIN, and Rev. Rul. 73-526.

6. An organization must get a new EIN if one of these legal changes apply:

a. A trust that re-forms to other than a trust

b. A corporation that re-forms to a trust

c. A corporation that reincorporates in the same state (i.e., state issues a new charter)

d. Corporations that change from for-profit to non-profit or LLC to non-profit only if the state of formation considers the new status an entirely new/separate entity (e.g., it is listed as two separate entities listed on the Secretary of State website)

Exception:

An unincorporated association (for purposes of tax exemption) is generally treated as electing to be treated as corporation (rather than a partnership) and generally doesn't require a new EIN if it incorporates with the state.

note: color and bold has been added for emphasis

Reminder:

A tax-exempt organization that changes legal form must submit a new application for exemption.

7. [redacted]

The “exception” within section 6 of the cited-IRM is presumably predicated on the fact that “corporate characteristics” of the PRE-UA were demonstrated when it sought (and presumably achieved) tax exemption; thereafter, federal tax status as a corporation is “generally” to be maintained (per this exception) even were the PRE-UA to alter its “form of legal entity” status by incorporating. That result contradicts the Exempt Organizations Division's treatment of the POST-UA as a “new” entity in light of its operation as a corporation, i.e., as a different form of legal entity. These parallel results being directed by the Exempt Organizations Division — according federal tax status as a “corporation,” as opposed to a “partnership,” upon the unincorporated association's seeking of tax-exemption; and treating as a “new taxpayer” (i.e., requiring a “new EIN”) a POST-UA who is continuing the operations of a PRE-UA because of legal change in form of entity — has led to unnecessary confusion and immense burden for exempt organizations who move to initiate exemption recognition while lacking state or other jurisdictional chartering as a nonprofit corporation.

That Internal Revenue Manual 7.20.2.2.2 (6) has not, until the determinations ruling I was recently apprised of, ever to my knowledge (or the knowledge of my colleague who represented the taxpayer at issue) been applied, reflects the need for more comprehensive guidance beyond that of solely addressing whether Example 4 of Rev. Rul. 67-390 should be reversed with respect to unincorporated association — to — nonprofit corporation reorganizations.

Moving into court precedent addressing federal tax status “as a corporation” overall, Private Letter Ruling 201522001 delineates relevant holdings:

The core test of corporate existence for purposes of federal income taxation is always a matter of federal law. Whether an organization is to be taxed as a corporation under the Code is determined by federal, not state, law. Ochs v. United States, 158 Ct. Cl. 115, 119 [10 AFTR 2d 5206], 305 F.2d 844, 847 (1962). A corporation is subject to federal corporate income tax liability as long as it continues to do business in a corporate manner, despite the fact that its recognized legal status under state law is voluntarily or involuntarily terminated. Messer v. Commissioner, 438 F.2d 774, 778 [27 AFTR 2d 71-621] (3d Cir. 1971).

The first case cited in PLR 201522001 demonstrates the disjuncture between what is a “new” corporation for federal tax purposes versus what is “an entity” for state law purposes. In Ochs v. United States., 58 Ct. Cl. 115, 119 [10 AFTR 2d 5206], 305 F.2d 844, 847 (1962), the taxpayers and the IRS disagreed about whether the demise of an entity's legal status mooted the entity's federal tax status (the issue being whether a state-chartered corporation “became” another taxpayer when it lost its corporate chartering and thus “became” an unincorporated association, the reverse of what Rev. Rul. 67-390, Example 4 speaks to). The court in Ochs rejected the plaintiff's argument that an organization that was neither a de facto nor de jure corporation under state law due to its charter's expiration thus had no one authorized to act on its (the demised corporation's) behalf. The ruling held that the demised corporation retained corporate federal tax characteristics and thus “was” the same taxpayer in now-association legal form.

3. At Issue: Whether an Unincorporated Association's Morph “into” a Nonprofit Corporation Results in the “Creation” of a New Taxpayer for Federal Tax Law Purposes when the Underlying Unincorporated Association is a 501(c) Exempt Organization

Income Tax Regulations¹ § 301.7701-2(b) addresses “who” is a corporation for federal tax purposes; its first two paragraphs speak to incorporated entities and unincorporated associations, respectively:

For federal tax purposes, the term corporation means:

(1) A business entity organized under a Federal or State statute, or under a statute of a federally recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate, or body politic;

(2) An association (as determined under § 301.7701-3).

Further elucidation of 301.7701-2(b)(2) pursuant to Regs. § 301.7701-3(a) is as follows:

(a) In general. A business entity that is not classified as a corporation under § 301.7701-2(b)(1) . . . (an eligible entity) can elect its classification for federal tax purposes as provided in this section. An eligible entity with at least two members can elect to be classified as either an association (and thus a corporation under § 301.7701-2(b)(2)) or a partnership, and an eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner. . . .

bold emphasis has been added

Accordingly, when an association has elected to be classified as a corporation under § 301.7701-2(b)(2), as it does when it asserts its right to exemption from federal corporate income tax (through self-declaration or by applying for recognition of tax-exemption, Revenue Ruling 67-390's Example 4 treats the fact of that association's later incorporation as though its “new” form of entity has birthed a new entity and thus “is” a new taxpayer. The basis for that result is unclear: is it that the POST-UA is classifiable (for federal tax purposes) as a corporation under Regs. § 301.7701-2(b)(1) and thus has lost ability to be classified (for federal tax purposes) as a corporation under Regs. § 301.7701-2(b)(2)?; or is it the Exempt Organizations Division is appropriately relying upon state law as the point of controlling a federal tax law result when the state (or other jurisdiction) “creates,” via chartering, a nonprofit corporation?

The former possibility focuses on a distinction that appears at best to be ephemeral. Furthermore, any such distinction is ignored under the exception in Internal Revenue Manual 7.20.2.2.2 (6) that was noted in section 2, above. The latter possibility requires the elevation of state (or other jurisdictional) corporate chartering to an absolute that ignores the notion of “successorship” (i.e., the state created a new entity so the relationship of such chartering to a predecessor organization is irrelevant). In any case, as noted in section 4, following, the application of Rev. Rul. 67-390's Example 4 when an unincorporated association that is self-described as exempt or already holding a determinations ruling letter chooses to effect existence as a nonprofit corporation places an enormous, undue and vastly burdensome set of constraints on the POST-UA.

4. Practical Guidance is Urgently Needed to Undo the Multiple Hurdles Example 4 of Rev. Rul. 67-390 Has Imposed Upon POST-UA Exempt Organizations Who Have, or Will in the Future, Undertake a PRE-UA to POST-UA Journey

As noted in section 2, preceding, the ability of a POST-UA to retain the same EIN as the PRE-UA it is successor to has only just recently been acknowledged by the Exempt Organizations Division via a favorable ruling recognizing the exemption of one POST-UA. That result should be apply and be secured for all via guidance. Thus, I urge you to issue guidance that plainly states that all POST-UAs are allowed to maintain the same EIN as that of their PRE-UA. Such guidance would provide hugely practical benefits immediately as existing exempt organizations who had been unincorporated associations but now have nonprofit corporation protection would no longer be faced with “bifurcated” PRE-versus POST-UA tax accounts. This result would devolve upon those in such situation who thus would, in general, NO LONGER need:

• to see to the closing of accounts at financial institutions which had been registered with the PRE-UA's EIN (assuming the PRE-UA's managers were no longer going to maintain ongoing control of the PRE-UA's accounts); and transfer assets to the POST-UA's newly-effected accounts

• to have the POST-UA effect new employer-employee relationships with those who had been employees of the PRE-UA in order to reflect the POST-UA's new payroll tax accounts with the IRS and state/local political subdivisions for its employees

• to issue final W-2s to employees of the PRE-UA and address demise or other transfer of retirement accounts the PRE-UA had established for those employees

• to re-situate tax reporting with vendors of or grantors to the PRE-UA (affecting W-9 issuance, ACH accounts, etc.)

As to unnecessary and burdensome result in place from Rev. Rul. 67-390's Example 4, I urge you to issue guidance that plainly states that an unincorporated association that has elected status (by exemption application filing/determination or via “self-declaration”) as an “association . . . thus a corporation” (pursuant to Regs. § 301.7701-3(a)) may reorganize and retain status as the same taxpayer with all (a) attendant federal tax attributes including tax-exemption. Internal Revenue Code section 368(1)(a)(F)'s definition relating to corporate reorganizations (“a mere change in identity, form, or place or organization of one corporation, however, effected”) can and should be the basis of such result. As noted in the next paragraph, and further elaborated upon in section 5 of this communication, such guidance would enormously benefit, through the reduction of burden, the exempt organizations sector overall.

Thousands of associations (if not tens of thousands) have “made the journey” from PRE-UA to POST-UA and later find themselves “at fault” under Rev. Rul. 67-390's Example 4 as they have continued to file as an exempt entity with the IRS and state and local jurisdictions utilizing the PRE-UA's exemption ruling and EIN. That error occurs predominantly with small organizations but it is not uncommon to see Form 990 filers in such circumstances. Taxpayers typically find themselves in such a situation due to reliance on those “helping” with the incorporation who themselves were ignorant of the IRS' posture that such a reorganization will, for federal tax purposes, “effect” a new taxpayer who is required to procure its own exemption ruling.

Clean-up of these scenarios is cumbersome, expensive, and often imperfect. Moreover, once found,² the resulting issues cannot be ignored by those licensed to practice before the IRS who are advising the entity on required filings. Indeed, when a paid preparer “finds” such error in play by a POST-UA client, they are required to address with that client that it wrongly believes itself to be tax-exempt. The resulting reality is messy and cumbersome to clean up, especially if the POST-UA had been mistakenly filing Forms 990-N, 990-EZ or 990 under the PRE-UA's EIN as those filings do nothing to prevent the POST-UA from being subject to “automatic revocation” under Internal Revenue Code section 6033(j).

A POST-UA subject to automatic revocation due to not having filed annual returns or the required 990-N notice under the new EIN “historically required” of those who have morphed into incorporated status, faces vast federal tax law correction needs. These include: a potential need to procure an EIN, making of an exemption application, addressing the ability to have “reasonable cause” automatic retroactive reinstatement effected (a need that, if absence of filing Form 990-series returns or the 990-N for a POST-UA goes back as far as tax years begun in 2007, and if in the tax year begun in 2007 gross receipts exceeded $100,000 or assets at yearend exceeded $250,000, streamlined reinstatement under Revenue Procedure 2014-11, section.04 will not be available). As of the issuance of Revenue Procedure 2014-11, I have found myself on an almost monthly basis providing pro bono consulting on this subject not only to small POST-UAs, but to preparers' groups initiated by representatives of societies of accountants or of enrolled agents; I field at least quarterly calls from college/university law school clinics or legal services clinics on the subject; and this topic is a constant “sidenote” that I include within CLE or CPE presentations I make on federal tax-exemption qualification or on preparation of Forms 1023, 1023-EZ, and 1024. It is, unfortunately, an all too-clear reality that the sector of advisors to such organizations is adrift as to how to meet the multiple needs of taxpayers who find themselves in these circumstances.

5. Conclusion

Guidance stating that a tax-exempt unincorporated association upon moving to nonprofit incorporated status (i.e., the PRE-UA to POST-UA morph addressed in this communication) may, but does not have to, procure a new EIN is necessary; same would eradicate a potentially false result that has for too long burdened the tax-exempt sector, especially small associations who realize across their life cycle they should seek corporate protection. Furthermore, voiding Example 4 in Revenue Ruling 67-390, and replacing same with guidance that in such situation, the right to, and attributes of, tax-exemption held by the unincorporated association survive the morph and thus will be respected as those of the POST-UA; that result would eradicate an unnecessary and undue burden on the tax-exempt sector overall.

I thank you for your time and consideration on this matter. Please feel free to reach me by phone (612.822.2677) or email (eve@BAMlawoffice.com) should you have any questions for me on this submission.

Respectfully,

Eve Rose Borenstein
BAM Law Office LLC
St. Louis Park, MN

cc:
Elinor Ramey, Attorney-Advisor, Treasury Office of Tax Policy