ABA Tax Section Offers Suggestions on Group Exemption Letter Proposal

September 9, 2020

Hon. Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on Notice 2020-36, Proposed Revision of Rev. Proc. 80-27

Dear Commissioner Rettig:

Enclosed please find comments regarding Notice 2020-36, the proposed revision of Rev. Proc. 80-27, regarding group exemption rulings and procedures. These comments are submitted on behalf of the Section of Taxation and have not been approved by the House of Delegates or the Board of Governors of the American Bar Association. Accordingly, they should not be construed as representing the position of the American Bar Association.

The Section of Taxation would be pleased to discuss these comments with you or your staff.

Sincerely,

Joan C. Arnold
Chair, Section of Taxation
American Bar Association
Washington, DC

Enclosure

cc:
Hon. David Kautter, Assistant Secretary (Tax Policy), Department of the Treasury
Krishna P. Vallabhaneni, Tax Legislative Counsel, Department of the Treasury
Matthew Giuliano, Attorney Advisor, Department of the Treasury
Hon. Michael Desmond, Chief Counsel, Internal Revenue Service
William M. Paul, Deputy Chief Counsel (Technical), Internal Revenue Service
Janine Cook, Acting Associate Chief Counsel, Employee Benefits, Exempt Organizations and Employment Taxes, Internal Revenue Service
Stephen B. Tackney, Deputy Associate Chief Counsel, Employee Benefits, Exempt Organizations and Employment Taxes, Internal Revenue Service

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AMERICAN BAR ASSOCIATION SECTION OF TAXATION

COMMENTS ON NOTICE 2020-36, PROPOSED REVISION OF REV. PROC. 80-27
REGARDING GROUP EXEMPTION RULINGS AND PROCEDURES

These comments (“Comments”) are submitted on behalf of the American Bar Association Section of Taxation (the “Section”) and have not been approved by the House of Delegates or the Board of Governors of the American Bar Association. Accordingly, they should not be construed as representing the position of the American Bar Association.

Principal responsibility for preparing these Comments was exercised by Michael Durham, Kimberly Eney, Rosemary E. Fei, Ingrid Mittermaier, Ryan Oberly, Richard F. Riley, Jr., and Thomas E. Wetmore. The Comments were reviewed by Ellen P. Aprill of the Section's Committee on Government Submission and the Section's Vice Chair for Government Relations, Kurt L. Lawson.

Although members of the Section may have clients who might be affected by the federal tax principles addressed by these Comments, no member who has been engaged by a client (or who is a member of a firm or other organization that has been engaged by a client) to make a government submission with respect to, or otherwise to influence the development or outcome of one or more specific issues addressed by, these Comments has participated in the preparation of the portion (or portions) of these Comments addressing those issues. Additionally, while the Section's diverse membership includes government officials, no such official was involved in any part of the drafting or review of these Comments.

Contacts:

Date: September 9, 2020

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TABLE OF CONTENTS

I. EXECUTIVE SUMMARY

II. INTRODUCTION AND OVERVIEW

III. RECOMMENDATIONS AND DISCUSSION

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I. EXECUTIVE SUMMARY

These Comments are submitted in response to a request for comments in Notice 2020-36 (the “Notice”).¹ The Notice provides the text of a Proposed Revenue Procedure (the “Proposed Revenue Procedure ”) under which recognition of exemption from federal income tax under section 501(c) could be obtained on a group basis for subordinate organizations affiliated with and under the general supervision or control of a central organization.² The Proposed Revenue Procedure also would update the process for a central organization to maintain a group exemption letter. These procedures would modify and supersede Revenue Procedure 80-27.³

Our Comments first provide an introduction and overview explaining the importance of a simplified and workable group exemption procedure for the many and varied elements of the exempt organization community. These Comments also summarize the key considerations that we recommend the Internal Revenue Service (the “Service”) take into account in any new group exemption guidance. The Comments then discuss the following specific issues in the Notice and the Proposed Revenue Procedure, as well as provide the following recommendations:

We appreciate consideration given to our recommendations concerning the Proposed Revenue Procedure, and we would be pleased to discuss these Comments.

II. INTRODUCTION AND OVERVIEW

We welcome the Service's intent to issue new guidance on group exemption procedures, which have not been updated significantly in 40 years. With the ACT Report in 2011 and the group ruling questionnaires that the Service sent to more than 2,000 central organizations in 2012, it is clear that both the Service and the tax-exempt organization community find current guidance wanting, and we support making the group ruling process more administrable. At the same time, however, the tax-exempt community has developed a wide range of comprehensive (albeit non-uniform) measures to adapt to the lack of guidance.

As a result, we believe that in its current form, the Proposed Revenue Procedure might create or exacerbate more difficulties than it ameliorates. It would oblige both central organizations and their subordinates to comply with a number of requirements without increasing the central organization's ability to exercise oversight over the subordinates. In some instances, it would make such oversight more difficult to exercise properly. In our view, it also would increase the Service's caseload, with thousands of organizations submitting applications for exemption that would not otherwise have needed to do so.

Especially in light of the ongoing resource constraints faced by the Service, now does not seem the time to present cumbersome changes to a group exemption system that has worked relatively well for decades. Instead, we believe that the Service's concerns are best addressed through a framework that articulates the concepts of affiliation, general supervision, and control with greater clarity and flexibility.

The group exemption procedures administered by the Service have affected and will continue to affect a large segment of the nonprofit sector in the United States. The Service's Exempt Organizations Business Master File (the “EO Master File”) currently lists some 4,167 group exemptions, covering approximately 443,000 of the approximately 1.77 million organizations on the Service's records.⁶ Thus, nearly one in every four organizations on the EO Master File is under a group exemption. Of these, almost 60% (approximately 242,000) are described in section 501(c)(3), and approximately half of those (approximately 120,000) are listed as churches.⁷

These figures likely understate the total number of subordinates under group exemptions (and the percentage of them that are religious organizations), because the Service does not have complete records as to church group exemptions. (The ACT Report authors estimated in 2011, after discussions with various major denominations, that there were another 100,000 to 150,000 religious organization subordinates beyond those listed on Service records.⁸)

Group rulings vary widely in size. Large group exemptions like those belonging to some major religious denominations, civic organizations, veterans' organizations, or fraternal organizations, might have thousands of subordinates (the largest have over 10,000). Yet more than half of all groups have a dozen or fewer subordinates, and the average number of subordinates per group is just over 100.⁹ The challenges associated with exercising supervision over subordinates, and the value of imposing uniformity, are vastly different at different ends of the size spectrum.

Size of Groups, Per EO Master File¹⁰

Size of Group	Groups this size	%	Organizations in groups this size	%
1	46911	11%	469	0%
2-10	1,473	35%	7,131	2%
11-100	1,613	39%	58,331	13%
101-1,000	535	13%	151,426	34%
1,001-5,000	67	2%	137,685	31%
5,001-10,000	8	0%	60,321	14%
10,001-20,000	2	0%	27,647	6%

Groups also differ in how they are organized. While some groups consist mainly of similar local subordinate units differing mainly in their geographic area of operation, others include various separately incorporated functional units that work together, each fulfilling a separate function (similar to the way that the Service is now organized into divisions based on area of functional responsibility rather than based on geographical districts and regions). Not uncommonly, a group might include some geographically based branch subordinates with some subordinates fulfilling special functional roles for the group as a whole. Also, groups might differ not only in the extent of control exercised by the central organization but also in the mechanism by which such control is exercised. Some central organizations might appoint one or more board members, whereas others might exert considerable control even without any governance relationship, for instance by means of a contract allowing the local unit to use the central organization's name and trademarks. Rules designed to aid administration and simplicity with respect to one type of group might make little sense for other types.

Group exemptions are especially important for the religious community. Existing denominations rely on group rulings to cover tens of thousands of affiliates, adding and deleting new churches and other religious organizations frequently. Governance structures among religions and denominations range widely, and the manner of governance often reflects key religious tenets. Church-related subordinates often include congregations, but also might include, for example, administrative and oversight complexes, seminaries, and schools/school systems from preschool to the university level.¹² Some might be corporations while others are unincorporated associations, not all of which have needed formal organizational documents, instead depending on some form of church teaching and sacred writing to guide their assembly. For some denominations, the concepts of both “control” and “significant supervision” contradict doctrinal freedom of conscience and accountability to none but God. The group exemption process has historically offered flexible mechanisms for these organizations to coordinate and synchronize their missions, while accommodating their beliefs in how they implement the group exemption requirements for control, or affiliation with supervision. As explained in more detail below, we are concerned that the Proposed Revenue Procedure would mandate significant changes for group exemption participants, both in scope and volume, which could be especially problematic for some denominations.

Group exemption also allows a church, religious order, or integrated auxiliary to have its tax status confirmed to donors in a manner on which donors can rely without the organization having to file the Form 1023. By allowing central organizations rather than the Service to confirm the tax deductibility of contributions to their subordinates, the group exemption process enables subordinate organizations to raise money from donors on the same terms as organizations recognized as exempt by the Service. More and more donative support comes through donor advised funds and similar institutional donors that require a determination letter or similar reliable proof of status before they will make a grant. Thus, this alternative means for recognition of tax-exempt status has become more important than ever.

Group exemption not only benefits central organizations and their subordinates, but the Service as well. Each subordinate covered by a group ruling might otherwise have applied to the Service for recognition of its exemption; the sheer number of such entities now represents a huge savings in the Service's determination resources. Provisions of the Proposed Revenue Procedure that make participation in a group ruling more difficult can be expected to reduce participation and increase the Service's caseload for processing applications for exemption. In addition, the Form 1023-EZ, which the Service developed to help lighten this administrative burden, is inapplicable to many common types of subordinates, such as churches, schools, and hospitals, that might need to apply for exemption to the Service under the Proposed Revenue Procedure. The corresponding increase in burden on the Service should be carefully weighed against the perceived benefits of such provisions. Aside from decreasing the volume of exemption applications to the Service, group exemptions also allow the Service to rely on central organizations, that are in a better position in some respects to evaluate whether an affiliated organization merits exemption. In the case of religious denominations, for example, group exemption shields the Service from having to recognize each religious subordinate's exempt status and answer the sometimes difficult and resource-intensive question of what is a church.

Saving the time and expense of filing a separate exemption application and separate annual Forms 990 can be a powerful incentive for subordinates to qualify for inclusion in a group ruling, but as importantly, excluding certain subordinates from being able to so qualify (as the Proposed Revenue Procedure would do) would put them at a substantial disadvantage relative to their peers. We expect that new groups will do their best to follow whatever rules the Service ultimately requires in terms of uniformity, affiliation, supervision, or control as a condition of coming within a group ruling, but we are concerned that such conformity might be detrimental to new groups in terms of management efficiency, or even diminished ability to achieve their exempt purposes. Such conformity requirements also might significantly impede organizations' efforts to adjust to new circumstances or changes in the law. We urge the Service to act cautiously in making changes that could, over time, exert significant homogenizing impact on the structure of U.S. civil society groups. In many cases, we believe that the gains from increased uniformity will be outweighed by the costs of requiring central organizations to impose one-size-fits-all solutions on their subordinate organizations. We recommend that any new group exemption procedure recognize that subordinate organizations are subject to different and evolving state laws, have differing sizes and resources, and might need to focus their programs in different ways in order to support the overall mission of the group.

III. RECOMMENDATIONS AND DISCUSSION

A. Meaning of Affiliation, General Supervision, and Control

Treas. Reg. § 1.6033-2(d)(1) requires, in order for a central organization to file a group return with respect to its subordinates, that each subordinate organization be “affiliated” with the central organization and also be under its “general supervision or control.” We agree with the Notice and the ACT Report¹³ on the need for clearer definitions of those terms that are flexible enough to accommodate the wide variety of governance structures in affiliated groups today. Current affiliation models range from top-down hierarchical structures to ground-up federated associations of members at local, regional, state, and national levels. For religious groups, accommodation of such differences is especially important in light of the Religion Clauses of the First Amendment.¹⁴ We believe that the changes we recommend to the Proposed Revenue Procedure, which are described in more detail below, would take into account better the valuable diversity of affiliation, control and supervisory relationships in affiliate groups where group exemption should be allowed.

1. General Standards for Determining Affiliation

a) Background

The Proposed Revenue Procedure states that whether affiliation exists will be determined based on the entirety of the information submitted but, like Revenue Procedure 80-27, provides no standards for what would pass the test.¹⁵ As with other aspects of these rules, we believe it is essential to have a definition of affiliation that is both broad and flexible. Moreover, because the affiliation requirement does not stand alone, but is in addition to general supervision or control, we believe it is appropriate to set the bar for affiliation fairly low in the group exemption context.

Flexibility is especially important for religious groups. In other areas of tax law, Congress and the Service have established flexible definitions of association or affiliation tailored to the special needs and protections of churches. Section 414(e)(3)(A), for example, allows an employee benefit plan classified as a church plan to serve not only church employees but also other employees of other organizations “controlled by or associated with” a church or convention or association of churches. For these purposes, section 414(e)(3)(D) states that an organization is “associated with” a church if “it shares common religious bonds and convictions” with the church. This broad definition accommodates a variety of governance relationships between a church and other affiliated organizations.¹⁶

The definition of an integrated auxiliary of a church or convention or association of churches also contains a broad and flexible standard for what constitutes affiliation,¹⁷ which might serve as a model. It indicates that an organization is affiliated if (1) it is a subordinate under the church's group exemption, (2) it is operated, supervised, or controlled by or in connection with (i.e., it has a Type I, II, or III relationship with, as defined in the rules governing section 509(a)(3) supporting organizations¹⁸) the church, or (3) it qualifies as affiliated with the church based on all the facts and circumstances. While a number of the factors indicating affiliation under this third test go to control or general supervision, which are dealt with independently in the group exemption context, several factors indicate affiliation regardless of control or supervision:

These factors are not exhaustive, and the absence of one or more factors is not dispositive in determining integrated auxiliary status. We note that factor (v) above would be present for all subordinates in a group exemption, because the central organization must affirmatively decide whether to include the subordinate in its ruling. That might explain why the integrated auxiliary test treats inclusion in a group ruling as a sufficient condition for affiliation in itself.

In the group exemption context, the requirement of general supervision or control applies separately from the requirement of affiliation.²⁰ At the same time, we note that organizations within an organization's control group commonly are considered its affiliates. ²¹ It would be a departure from standard usage to require organizations controlled by or under common control with a central organization under traditional concepts of corporate law to meet other factors in order to qualify as affiliated with the central organization. As explained in more detail below, we believe that the Service can maintain its separate treatment of the affiliation and the general supervision or control standards, but still recognize that some close corporate relationships are sufficient to establish both affiliation and control.

b) Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, treat any organization that would be a “related organization” to a central organization for purposes of Form 990, Schedule R (without regard to whether the organization actually must file Schedule R), as satisfying the affiliation test.

Drawing on the integrated auxiliary rules, for all organizations, not just religious ones, we also recommend that the Proposed Revenue Procedure, when finalized, treat any organization that it is operated, supervised, or controlled by or in connection with (i.e., has a Type I, II, or III relationship with, as defined in the rules governing section 509(a)(3) supporting organizations) the central organization as satisfying the affiliation test. (This issue is distinct from whether and which types of supporting organizations are or should be eligible for inclusion in a group ruling, discussed in Comments infra Section III.F) Otherwise, there could be organizations sufficiently affiliated with a church to qualify as an integrated auxiliary exempt from filing Form 990 or Form 1023, but not sufficiently affiliated to be included in a group ruling. We see no compelling reason why the standard for affiliation in the group ruling context should be higher than in the integrated auxiliary context.

Furthermore, we recommend that the Proposed Revenue Procedure, when finalized, treat the presence of any one or more of the following factors as satisfying the affiliation test:

• The subordinate's governing instruments affirm that it is dedicated to supporting, performing the functions of, or carrying out the purposes of the central organization.

• The central organization has the authority to appoint or remove, or to control or approve the appointment or removal of, at least one director or trustee of the subordinate.

• Directly or through an intermediate unit of the central organization, the subordinate has the right to participate in the election of at least one member of a body having a significant governance role within the central organization.

• Members of the subordinate automatically become members of the central organization, or vice versa.

• The corporate name of the subordinate indicates an institutional relationship with the central organization.

• The subordinate has entered an affiliation agreement or similar contract requiring it to operate in accordance with policies, procedures, and purposes of the central organization, or to be bound by decisions of the central organization, with respect to one or more matters materially affecting its operations.

• The central organization licenses its name, marks, or other intellectual property to the subordinate, provides a material source of funding to the subordinate, or provides other resources or assets necessary to the operations of the subordinate, such that terminating its relationship with the central organization would have a substantial adverse impact on the subordinate.

• In the event of dissolution, the subordinate's assets are required to be distributed to the central organization or another affiliate of the central organization (whether or not also included in the group ruling).

• The central organization and the subordinate regularly coordinate activities or share employees and other resources to a material extent.

This list is not intended to be exhaustive; we suggest the Service consider other facts and circumstances demonstrating to the Service's satisfaction that the subordinate has a substantial association with the central organization's group and participates meaningfully in its activities.

Finally, we recommend that the Proposed Revenue Procedure, when finalized, treat any organization that satisfies section 414's “common religious bonds and convictions” test with respect to any central organization that is a church as satisfying the affiliation test.²²

2. Relevance of Indirect Relationships in Establishing General Supervision and Control

a) Background

The Proposed Revenue Procedure defines control so that the subordinate is controlled by a central organization only if the central organization directly appoints (or its representatives serve as) a majority of the subordinate's officers, directors, or trustees.²³ This definition appears to preclude indirect control through multiple layers of controlled organizations, and in this respect is narrower than more typical definitions of control in the Code. For instance, in determining whether an organization is a “related organization” for purposes of Form 990, Schedule R, the instructions explicitly provide for indirect control through one or more tiers of controlled organization, as do other provisions of the Code.²⁴ To require direct control by the central organization over each and every subordinate would preclude the exercise of such control by intermediate bodies within the hierarchy. Moreover, in the case of the largest groups, without the ability to delegate control to intermediate subordinates, the central organization would be unable to give sufficient attention to each appointment, or have sufficient representatives in service, to ensure appropriate control. While workable for smaller groups, we believe that the flatter governance favored by the Proposed Revenue Procedure in fact would undermine the goal of increasing the central organization's ability to exercise control and ensure compliance above some threshold. In addition, in the religious context, we believe that this requirement could easily require control relationships inconsistent with the internal rules of a particular organization or denomination.

Allowing middle-level organizations to participate in exercising general supervision and control was a major recommendation of the ACT Report as well, especially in the case of religious groups:

Specifically, because of theological doctrine or practice, many church denominations are prohibited from having one central entity exercise supervision or control (in the conventional legal or corporate sense) over other entities within the denomination. Therefore, there should be another model for general supervision or control in the church group exemption context.

In many church group exemptions, the central organization is not always the “closest” church entity to the subordinate organizations. Instead, there are middle-level or regional “subunits” of the church that exercise more direct supervision or control over the subordinate organizations. For example, the middle-level church entities may own or have an interest in the property held by lower-level church entities. But more significantly, the middle-level entities (or their officials) may exercise religious or ecclesial supervision or control over lower-level church bodies and their leaders (i.e., clergy). And this type of supervision or control can be extremely powerful. Indeed, in some denominations, the clergy leadership of non-compliant subordinate organizations can be summarily removed from their positions by middle-level entities (or their officials) — even in the absence of any corporate board type of control over the subordinate organizations. In summary, the ACT believes that the centralized, conventional legal or corporate model of general supervision or control simply does not work for church group exemptions. Middle-level entities or subunits of the church should be permitted to provide the requisite level of ongoing supervision or control over the subordinate organizations in church group exemptions.

In summary, the ACT believes that the centralized, conventional legal or corporate model of general supervision or control simply does not work for church group exemptions. Middle-level entities or subunits of the church should be permitted to provide the requisite level of ongoing supervision or control over the subordinate organizations in church group exemptions.²⁵

b) Recommendations

We agree with the ACT Report's recommendation that church groups be allowed to use their existing structures — hierarchical or not — to exercise general supervision in the group exemption context. We recommend that the Proposed Revenue Procedure, when finalized, give non-religious groups similar flexibility. Having multiple tiers in a governance structure allows each subordinate to be supervised by a higher-level organization that has a sufficiently small number of entities under its purview that it can exercise meaningful review and oversight over the layer below. Requiring a central organization to review information with respect to thousands of local chapters is likely to result in less meaningful oversight than allowing that organization to take advantage of the same tiered structure it uses to supervise other aspects of the overall group's work.

We recognize that allowing a central organization to avoid dealing directly with affiliates at the local level increases the possibility of errors of transmission between local subordinates and the central organization. Furthermore, differences in structure from group to group prevent the Service from mandating any one model for using intermediate-level organizations to help exercise general supervision over other subordinates in larger groups. Accordingly, we recommend that the Proposed Revenue Procedure, when finalized, require a central organization that uses a tiered structure to exercise general supervision be prepared to explain how intermediate-tier organizations would assist in providing general supervision, and what measures the central organization would take to make sure that the information from intermediate-level organizations would be accurate and complete.

There is a parallel need to broaden the definition of “general supervision” to provide for multiple levels within a group. The current definition, although not explicit on this point, is read most naturally as contemplating a direct exchange of information between each subordinate and the central organization.²⁶ Accordingly, we recommend that the definition of general supervision in the Proposed Revenue Procedure, when finalized, explicitly state that a central organization can provide and obtain the requisite information either directly, or indirectly through intervening tiers of organizations. For instance, a national organization could review reports from state- or regional-level entities, which might in turn be based on reports received from and compiled by state or local councils with respect to their individual chapters. At each level, the report to the next level up could include a certification that the information is complete and accurate, or note any exceptions.

3. Exercise of Control Through Officers, Directors, or Trustees

a) Background

As noted above, the Proposed Revenue Procedure defines control so that the subordinate is controlled by a central organization only if the central organization directly appoints (or its representatives serve as) a majority of the subordinate's officers, directors, or trustees. With respect to members of the board or governing body, this reference to “majority” makes sense, although the Service might wish to clarify that it refers to directors or trustees holding a majority of the voting power, which might not be a strict numerical majority if there are different classes of directors having different votes.

However, we believe that a direct appointment test would exclude common governance structures that also vest sufficient control in the central organization. For instance, in many groups, local organizations appoint their own officers and directors, subject to approval of the central organization. When a majority of the directors can be elected only subject to such approval, we believe the subordinate is adequately controlled by the central organization. Similarly, we believe that an organization controls another if it can remove and replace more than half of the members of the governing body of the subordinate organization. Finally, it is not uncommon for such appointment, approval, removal, or replacement powers to be vested in particular officers of the central organization, rather than requiring the central organization's governing body to act; we believe that such arrangements place sufficient authority in the central organization to constitute control.

b) Recommendations

We are uncertain how to apply the concept of “a majority” in the Proposed Revenue Procedure to the appointment of officers, who typically do not exercise their power by casting votes as part of a governing body. Under the proposed definition, we surmise that a subordinate with a five-person board, a president, a treasurer, a secretary, and an assistant secretary, would be controlled by a central organization if the central organization appointed the treasurer, the secretary, the assistant secretary, and two of the five directors — even though the central organization would have no real power to force the subordinate to take any corporate action. Accordingly, we recommend that any reference in the Proposed Revenue Procedure, when finalized, to control by appointing a majority be limited to appointments to a decision-making body that acts by majority vote.

At the same time, we recommend that the Proposed Revenue Procedure, when finalized, define control through the appointment of officers separately and without reference to a majority, and provide that it exists only if the chief executive of the subordinate is either a representative of the central organization, or is appointed (or approved, or removable and replaceable) by the central organization or its representatives.

Finally, we recommend that the Proposed Revenue Procedure, when finalized, clarify that either control over the governing body or control over the chief executive officer would be sufficient for a central organization to control a subordinate for purposes of group exemption.

4. Impact of Uniformity Requirements on Control

a) Background

The Proposed Revenue Procedure would require all subordinate organizations to adopt a uniform governing instrument.²⁷ We address this requirement in detail elsewhere in these Comments.²⁸ However, in this section on general supervision and control, we wish to note that this new requirement, whatever value it might have in improving administrability from the perspective of the Service, necessarily would change the central organization's control relationship with its subordinates. To take one example, the requirement of a uniform governing instrument would put the central organization in the position of deciding which one instrument works best for the group, and require the central organization to dictate to it subordinates what their governing instruments say. We believe that such a requirement for group exemption would run counter to the philosophies of many groups and could be especially problematic in the case of religious denominations; in some cases, it might require them to choose between foregoing group exemption and violating their religious doctrine or internal rules of polity. For instance, the Constitution of the Southern Baptist Convention prohibits it from exercising any authority over its cooperating churches,²⁹ and it proudly proclaims as one application of this principle that these churches can have their own governing documents as well as their own methods for selecting leaders.³⁰

Outside the religious context, holding and attracting subordinates can be a delicate balance of carrots and sticks for the central organization. Especially where potential subordinates were formed before a new group exemption letter, forcing them to adopt fully uniform governing documents would be a more difficult “pitch” than making amendments sufficient to ensure affiliation and general supervision or control. A perception of unreasonable control by the central organization might discourage some organizations that otherwise would have been interested in and benefitted from participating in the group. Given the efficiency and reduction in administrative burden that are the objects of group exemptions in the first place, discouraging participation brings disadvantages for the potential subordinate, the central organization, and the Service.

b) Recommendation

We recommend that the Proposed Revenue Procedure, when finalized, not only keep the definitions of affiliation, general supervision, and control flexible enough to accommodate a wide range of religious and nonreligious governance structures, but also avoid uniformity requirements that implicitly impose a degree of top-down control beyond what is necessary for proper oversight by central organizations.

B. Information Obtained and Reviewed by Central Organization

1. General Information Requirements

a) Background

The Proposed Revenue Procedure states that “general supervision” exists if the central organization “annually obtains, reviews, and retains information on the subordinate organization's finances, activities, and compliance with annual filing requirements.”³¹ Specificity as to the information that must be provided is especially important if the Service continues to take the position that failure to obtain required information with respect to even one subordinate can be enough to revoke a group ruling³² (although we recommend further below that the Service not take such an approach).³³

b) Recommendations

For subordinate organizations that file a Form 990 themselves, we recommend that the Proposed Revenue Procedure, when finalized, treat general supervision as existing if the subordinate organization provides a copy of that Form 990 (as filed) to the parent organization, or to an intermediate-level organization in the hierarchy, for further review and aggregate reporting up the chain. For those that qualify to file the Form 990-N, we recommend that the Proposed Revenue Procedure, when finalized, treat general supervision as existing if the subordinate organization provides a certification that it qualified to file, and actually did file, the Form 990-N. After all, if Congress concluded that Form 990-N provides enough information to the Service to verify continuing qualification for exemption for unaffiliated organizations up to a given size,³⁴ logically it should be enough for central organizations effectively standing in the shoes of the Service in terms of monitoring their similarly small subordinates for the same purpose.

We believe that, in general, the data required to be provided to a central organization by a subordinate organization in order to complete the group return should be enough to satisfy the general supervision requirement. However, if more is needed, we recommend that the Proposed Revenue Procedure, when finalized, require subordinate organizations described in section 170(b)(1)(A)(vi) or section 509(a)(2) to provide a computation of their individual public support percentage similar to the one in Schedule A of the Form 990.³⁵ Public support figures computed on an aggregate basis across subordinates have little relevance to whether each individual organization continues to qualify as a public charity. We recommend that subordinates below the 33-1/3% threshold also be required to provide the central organization with a brief explanation of why they still qualify as a public charity under the facts-and-circumstances test.

For subordinate organizations such as integrated auxiliaries that otherwise would not have a filing obligation, we also recommend that the Proposed Revenue Procedure, when finalized, require some collection of information, but not as much as the full Form 990 would require. We believe that providing the following information to the central organization (or to an intermediate entity to be collected and summarized) should be sufficient:

• Summary information on total income, expenses, assets, and liabilities (not necessarily audited financial statements).

• For section 170(b)(1)(A)(vi) and 509(a)(2) organizations, the public support percentage for the five-year period ending with the most recently completed tax year or the previous tax year showing that the relevant public support test was satisfied and an explanation, if necessary, of how the facts-and-circumstances test was met.

• A brief description of the organization's major activities (similar to the explanation in Part III of the 990, without requiring breakdowns of expenditures between major program areas).

• A statement of the amount of political campaign intervention expense, lobbying expense, and unrelated business revenue, if any, together with a description of the corresponding activities and a copy of any Form 990-T or 1120-POL filed.

• A certification that the organization has complied with the conditions of its exempt status and has not engaged in any activity subject to tax on Form 4720 (or a description of any exceptions, and a copy of any Form 4720 filed).

• Information about any change of name or address and other items required to be reported on the annual Supplemental Group Ruling Information (“SGRI”).

Unless otherwise noted, we recommend that the Proposed Revenue Procedure, when finalized, require the central organization to collect required information with respect to the most recently completed tax year in order to ensure sufficient time for financial statements to be prepared. Even with respect to changes to be reported as part of the SGRI submission, we do not believe that up-to-the-minute accuracy is possible or necessary. Multiple-level hierarchies will require some time to gather information at the local level, apply appropriate quality controls, and filter it up to the top. Thus, we recommend that the Revenue Procedure allow the submission of SGRI data based on local data up to four months old.

Furthermore, we recommend that the Proposed Revenue Procedure, when finalized, allow central organizations flexibility in delegating responsibility for collecting, reviewing, and retaining the information provided by subordinates. In some cases, the central organization might collect and retain the raw data from all of its subordinates and review that raw data itself. In other cases, it might train intermediate organizations to review and retain the information provided by lower tier organizations and only report a summary of that information further up the chain. However, we recommend that the central organization be required to explain in the group application how relevant information will be collected and preserved, by whom, and following what quality assurance protocols, and that it update this explanation in its annual SGRI submission. If intermediate organizations are involved in the review process, we recommend that the Proposed Revenue Procedure, when finalized, require the central organization to provide reasonably necessary training to enable those organizations to fill their role effectively, and include a description of that training in the description of the information collection process.

Finally, we recommend that the Proposed Revenue Procedure, when finalized, specify how long information collected from subordinates needs to be retained. In our experience, a four-year period of time is typical, because it normally allows the information to be available until the end of the normal three-year statute of limitations applicable to most tax returns.

2. Information About Maintaining Exempt Status from a Central Organization

a) Background

The Proposed Revenue Procedure states that general supervision by a central organization includes providing written information or other education “about the requirements to maintain tax-exempt status under the appropriate paragraph of section 501(c), including annual filing requirements.”³⁶ As noted above, specificity as to the information that must be provided is especially important if the Service continues to take the position that failure to obtain required information with respect to even one subordinate can be enough to revoke a group ruling.

b) Recommendations

With respect to the annual filing requirements, we recommend that the Proposed Revenue Procedure, when finalized, treat an annual reminder of the normal and extended due dates for the Form 990, and the standards for determining which 990-series form must be filed, as adequate.

With respect to other requirements for maintaining tax exemption, creating a single standard is more difficult, as different subordinates might have different challenges. One subordinate might be in danger of engaging in too much lobbying activity, while another's biggest risk might be failing to meet the public support test and becoming a private foundation. Central organizations could provide lengthy materials covering all potential compliance risks to each and every subordinate, such as a copy of Publication 557, “Tax-Exempt Status for Your Organization,” but that approach would fail to take advantage of the intimate knowledge that central organizations should have about their subordinates on which group exemption is premised. We believe that erring on the side of completeness in this way would be less effective than more tailored content. Local volunteers running local chapters on limited time could be burdened by having to wade through a comprehensive treatise to find the applicable or useful portions, rather than being encouraged to look to the central organization for assistance.

Accordingly, we recommend that the Proposed Revenue Procedure, when finalized, offer guidance but give central organizations reasonable discretion in deciding how to balance completeness with accessibility. Thus, we recommend that the Revenue Procedure explicitly state that this requirement will be met if every subordinate is given access to one educational event or one written message about compliance annually, as long as the central organization reasonably believes the content of that event or message is reasonably complete with respect to the specific needs of the recipient subordinate for maintaining its tax-exempt status. If, as we recommend, a group continues to be allowed to include members having different public charity classifications, we further recommend that the Revenue Procedure require the central organization to provide information specific to maintaining that public charity classification to the subordinates.

Furthermore, we recommend that the Proposed Revenue Procedure, when finalized, state explicitly that the educational material may be provided on the central organization's website, as long as the filing reminders sent to the subordinates link or refer them to the educational content on the website. We also recommend that the Revenue Procedure permit central organizations to provide the required information to subordinates through linking to Service guidance or other third-party resources.

Finally, as in the case of information gathering, we recommend that the Proposed Revenue Procedure, when finalized, allow central organizations to provide the relevant education indirectly through intermediate-level organizations as well as directly.

If the Service deems it necessary, the Proposed Revenue Procedure, when finalized, could require the central organization to explain in the initial group application, updated from time to time in the SGRI when necessary, what steps it takes to make sure that all subordinates, directly or indirectly, receive appropriate information.

C. Minimum Number of Subordinates Requirements

1. Background

In the many decades of group exemptions, the Service never has required a central organization to have a set number of subordinates in order to obtain or maintain a group ruling. The Proposed Revenue Procedure would introduce two new threshold requirements: It would require a central organization to have at least five subordinates in order to obtain a group ruling, and one subordinate in order to maintain the group ruling.³⁷ Organizations, however, historically have sought group rulings with as few subordinates as possible for a number of important practical and legal reasons.

Section 10.02 of the Proposed Revenue Procedure says that the effective date of exemption for subordinates transitioning from a prior group ruling that were not included in the initial group application, i.e., are subsequent additions to the group ruling, will be the same as before their addition to the second group exemption letter. Section 10.01 of the Proposed Revenue Procedure contains no similar statement for subordinates transitioning from a prior group ruling or individual exemption that were included in the initial group application.

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, either eliminate the minimum-number-of-subordinates requirement or lower the minimum number of subordinates to obtain a group ruling to three.

If the minimum-number-of-subordinates requirement is not eliminated, then, whether the minimum number required to obtain a group ruling remains at five or is lowered to three, we recommend that the Proposed Revenue Procedure, when finalized, allow a central organization to submit a group ruling application that provides the requisite corporate and operational information for at least the minimum number subordinates, together with attestations that the subordinates will transition over to the group ruling within the next taxable year following approval of the group ruling.

Finally, we recommend that Section 10.01 of the Proposed Revenue Procedure, when finalized, include a rule regarding the effective date of exemption for subordinates included in the initial group application that parallels the rule in Section 10.02 for subordinates subsequently added to the group ruling.

The reasons for our recommendations are set forth separately below.

a) Elimination of Requirement

We believe that the minimum-number-of-subordinates requirement would discourage the use of group exemptions, by increasing the difficulty that central organizations already face in recruiting subordinates to participate in group applications, which would have deleterious effects on both the Service and the community of exempt organizations.

First, a subordinate organization considering joining a group application must be willing to subject itself to the control and supervision of the central organization. Convincing an organization to do that in exchange for an exemption that is not certain to be approved can be difficult, and requiring five or even three such organizations might be an insurmountable hurdle for some central organizations, especially central organizations that are themselves new and waiting for recognition of their own exemptions. This obstacle would exist even though a group exemption might well be appropriate and efficient for both the exempt organizations and the Service.

Second, a subordinate organization considering joining a group application must be willing to put up with an extended period of time — until the group exemption is approved — during which its own tax exemption is uncertain. In the case of a newly formed organization, its exempt status will be granted retroactively, either to the date it was formed if the exemption application is filed within 27 months of that date or to the date the application is filed if it is filed more than 27 months after that date. But during the pendency of the application, the subordinate cannot provide evidence of its tax-exempt status. While a newly formed organization has the same risk when it applies for an individual exemption, the risk is greater when it participates in a group exemption application because it takes longer for a central organization to assemble, and for the Service to review, such an application.

Existing organizations can have the same problem. It is quite common, as part of restructures or for other organizational reasons, for a new group application to include one or more proposed subordinates that already are exempt under a separate group ruling. If a new subordinate currently is exempt under another group ruling, that organization must affirmatively withdraw from its current group ruling before joining the new group ruling.³⁸ If the subordinate will be included as one of the five organizations in the central organization's initial group application, that withdrawal must occur before submission of the new group application to the Service.³⁹

This withdrawal requirement creates a challenging transition period for subordinates with current operations because essentially they are operating without tax-exempt status from the date that they notify the prior central organization that they are leaving its group ruling until the date the new group application is approved (assuming it is approved). In our experience, this transition period can, and has, negatively impacted subordinates' grant and fundraising opportunities, state tax exemptions, charitable solicitation registrations, and other qualifications requiring proof of exempt status. While a subordinate's exempt status will be granted retroactively to the date it applied if and when the new group application is approved, during the pendency of the application, the subordinate — like a newly formed subordinate — cannot provide evidence of its tax-exempt status.

For these reasons, central organizations usually apply with as few subordinates as possible, and subordinates that are a part of a prior group ruling usually prefer to wait until a group ruling is secured before transitioning from one group to another. Requiring five or even three subordinates to be included in the group's initial application would expose more organizations to this problematic transition issue.

b) Lowering of Minimum Number of Subordinates to Three

We believe that reducing the minimum number of subordinates to three would be less likely to discourage the use of group exemptions than leaving it at five. Making this change would continue to require a central organization to be viable enough to have multiple subordinates and to eliminate most cases in which a group has so few affiliates that processing a group application is inefficient for the Service. Over 25% of all groups on the Service's records today have two or fewer subordinates, and thus would fail to meet the lower threshold of three subordinates; only an additional 11% have three or four subordinates.⁴⁰ Assuming that existing group exemptions are representative of new applicants in this respect, the lower threshold would continue to screen out 70% of the groups that would be screened out by a higher threshold of five.⁴¹

Requiring a high number of subordinates to obtain an initial group exemption also would run counter to the natural progression of organizational growth, which is from small numbers of subordinates to increasingly large numbers. Starting a new venture requires significant resources and, most of all, time to reach viability. Other Code provisions applicable to exempt organizations provide generous start-up periods. For example, the public support test allows a five-year start-up period.⁴² Requiring a lower number of subordinates effectively would create a similar start-up period for organizations seeking group exemption.

c) Effective Date Considerations

We also believe it would be helpful for Section 10.01 of the Proposed Revenue Procedure to clarify that the effective date of exemption for a subordinate included in the initial group application that is transitioning from a prior group ruling or individual exemption will be the same as before its initial inclusion in a group application.

D. Section 501(c) Matching Requirements

1. Background

The Proposed Revenue Procedure introduces a new requirement that subordinates in a group ruling must be described in the same paragraph of section 501(c) as the central organization.⁴³ This proposal would tighten the “matching requirements” of Revenue Procedure 80-27, which require all subordinates to be in the same paragraph as each other, but do not require them to be in the same paragraph as the central organization.⁴⁴

Although Revenue Procedure 80-27 requires all subordinates to be in the same paragraph as each other, it does not prohibit a central organization from holding more than one group exemption, each of which covers a group of subordinates in the same paragraph as each other, but in a different paragraph from subordinates in another group exemption. The Proposed Revenue Procedure would prohibit this practice, as well.

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, preserve the ability of a central organization to have subordinates falling under a different paragraph of section 501(c) than the central organization. We also recommend that it preserve the effective ability of a central organization to have subordinates falling under different paragraphs than each other, either by eliminating the one-paragraph requirement altogether or by permitting a central organization to hold multiple rulings.⁴⁵

We believe that instead of adopting the proposed rule, the Service could make the user fee higher for a group ruling that would allow for subordinates under multiple paragraphs of section 501(c), and could require as a condition of such a ruling that the central organization clearly spell out the characteristics of subordinates under each paragraph of section 501(c).

The reasons for our recommendations are set forth separately below.

a) Differences Between the Central Organization and its Subordinates

The standards of Revenue Procedure 80-27 are in harmony with the regulations governing group returns, which explicitly allow a central organization to file a group return for subordinates described in a different paragraph of section 501(c) than the central organization.⁴⁶ Changing the standards for group exemptions would create inconsistency between the standards for group rulings and for group returns. We recommend keeping these standards aligned.

b) Differences Among Subordinates

According to Service records in the EO Master File, the “same paragraph of section 501(c)” requirement would represent a change for a large number of organizations. Currently, nearly 400 groups covering almost 140,000 subordinates (almost one-third of all subordinates under group rulings) are listed as having members violating this requirement.⁴⁷ Of these, approximately 35 groups with approximately 1,380 members are groups in which all subordinates share a single paragraph different from that of the central organization, as permitted by Revenue Procedure 80-27.⁴⁸ Under the proposed grandfather rules, these latter groups would be allowed to continue to exist, but would not be allowed to add new subordinates.⁴⁹

We believe this result is not warranted. The difference in classification between the central organizations and their subordinates in these cases often reflects a natural differentiation of function in pursuit of the same overarching goals. For example, a group of social clubs under section 501(c)(7) devoted to a particular hobby might have a parent organization described in section 501(c)(3) devoted to educating about that hobby. Similarly, a number of groups of section 501(c)(6) trade associations or section 501(c)(4) advocacy organizations have section 501(c)(3) central organizations focusing on charitable activities of the group. A group of credit unions described in section 501(c)(14) might have a parent that is a trade association described in section 501(c)(6). (Indeed, it is not clear that such an association of credit unions could itself qualify as a credit union, so it might be impossible to have a separate credit union central organization described in the same paragraph of section 501(c) as its subordinates.) We see no compelling reason to discourage these kinds of groups by preventing them from obtaining group exemptions.

In most existing cases that would violate the new rule, the central organization has subordinates falling under two paragraphs of section 501(c), and a number of groups have subordinates in several different paragraphs.⁵⁰ Thus, a large number of organizations are in groups that currently violate both the rule of the Proposed Revenue Procedure and the more liberal rule of Revenue Procedure 80-27. For example, a veterans' organization might have several local posts described in section 501(c)(19), a few charitable affiliates, and one or more section 501(c)(7) subordinates managing social facilities for members. Groups of fraternal organizations sometimes have a central organization described in section 501(c)(8) (fraternal organizations providing certain member benefits) and subordinates described in section 501(c)(10) (fraternal organizations engaging in charitable activities) or vice versa, or a mix of subordinates of each type depending on the focus of local chapters. Advocacy organizations might have some subordinates significantly involved in legislative matters and described in section 501(c)(4), and others focused on non-legislative advocacy under section 501(c)(3).

Under the Proposed Revenue Procedure, these diverse groups would have to remove subordinates so that all remaining subordinates would be covered by the same paragraph of section 501(c). (Even then, if the central organization were covered by a different paragraph, the group would be prohibited from adding new members.)

In cases like the foregoing, many aspects of the subordinates' operation would be similar across the entire group, and subordinates under each paragraph often would be especially similar. Allowing affiliates under different paragraphs to participate in a group exemption would still yield substantial efficiencies for the Service and for the exempt organizations, as compared with each subordinate under a different paragraph from the central organization applying for exemption individually. Reviewing the operations of each type of subordinate in one application would often be more efficient for the Service because the operation of each type of subordinate would be best understood in the context of the operations of the overall group.

Furthermore, just as in the case of the foundation-classification requirement discussed below,⁵² we believe that requiring a central organization to follow two different sets of rules with respect to subordinates under the group ruling and affiliates that are excluded would lead to confusion and error. This in turn would likely create more administrative burden for the Service. Having a larger number of ancillary organizations outside the group ruling would also decrease transparency by making the list of subordinates in the group exemption less reflective of the complete set of organizations affiliated with the central organization.

In many cases, the group might seek to obtain separate group rulings for subordinates under each relevant paragraph of section 501(c), each overseen by one of the organizations in that group. As the chart above shows, there are thousands of groups that would have enough subordinates of a second type that they could seek a separate group ruling for the new subordinates. This would be a significant burden on the Service's scarce resources, and the net effect would simply be to replace one group ruling having diverse subordinates with several group rulings each held by a different organization in the group. That, in turn, will disperse accountability for general supervision over subordinates, increase confusion and filing errors, and make it harder to assemble information about the overall group. We recognize that the Service has legitimate concerns with a central organization that decides to include subordinates under a paragraph of section 501(c) that was not addressed in its group application. However, if the nature of the subordinates is properly disclosed in a group application, we do not see any compelling reason why a central organization described in one paragraph could not exercise adequate oversight over subordinates within the group described in multiple paragraphs of section 501(c).

E. Same NTEE Code Requirement

1. Background

The Proposed Revenue Procedure requires that subordinate organizations described in section 501(c) other than section 501(c)(3) to be described by the same three-character NTEE code.⁵³ The Notice states that this requirement is meant to “facilitate the central organization's exercise of general supervision or control and reduce the administrative burden of the group exemption letter program.”

2. Recommendation

We recommend that the Proposed Revenue Procedure, when finalized, not include the same-NTEE code requirement.

We believe that the new requirement would create a number of new difficulties in administering the program. Many groups segregate different functions into different entities. Those functions often are in service of a common overarching purpose, which the central organization is well-suited to oversee. However, NTEE codes identify not only the purpose of an organization but its principal activity. Thus, many times differentiation in function will cause different subordinates to have different NTEE codes. For instance, within each general NTEE purpose category (designated by the first letter of the code), there are a variety of subclassifications. Several of these reference the type of support role that an entity plays relative to other organizations. For instance, there are separate codes within each general-purpose category for organizations that:

• support or fundraise for a single entity (codes ending in “11”);

• support or fundraise for multiple entities (codes ending in “12”);

• provide other kinds of support (codes ending in “19”);

• provide management to other entities (codes ending in “02”);

• serve as an association of other entities within the general issue area (codes ending in “03”); and

• focus on influencing policy within the general-purpose category (codes ending in “01”).⁵⁴

As a result, almost any affiliate serving any of these discrete functions in support of a larger group's activities would not be able to be included with subordinates furthering the general purpose in other ways. This might mean, for example, that middle-level organizations assisting local branches could not be in the same group with the subordinates they support. Similarly, a separate corporation holding liability reserves or managing employee benefit plans for group members likely would not have the same code as the subordinates it supports. In many cases, such support operations start out within another entity, and then are parsed into separate corporations for liability protection or similar purposes. The proposed rule would push central organizations to avoid moving supporting operations into separate corporations, because doing so would affect eligibility for inclusion in the group. We believe there is no compelling reason for discouraging such movements.

In many cases, organizations working in a particular issue area might have activities falling into any of several potential NTEE codes or falling only into general catchall codes. Some codes are designed to overlap with others, or to capture small differences in focus. For instance, in the civil rights area, code R20 designates a “civil rights” organization generally, while code R22 is more specifically for minority rights, R23 for disabled persons' rights, and R24 for women's rights; R21 is an experimental code for immigration rights. In addition, R01 might apply to organizations focusing on legislative or policy advocacy in any of these areas, and R99 is a catchall code for other civil rights and social action organizations for which there is no more specific code.⁵⁵ A central organization in the area of civil rights easily could have affiliates with programs fitting under each of these codes, and we see no reason why it could not exercise adequate supervision over each. Indeed, individual subordinates could work in multiple areas, making it a judgment call each year to determine which NTEE code best describes each subordinate each year. Such year-to-year changes could have immediate detrimental effects on the entire group. If even one existing subordinate's NTEE code were to change, it appears that no new organizations having the group's normal code could be added until the non-matching organization was removed, because no new organization could match the NTEE codes of all of its fellow subordinates.⁵⁶ Requiring separate group exemptions for each NTEE code could also result in more administrative burden for the Service, as many central organizations might need to operate several different group exemptions and move their subordinates between them.

As the examples above demonstrate, NTEE codes offer more differentiation for common types of organization, whereas less common activities are more likely to fall into broader catchall categories. As a result, the Proposed Revenue Procedure inadvertently requires groups working in commonly occurring fields to stay within a very narrow band of activity, whereas groups working in less common areas can have subordinates conducting a considerably more diverse range of activities, all of which fit under a general catchall NTEE code. We recommend against adopting a rule that generates this kind of difference between groups. We also are concerned that the rule in the Proposed Revenue Procedure would create pressure for subordinates to describe their activities using the most general codes possible, making NTEE reporting less useful from a statistical and information-gathering perspective.

F. Foundation-Classification Requirement

1. Background

The Proposed Revenue Procedure introduces a new requirement that all subordinate organizations in a group ruling described in section 501(c)(3) must have the same foundation classification under section 509(a).⁵⁷ However, it treats any subclassification under section 509(a)(1), and all section 509(a)(2) organizations, as falling within the same foundation classification.⁵⁸

2. Recommendation

We recommend that the Proposed Revenue Procedure, when finalized, either (1) delete the foundation-classification requirement in its entirety or (2) treat Type I and Type II supporting organizations as falling within the same foundation classification as organizations described in section 509(a)(1) and (a)(2).

We believe that allowing a single group ruling that includes both supporting organizations and supported organizations would increase transparency to both the Service and the public at large. It also would reduce administrative burdens on the central organization and its subordinates, as well as easing ongoing compliance at all levels. The central organization would not have to track significant numbers of affiliates that are not a part of any group ruling or are tracked in a separate group ruling managed by another legal entity. Moreover, all of the subordinates in group rulings (unless otherwise exempt) would provide annual reporting to the Service of their foundation classification on the Forms 990 and 990-EZ.

Our concerns about the foundation-classification requirement are set forth separately below.

The exceptions in the Proposed Revenue Procedure from the new foundation rule for section 509(a)(1) and (a)(2) classifications would allow a single group ruling to continue to accept subordinate organizations classified as any of the following types of public charities:

• churches and associations of churches;

• schools;

• hospitals;

• medical research organizations;

• agricultural research organizations;

• section 170(b)(1)(a)(vi) organizations; and

• section 509(a)(2) organizations.

These exceptions would protect the traditional operations of a great many group rulings — particularly in the religious community — that include subordinates operating under different foundation classifications. However, without further modifications one effect of this new foundation rule in practice would be to exclude Type I and Type II supporting organizations under section 509(a)(3). According to publicly available EO Master File data, nearly 70 groups including some 33,500 organizations would be in violation of this rule.⁵⁹ However, we are aware anecdotally that in many cases the EO Master File data regarding church groups is inaccurate, counting various entities as churches described in section 509(a)(1) when they are in fact supporting organizations described in section 509(a)(3). If so, many more groups and subordinates would be affected by this rule.

The Notice explains the rationale for the same foundation-classification requirement as follows:

Traditionally, IRS electronic databases have not systemically tracked multiple foundation classifications in connection with a particular group exemption letter. This limitation reduces transparency, complicates compliance, and increases the administrative burden because different foundation classifications have different requirements.⁶⁰

However, we are not aware of any evidence that maintaining different foundation classifications under 509(a) in a single group ruling would complicate compliance.

The proposed rule would permit a central organization to oversee nearly every foundation classification in one group ruling, except Type I and Type II supporting organizations. Yet to us the compliance requirements for Type I or Type II supporting organizations do not seem uniquely more challenging than the other foundation classifications (such as the public support calculations under section 509(a)(1) and (a)(2) and the operational tests for churches, hospitals, schools, or medical and research organizations). For many volunteers, the supporting organization rules are easier to understand and pose significantly less compliance risk on an annual basis than the rules for some of the other public charity statuses. We do not believe that excluding these particular categories of organizations from a group ruling would improve compliance. In fact, as detailed in two examples below, we suggest that the proposed rule would increase compliance problems significantly.

a) Example One: Property-Holding Type I Supporting Organizations

Many churches, hospitals, schools, and other charities with direct charitable programs use a multi-entity structure in which a Type I supporting organization serves as a controlled subsidiary to separately hold and maintain real property or other assets for risk-management purposes. These groups often operate programs that carry the potential for significant civil liability, and this structure offers important legal protection from flow-through liabilities. We see this use of supporting organizations within group rulings frequently.

Under the proposed rule, these supporting organizations no longer could be included on the same group ruling as the supported organizations. If, as we recommend, a central organization were permitted to maintain more than one group ruling letter, a second group ruling could cover its supporting organizations, leaving all other types of public charities on the first group ruling. However, the Proposed Revenue Procedure specifically prohibits the maintenance of more than one group exemption letter by a central organization, so this approach would not be available if the Proposed Revenue Procedure was adopted as presented.⁶¹

Although these supporting organizations no longer would qualify for the single group ruling under the Proposed Revenue Procedure, they still would carry out an important function for the group and therefore still would need to exist as affiliates of the central organization. They also most likely would be subject to the central organization's supervision or control because they support its subordinates. Accordingly, under the Proposed Revenue Procedure, a central organization would need to develop and maintain at least two different administrative systems: (1) a system for the supported organizations that qualify as subordinates under section 509(a)(1) or (a)(2); and (2) a system for affiliated supporting organizations that now must be recognized independently for tax-exempt status.

This bifurcation into two regimes, one for supporting organizations and another for supported organizations, likely would create confusion and administrative burdens, not only for the central organization, but for volunteers who serve on the boards of supporting organizations and supported organizations, and especially if one individual serves on boards of both types, a not infrequent occurrence. The supported organization might file as part of the group return, provide reporting to meet the supervision requirement, and use the group ruling to demonstrate its exempt status. Meanwhile, the supporting organization would be required to secure its exempt status by filing Form 1023, rely on a determination letter, not include the Group Exemption Number (“GEN”) on its Form 990, and not provide reporting or revisions to meet the supervision requirement to the central organization. For volunteer boards and a central organization overseeing thousands of subordinates, these distinctions likely would create a host of ongoing filing and reporting errors, increase financial costs, require the development and implementation of educational initiatives, and place new administrative burdens on central organizations now tasked with the need to monitor and address these classification distinctions.

For the general public, excluding supporting organizations from the main group ruling means the list of subordinates no longer would provide a complete and accurate overview of the entire organizational system. Supporting organizations that are not part of the group ruling cannot use the GEN. The GEN, which is disclosed on page one of Forms 990 and 990-EZ, offers a helpful tool for the public and regulators when searching the EO Masterfile for identifying entities affiliated with the central organization. In short, an unintended consequence of excluding supporting organizations from group rulings would be a significant loss of transparency in public records.

For group rulings that include church subordinates, supporting organizations organized as property-holding entities or serving other supporting functions usually will qualify as integrated auxiliaries. While not required to file for exemption under section 508, such supporting organizations typically apply for inclusion on the group ruling and are listed as subordinates on the group ruling. Such inclusion increases transparency by providing a more complete and accurate record of the exempt organizations operating in the group. Under the proposed rule, however, these church-related Type I and Type II supporting organizations likely would operate without any notice to or connections with the Service at all.

b) Example Two: Group Rulings for Multi-Tiered Organizations

Many charitable, educational, and religious organizations that hold group rulings operate nationwide to accomplish charitable, educational, or religious purposes under section 501(c)(3). These groups often include multiple levels of subordinates organized geographically. For example, a national organization might be the central organization holding the group ruling. Under the national organization might be four or more regional subordinates, which are then broken into dozens of sub-regions or state-level subordinates. Each state subordinate might then be broken into lower-level regional subordinates and then below that into local subordinates that operate in a city, municipality, or community.

Often, fundraising and direct charitable programs do not exist at every level of such a multi-tiered structure. In fact, these activities might be restricted intentionally to the top or lowest levels so that middle levels do not unintentionally usurp or conflict with the groups they are organized to support. The middle-level subordinates instead share resources, provide continuity in leadership and governance, or serve other support purposes. Because these middle-level subordinates do not directly conduct fundraising or charitable services that meet the public support tests under section 509(a)(1) or (a)(2), they often qualify only as Type I or Type II supporting organizations. That is, their purpose is to support the subordinates directly below (as a Type II supporting organization) or above (as a Type I supporting organization) them.

Under the proposed new foundation rule, any middle-level subordinates that qualified only as Type I and Type II supporting organizations would be prevented from joining the central organization's group ruling. Yet these supporting organizations, like the property-holding entities in the prior example, generally are governed by the same volunteer leaders as the supported organizations (typically on some representative basis) and serve a critical governance and support role in the group. Thus, their exclusion from the central organization's group ruling would add another layer of complexity. Volunteers would be required to understand and comply with two distinct tax exemption systems — operating within a group ruling, independently, or even both at the same time — depending on which level(s) of the national organization at which they served. The costs associated with implementing this system also would be significant.

G. Central Organization Maintaining More Than One Group Ruling

1. Background

The Proposed Revenue Procedure would allow a central organization to maintain only one group exemption letter.⁶²

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, not include the one-group-exemption requirement. We believe that it would create significant administrative burdens on all sides, and decrease transparency, without any significant corresponding benefits.

This proposed rule would affect directly, and be affected directly by, the section 501(c) paragraph, similar purpose, foundation-classification, and uniform-governing-instrument requirements in the Proposed Revenue Procedure (each covered separately at Sections III.D, III.E, III.F, and III.H in these Comments). If these rules were broadened to provide more flexibility for a central organization's inclusion of subordinates, limiting a central organization to a single group ruling would pose a smaller problem for fewer central organizations.

If, on the other hand, the foundation-classification requirement and the uniform-governing-instrument requirement, in particular, were not broadened significantly, dropping the single ruling limit would become urgent. Consider, for example, a central organization that included Type I or Type II supporting organizations as part of its overarching affiliation structure. Under the foundation-classification rule, the central organization would not be able to do so in its single group ruling. On the other hand, if the entity could maintain more than one group ruling, it could secure a separate group ruling for all such supporting organizations, without having to change fundamentally the nature of its existing affiliation, supervisory, or control relationships to them. While more work than a single group ruling under which all foundation classifications are permitted, allowing more than one group ruling nonetheless would be preferable to either having to seek and maintain independent exemption for each supporting organization, or creating a new entity for the sole purpose of holding a second group exemption letter for supporting organizations.

H. Uniform-Governing-Instrument Requirement

1. Background

The Proposed Revenue Procedure would introduce a new requirement both for initial inclusion in or subsequent addition to a group exemption letter, one that it refers to as the “uniform governing instrument” requirement.⁶³ The Notice asserts that “governing instruments that are not uniform are not consistent with the similar purpose requirement.”⁶⁴

Currently Revenue Procedure 80-27 requires a central organization to provide a sample copy of a uniform governing instrument (charter, trust indenture, articles of association, etc.) adopted by the subordinates, or, in the absence of a uniform governing instrument, copies of representative instruments.⁶⁵ Section 3.03(2)(d) of the Proposed Revenue Procedure would eliminate the option of submitting copies of representative instruments and instead require all subordinate organizations to adopt a uniform governing instrument. While, like Revenue Procedure 80-27, the Proposed Revenue Procedure lists as examples of a uniform governing instrument a charter, trust indenture, or articles of association, it provides no further definition of the phrase “uniform governing instrument.”⁶⁶

The Proposed Revenue Procedure would provide a limited exception to the uniform-governing-instrument requirement for section 501(c)(3) groups, allowing the governing instruments of subordinate organizations described in section 501(c)(3) to describe different purposes.⁶⁷ It would require that if a group exemption letter includes subordinate organizations described in section 501(c)(3) with different purposes, the governing instrument describing each distinct purpose must be a uniform governing instrument.⁶⁸ For example, “all the subordinate organizations that are schools must adopt a uniform governing instrument describing their educational purpose and all the subordinate organizations that are hospitals must adopt a uniform governing instrument describing their charitable purpose.”⁶⁹

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, either eliminate the uniform-governing-instrument requirement or ease it and define its reach more precisely. The reasons for our recommendations are set forth separately below.

a) Elimination of Requirement

(1) Variations of Subsidiaries in Affiliate Structures

(a) Variations in Functions

As elaborated in other sections of these Comments, group exemptions cover entities playing a range of different functions in relation to the group's overarching purposes. A group of affiliated entities could include operating entities, title-holding entities, investment vehicles, administrative entities, district-level versus chapter-level entities, etc. We do not believe that it is realistic to expect every subordinate at every level of the affiliated structure to have the same governing instrument when their functions might be so different. In addition, subordinates in a group exemption often are distinguished by the geographic region they serve, and the governing instrument typically names the geographic region.

(b) Variations in Legal Entity Type

The choice of legal entity for a subordinate might reflect its role, or be related to the law at the time it was formed, or its stage of development. For example, limited liability companies (“LLCs”) are now heavily favored for use as title holding entities for a number of reasons, but states began allowing the formation of LLCs at different times. What was available at the time of a subordinate's formation might have dictated the choice of entity as well as its function. In states that permit corporations sole for church denominations, a corporation sole might hold title to certain properties instead of an LLC, but corporations sole also commonly are operating entities. Entities with complex or liability-generating operations, such as hospitals and schools, are typically formed as corporations. Small chapters in a ruling, without real estate of their own, might be formed as unincorporated associations, which require the least expense and formality to create, but provide less protection for principals. As a chapter grows in activities or assets, it might determine incorporation would be prudent and convert from unincorporated association status.

State law requirements regarding the formational document for each type of entity differ. Imposing uniformity beyond the purpose clause would be tantamount to the Service dictating that all subordinates must be the same type of legal entity, regardless of the fact that different choices would better fit their roles or stage of development or history.

(2) Variations in State Entity Laws

For groups that operate in many different states, variations in state corporate and tax laws also come into play, affecting choice of entity (as discussed above) and dictating differences in formational documents by state. For example, different states have more or less robust unincorporated association statutes, which in turn might make that legal entity choice more or less attractive.⁷⁰ States differ as well in how they tax various entities.⁷¹ These state differences affect choice of entity.

In many cases, the preferred choice of legal entity is a corporation. However, each state has its own statutory provisions for corporations, and these differences directly implicate the formational document, for example mandating that certain statements appear verbatim to incorporate in that state. (These differences proliferate rapidly if secondary governing documents are considered, providing another reason to apply any uniformity requirement only to the formational document.⁷²) Delaware requires voting members,⁷³ while California does not.⁷⁴ For a corporation that does have voting members, California provides extensive member rights that are not tracked in Delaware law.⁷⁵ Each state has different laws regarding indemnification,⁷⁶ which typically appear in the government instruments. Each state has different rules for whether members versus directors need to approve articles and bylaws amendments.⁷⁷

As a result of this lack of uniformity in state corporate and legal entity laws across the country, even if a central organization were in a position to require that every subordinate in a group ruling had to be the same type of entity, say a corporation, a strict uniformity rule essentially would require that every subordinate incorporate in the same state. That is a heavy, and perhaps unintentional, burden for the group exemption rules to impose.

Because of different functions, different choices of legal entities, and different state law statutory provisions, a group of affiliated entities could justifiably have large variations in many aspects of their governance instruments. We urge the Service to ensure that any uniform-governing-instrument requirement permit for these important choices and variations, and formation in multiple states.

(3) Addressing the Service's Goals While Permitting Necessary Variations

(a) Purpose Alignment

While the Notice links the uniform-governing-instrument requirement to implementing the similar-purpose requirement,⁷⁸ we think this premise is questionable: Similar purposes simply do not require uniform governing instruments. For example, hospitals' governing instruments vary widely, displaying little uniformity beyond describing themselves as hospitals. That variation — that lack of uniformity — does not prevent them from all sharing similar hospital purposes.

At the same time, we agree that a uniformity requirement that focused only on key purpose provisions in governing instruments could support the similar purposes requirement without placing an unreasonable burden on subordinates. For example, the final Revenue Procedure could require a certain degree of uniformity in the purpose statement in each subordinate's formational document. For section 501(c)(3) group rulings, subordinates could be divided into subgroups according to purpose, and each subgroup could be required to share a degree of uniformity in their purpose statements. However, even among entities with “uniform” purposes, such as hospitals, schools, or title-holding entities, we believe that appropriate differences should be permitted.

(b) Uniformity in Affiliation, Supervision, and Control

To some extent, the uniform-governing-instrument requirement could be used to reinforce the requirements of affiliation and either general supervision or control. These requirements are defined separately in the Proposed Revenue Procedure and discussed extensively in previous sections of these Comments.⁷⁹ Here we note that governing instruments often would not directly address affiliation⁸⁰ or general supervision⁸¹ at all; and, while control provisions⁸² typically would appear in governing instruments, there are many different ways to accomplish control. Provided that the requisite control is present, we do not believe that the Service needs to be concerned with the specific means of accomplishing it in the governing instruments. Therefore, we believe that the difficulties presented by uniformity requirements in the face of groups' variation weigh against the marginal benefit of using governing instrument uniformity for those purposes.

We also note that many portions of the governing instruments⁸³ would not bear on affiliation, general supervision, or control, and therefore any uniformity requirement directed at these concerns could focus much more narrowly on key provisions, such as the manner in which the governing board or similar body is appointed.

(c) Administrability

A stricter uniformity requirement could make group exemptions more administrable, by reducing the variations among different subordinates. We believe, however, that the requirements imposed on a central organization regarding its subordinate organizations and those on subordinate organizations seeking inclusion in a group ruling elsewhere in the Proposed Revenue Procedure would serve sufficiently to ensure administrability.⁸⁴

b) Clarification of Requirement

Neither the Proposed Revenue Procedure nor the Notice explains the meaning of uniformity in governing instruments. Under Revenue Procedure 80-27, these definitions were less important, because groups could rely on the more relaxed “representative instrument” standard. If the final Revenue Procedure retains this new uniformity requirement, the definitions become extremely important and, without further guidance, we believe problematic.

(1) Definition of “Governing Instrument”

Different types of legal entities have different governing instruments and sometimes more than one governing instrument, depending on state law. Corporations use articles of incorporation (or in Delaware a certificate of incorporation), but also address governance in bylaws. Unincorporated associations use articles of association. LLCs use articles of organization, and address governance in operating agreements. Corporations sole use articles of incorporation. The examples listed in section 3.03(2)(d) of the Proposed Revenue Procedure refer only to the fundamental organizational document that establishes or causes the formation of the legal entity, rather than secondary documents such as bylaws or an operating agreement that are typically more easily amended and address governance and other internal affairs. We recommend that the Revenue Procedure, when finalized, make explicit what is now implicit — that such secondary documents need not be uniform. One way to accomplish this recommendation would be to define “governing instrument” as the formational document creating or establishing the organization as a legal entity under applicable state law.

(2) Definition of “Uniform”

If the goal of uniformity is to ensure that the purpose language for the same types of entities are the same, we recommend that the Proposed Revenue Procedure, when finalized, apply the uniform-governing-instrument requirement only to certain key purpose provisions in each governing instrument. The current language of the Notice seems to imply a much broader definition.⁸⁵ It suggests that the governing instruments of all subsidiaries in a group ruling must have nearly identical governing instruments.⁸⁶ We believe that such a broad uniformity requirement would reach many provisions entirely unrelated to an entity's purposes. If it is retained, we recommend that the uniform-governing-instrument requirement apply only to certain key purpose provisions of governing instruments.

c) Coordination with Requirement that Central Organization Have Only One Group Ruling

As noted earlier,⁸⁷ if the final Revenue Procedure adopts stricter standards for uniformity in governing instruments, then allowing central organizations to have more than one group ruling gains in importance in order to manage a complex affiliate structure by at least allowing different groups of subordinates to adopt different uniform governing documents more tailored to their different needs.

I. Grandfather and Transition Rules

1. Background

The Proposed Revenue Procedure generally would apply all of its new requirements for subordinate organizations to preexisting subordinate organizations. However, Section 14.02(4)(b) would provide that (1) the definitions of “general supervision” or “control,” (2) the matching, foundation-classification, similar-purpose, and uniform-governing-instrument requirements, and (3) the limitation applicable to Type III supporting organizations, would not apply to them. Instead, definitions and rules similar to those contained in Rev. Proc. 80-27 would continue to apply.

The Proposed Revenue Procedure would impose its matching, foundation-classification, and NTEE-code requirements on all new subordinates of existing group rulings.⁸⁸

The Proposed Revenue Procedure generally would apply all of its new requirements immediately. However, section 14.02(2)(a) would provide that the requirements (1) that a central organization have at least one subordinate organization to maintain a group exemption letter and (2) that the central organization maintain only one group exemption letter would apply after a one year transition period.

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, expand its grandfather rule for preexisting subordinate organizations to include all of its new requirements for subordinate organizations. To the extent they are retained, we recommend that it require new subordinates to meet the section 501(c) matching, foundation-classification, and NTEE-code requirements with each other but not with preexisting subordinates, or require them to match with the plurality of preexisting subordinates, or with a category of pre-existing subordinate of their choice. We also recommend that an existing central organization be allowed to transfer its existing group rulings to a new central organization in the group, one that has the same section 501(c) subsection as the subordinates.

We recommend that the Proposed Revenue Procedure, when finalized, extend its one-year transition period for central organizations to comply with the one-subordinate-organization and the one-group-exemption requirement to a period of at least 36 months. We also recommend that it allow new subordinates to be added during the transition period.

The reasons for our recommendations are set forth separately below.

a) Grandfather Rule

As a result of the Proposed Revenue Procedure's new requirements for subordinate organizations, a potentially very large number of organizations would need to apply directly to the Service for recognition of tax-exempt status. Based on EO Master File data, the rule regarding matching among subordinates would require the immediate removal of at least 2,279 subordinates. Moreover, if a group wished to be able to continue to add members, it would need to remove any subordinates that did not comply with the rule regarding matching between subordinates and their central organization. There currently are over 11,200 subordinates that would need to be removed before all current groups could continue to add new subordinates.⁸⁹ These figures are based solely on the section 501(c) classification matching requirement. If other requirements such as the foundation-classification requirement or NTEE-code requirement were similarly interpreted to preclude adding new subordinates if the existing subordinates were not uniform, it could cause the removal of many thousands more.

As noted above, the Proposed Revenue Procedure would impose its matching, foundation-classification, and NTEE-code requirements on all new subordinates of existing group rulings. Each of these requirements uses very similar language requiring “all subordinates” in a group to share the applicable feature.⁹⁰ However, the Proposed Revenue Procedure seems to apply these requirements to new organizations in an inconsistent manner. In the case of the matching requirement, Example 1 of Section 14.03 appears to interpret the requirement to mean that each new subordinate must be in the same paragraph as the central organization and every existing subordinate (even those grandfathered subordinates that are not in the same subsection as the central organization).⁹¹ If so, this requirement could “freeze” a group exemption, because the diversity in classification of the existing subordinates in the group, although permissible for the existing subordinates, would preclude new subordinates from being able to match all pre-existing subordinates in a ruling.⁹²

On the other hand, Example 2 of Section 14.03 appears to interpret the foundation-classification requirement to require all new subordinates to share the same foundation classification with each other, but not with all grandfathered subordinates.⁹³ The Proposed Revenue Procedure does not provide an example of how preexisting subordinates' NTEE codes should affect the ability to add new subordinates.

We find the disparate results in these examples difficult to square with the stated rules, which apply each of these requirements equally to all new subordinates of existing central organizations. Explicitly providing that new subordinates must meet the matching, foundation-classification, and NTEE-code requirements (to the extent they are retained) with each other but not with preexisting subordinates, or with the plurality of preexisting subordinates, or with a category of pre-existing subordinate of their choice, would address this inconsistency and allow existing groups to continue to add members and function.

With respect to section 501(c) classification, the requirement to match both the central organization and at least some subordinates still could make it impossible to add new subordinates in some cases. We estimate that almost 400 groups, covering approximately 140,000 subordinates, at least initially would be precluded from adding subordinates under the proposed rules; and, even if they dropped 2,297 differently classified subordinates so that the remaining subordinates matched each other, there still would be more than 80 groups with more than 11,500 members that would be prohibited permanently from adding new members because the subordinates and the central organization would not be described in the same paragraph.⁹⁴ We recommend against imposing this harsh result on existing groups just because their subordinates fall under a different code classification than the central organization, as permitted by current law.

The simplest solution to the latter problem would be to dispense with the requirement that subordinates match their central organization, as discussed elsewhere.⁹⁵ If the Service does not accept that recommendation, the alternative of allowing an existing central organization to transfer its existing group ruling to a new central organization in the group, one that has the same subsection as the subordinates, seems to us to be easier from the perspective of tax administration than forcing thousands of subordinates to apply for exempt status individually or forcing hundreds of new central organizations to submit new group applications.

b) Transition Rule

Our recommendation to extend the one-year transition period to a period of at least 36 months would be consistent with the Regulations under section 508, which allow an organization to file an application for exemption under section 501(c)(3) within 27 months of the date of formation, and the fact that the Service often takes several months to review and approve an application.⁹⁶ It also would give central organizations sufficient time to determine which subordinates will be able to continue under their group rules and prepare guidance for subordinates on their options, and give subordinates time to decide how to proceed given their options and to prepare and submit applications for exemption and receive recognition of their tax-exempt status. As importantly, the longer transition period would spread the flood of applications over a longer period, reducing the stress on the Service's limited determination resources.

In our view, allowing new subordinates to be added during the transition period, even if their relationship to pre-existing subordinates causes them not to meet all matching requirements imposed by the new rules, would allow existing groups to continue to function in an orderly fashion during the transition period.

J. Effective Date Issues

1. Background

The Proposed Revenue Procedure would make the effective date of exemption for a subsequently added subordinate organization be the postmark date of the central organization's submission of supplemental information about that subordinate to the Service.⁹⁷ It also would preserve the rule in Revenue Procedure 80-27 that, if any subordinate organization listed in an application for group exemption is over 27 months old, all of the organizations in the group will be exempt only as of the postmark date of the group application.⁹⁸

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, treat newly incorporated organizations as exempt from their date of incorporation as long as the relevant supplemental information adding them to the group ruling was submitted less than 27 months after their date of incorporation. We also recommend that it provide that, where the central organization is not required to provide SGRI, a new subordinate's exemption will be effective immediately upon its inclusion in the group, as long as all the conditions for such inclusion — including the subordinate's consent — have been satisfied. For example, the central organization could be required to keep records internally of that date.

We recommend that the Proposed Revenue Procedure, when finalized, determine the effective date of each subordinate's exemption separately based on the length of time between its incorporation and the submission of the group application. Specifically, any organization already in existence for more than 27 months at the time of the exemption application would be treated as a newly added organization, the information for which would be deemed to have been submitted on the postmark date of the group application.

The reasons for our recommendations are set forth separately below.

a) Subsequently Added Subordinates

In the typical case in which a newly added subordinate also is newly incorporated, the timing rule in the Proposed Revenue Procedure would result in the subordinate having some period of time in which it exists but is not yet tax-exempt. Presumably it could file Form 1120 with respect to that initial time or apply for separate recognition of its tax-exempt status for that early time period. Either of those options, however, might not be efficient uses of both subordinates' and the Service's resources, defeating the purpose of coming under the group ruling. Moreover, in many cases, the subordinate's Form 1023 exemption application might arrive at the Service after the postmark date of the central organization's submission, meaning that the subordinate already would have been added to the group ruling. Receiving the application at that point would create confusion.

These difficulties would be mitigated somewhat if the central organization filed the required information with the Service immediately upon the subordinate's incorporation, but that would be practically impossible for a central organization managing thousands of subordinates. It also would give subordinates no time to determine whether they wished to come under a group ruling or seek their own individual determination letters from the Service.

b) Newly Added Organizations in Groups Not Required to Provide SGRI

While most organizations are required to provide SGRI under section 6.05 of the Proposed Revenue Procedure, central organizations that are churches or conventions or associations of churches are not required to do so. The timing rule in the Proposed Revenue Procedure would not provide clear guidance as to the effective date of exemption in the case of a church central organization that is not required to and does not submit SGRI.

One possible interpretation of this rule would require church groups to submit SGRI whenever they added new affiliates to the group. However, we believe that such an approach would not be consistent with statutory directives allowing churches, conventions and associations of churches, and integrated auxiliaries to be exempt from tax without requiring prior notice to the Service.⁹⁹ The group ruling mechanism allows, and in fact requires, donors and third parties to rely on the central organization's certification of the subordinate's inclusion in the group rather than on the Service's records. Thus, requiring notice to the Service before an organization's exemption can be effective seems both inconsistent and unnecessary.

c) Organizations More Than 27 Months Old That Are Included As Subordinates

We believe that the timing rule regarding subordinate organizations that are more than 27 months old would penalize many innocent subordinates for the filing delay of one particular subordinate. Under this rule, including any organization that has been in existence for more than 27 months would create a disincentive for other subordinates to join the group application. Alternatively, it would encourage the central organization to exclude from the group application any organization in existence for more than 27 and then add it as a newly included organization after the group ruling was issued. Respectfully, we do not see any policy reason for results that differ depending on whether an older organization joins a group ruling before or after submission of the group application.

K. Changes to Information on Which a Group Ruling is Based

1. Background

The Proposed Revenue Procedure contemplates that information about a group's subordinates and their activities and qualification for tax-exempt status will be included in an initial group application.¹⁰⁰ Thereafter, it provides for central organizations to identify any changes to their subordinates' governing instruments, purposes, or activities.¹⁰¹ It does not provide guidance on the reporting of other changes.

2. Recommendations

We recommend that the Service's group exemption procedures be kept flexible enough to accommodate the need for central organizations and subordinates to make changes over time to respond to unforeseeable developments in the world and in the law. To that end, we make several specific recommendations that are detailed below.

It is important to recognize that group rulings can have a lifetime potentially much longer than that of the average subordinate in the group. A number of large group rulings have been in effect for the better part of a century. The length of time a group ruling may be in effect makes it impossible to foresee all the ways in which the group's activities and organizational structure may evolve, not to mention changes in law that may necessitate modifications to governing documents, tax classification of subordinates, or other changes. To take one example, more than 80% of organizations currently listed under a group exemption on the EO Master File are under rulings that predate the Tax Reform Act of 1969 that established the modern distinction between private foundations and public charities.

The Proposed Revenue Procedure would require the annual listing of new subordinates as part of the SGRI to include a representation that “the information upon which the group exemption letter was based [under section 5.03 of the Revenue Procedure] is applicable in all material respects to the subordinate organizations being added to the group exemption letter.”¹⁰² However, if the group's purposes or activities have changed, and those changes have been properly reported in the SGRI, it might not be appropriate to say that the original information submitted is applicable to the new subordinates in all material respects. We recommend amending this language to state that “the information upon which the group exempt letter was based, as updated by this or previous SGRI submissions” applies to each new subordinate.

Section 14.02(3)(b) of the Proposed Revenue Procedure would require the information normally submitted in a group application to be submitted when new subordinates are first added to pre-existing group rulings.¹⁰³ Because church central organizations are not required to provide SGRI, we recommend that the Service provide guidance as to how existing church central organizations should provide the data referenced by section 14.02(3)(b) when they first add new subordinates under the new regime. We also recommend that the Service clarify that central organizations of religious and non-religious organizations may provide updates to the information originally filed pursuant to section 5.03 of the Proposed Revenue Procedure at any time. Finally, we recommend that the Service provide some avenue for central organizations to request Service approval of modifications to the information on which their group ruling was based, so that they can make sure that their standards for reviewing new subordinates are still acceptable to the Service.

We note that changes of the kind reportable in the SGRI (and thus apparently intended to be permissible), such as changes to governing documents, purposes, or activities,¹⁰⁴ often will take time to propagate through a large group. If interpreted strictly, the Proposed Revenue Procedure's matching requirements could make it impossible to execute some such changes, because the first subordinate to make the change would cause the group to fail the relevant uniformity requirement. Therefore, we recommend that the Service provide guidance allowing a reasonable period of time (for instance, one year) over which proposed changes to the group's uniform governing documents or purposes can be in progress — and, in the interim, adopted by some subordinates but not others — without risking the entire group's qualification.

L. Effect of Noncompliance

1. Background

The Proposed Revenue Procedure would allow the Service to revoke a group ruling in a number of circumstances. Some of these would apply only in the case of group-wide noncompliance within the group ruling requirements, for instance if more than half of the subordinates had their exemption automatically revoked or failed to meet the requirements for inclusion in the group, or if the central organization lost exempt status or had no subordinate.¹⁰⁵ Other provisions would appear to allow revocation for more isolated errors. For instance, any lateness in submitting any annual SGRI, any failure to exercise “general supervision” or “control” over “one or more subordinate organizations,” or any other failure to comply with the Proposed Revenue Procedure also could be grounds for revoking a group ruling.¹⁰⁶

2. Recommendations

We recommend that the Proposed Revenue Procedure, when finalized, clarify that isolated lapses by the central organization will not result in revocation of a group exemption with respect to all subordinate organizations, and that instead only material failures that suggested a substantial deficiency in the central organization's administration of the group ruling would have that effect. To that end, we make several specific recommendations that are detailed below.

Central organizations must deal with the difficulty of obtaining current information from small subordinates and the reality that in some cases they do not respond or become non-functional. While “general supervision” requires the central organization to obtain and review information from each subordinate, for a variety of reasons the central organization might request but fail to receive the required information from a handful of subordinates.¹⁰⁷ Therefore, we recommend that the Proposed Revenue Procedure, when finalized, deem a central organization to meet its obligations if it makes a reasonably diligent effort to obtain the required information and removes a subordinate that does not provide the information after a sufficient period of time (we propose two years).

Often, a central organization will identify noncompliance reasonably promptly and either require the subordinate to correct it or remove the subordinate from the group exemption, in advance of any inquiry by the Service. We recommend that the Proposed Revenue Procedure, when finalized, clarify that organizations voluntarily removed by the central organization for noncompliance before they are revoked automatically will not count in determining whether more than half of a group's subordinates have been automatically revoked or otherwise fail to qualify for inclusion in the group.

Finally, we are concerned that the Proposed Revenue Procedure could effectively suspend a central organization from adding any new subordinates any time a subordinate failed to keep the same NTEE code, foundation classification, or section 501(c) paragraph. Any such new subordinate would not be able to match all of its fellow subordinates, because the pre-existing subordinates themselves no longer would be uniform.¹⁰⁸ We recommend that the Proposed Revenue Procedure, when finalized, give a central organization a reasonable period of time upon becoming aware of a subordinate's failure to meet one or more requirements for inclusion in the group to allow the subordinate to correct the problem. During that time, the out-of-compliance subordinate would be disregarded in determining whether the group as a whole and all the other subordinates met the relevant uniformity and matching requirements. At the end of that period, the group would be deemed to fail the relevant uniformity or matching requirement unless either (a) the subordinate had corrected its noncompliance, or (b) the central organization had removed the offending subordinate from the group. Because some of these matching and uniformity requirements depend on features of an organization evaluated one tax year at a time, we recommend that a “reasonable time” for this purpose extend three months past the end of the succeeding tax year, to give the subordinate a chance to correct its classification for the following tax year and for the central organization to determine whether the subordinate has done so.

M. Donor Reliance

1. Background

The group ruling process has always served as a means of providing an alternative avenue for donors and other third parties to confirm that a particular subordinate is exempt, without requiring the Service to issue a separate determination letter to that subordinate. In theory, group rulings allow subordinate organizations equal access to donations because donors can rely on the combination of a group exemption letter and the central organization's certification of a subordinate to the same extent that a donor can ordinarily rely on a separate determination letter.

In practice, though, subordinate organizations are increasingly at a disadvantage. As it has become easier and easier to check tax-exempt status online, donors have become more and more dependent on such online checks. Many donors do not understand the different path for confirming charitable status of a subordinate organization with its central organization. Even if they do, it can be difficult for them to find out how to request confirmation from the central organization of the subordinate's status. Subordinates frequently face requests to provide a determination letter as a condition of receiving a grant or donation and try to persuade donors and grant-makers that they do not need to provide such a letter, with mixed success.

In addition, more and more charitable giving is taking place through institutions such as sponsoring organizations of donor advised funds. These groups often have standard procedures for checking the status of an organization against the Service's records that do not include procedures for checking group rulings. Especially since passage of the Pension Protection Act in 2006,¹⁰⁹ these institutional donors find themselves subject to rules requiring them not only to confirm the tax deductibility of their contributions under section 170, but also to confirm that the recipient is a public charity and that it is not a supporting organization of a particular type.¹¹⁰ Numerous resources are now available, especially online, to aid this diligence process.¹¹¹

The regime for checking the tax classification of group exemption subordinates has not kept pace with these developments. The Proposed Revenue Procedure's provisions on reliance would address only deductibility under section 170. They would not consider public charity classification or a grant's treatment under other Code sections such as section 4942, 4945, or 4966.

We are not aware of any guidance as to how grantors can obtain public charity classification information about subordinate organizations upon which they may rely; indeed, existing guidance expressly prohibits relying on Service data for the public charity classification of subordinates.¹¹² This state of affairs makes grants to subordinate organizations more risky for private foundations and sponsoring organizations of donor advised funds. As a result, these organizations might be less likely to make grants to subordinate organizations. In some cases, we are aware that third-party services such as Guidestar have tried to provide a central organization's information about its subordinates to the public. These laudable efforts are hampered by the absence of guidance affirmatively allowing reliance on third party republication of this data generally, and expressly denying reliance on the data for purposes of determining public charity classification.

2. Recommendations

We recommend two changes to the Proposed Revenue Procedure to bring the donor reliance provisions with respect to group exemptions closer to parity with the provisions for individual determination letters.

First, parallel to the changes allowing reliance on the EO Master File, Publication 78, and Exempt Organizations search, we recommend that the Proposed Revenue Procedure, when finalized, or the Service in other guidance, allow donors to rely on the central organization's records as to which paragraph of section 501(c) applies to a subordinate, the subordinate's public charity classification, and its supporting organization type if applicable. We urge that such reliance extend not only to grants by private foundations and donor advised funds under sections 4942, 4945, and 4966, but also apply more generally in other contexts where the subordinate's tax status may be relevant.¹¹³

Second, parallel to the relief first provided in Revenue Procedure 2011-33¹¹⁴ with respect to reliance on third-party data providers, we recommend that the Proposed Revenue Procedure, when finalized, or the Service in other guidance, authorize donors to rely on data from central organizations provided to third parties such as Guidestar. Such use of third parties would allow the Service, if it wished, to continue denying donor reliance on its data on subordinate organizations. It would, however, offer an avenue for central organizations to work with major third-party providers of tax classification data like Guidestar to furnish up-to-date information about their subordinates. If so, donor advised fund sponsoring organizations and similar institutions would be able to find and rely on current information about subordinate organizations using the same tools they use to confirm status of other grantees holding their own determination letters. In our view, the Service could reasonably require that the third-party provider certify that its data had been updated by the central organization within a certain window of time. We recommend that the window be at least six months, because many central organizations would not be able to provide updated information more frequently.