The IRS Advisory Committee on Tax Exempt and Government Entities ("ACT") issued a report in June 2011 that addresses a number of tax compliance issues, including group exemption rulings. The report caught the attention of many church leaders, since thousands of churches have obtained recognition of tax-exempt status by being included in the group exemption ruling of a parent denomination. Unfortunately, the report has caused needless concern, in part because of the false claims of some seminar leaders that the IRS is going to "revoke the group exemptions of churches by the end of the year." The good news is that the IRS is not going to revoke group exemptions. This article will explain the recent ACT report and set the record straight.
Each year, tens of thousands of organizations file individual applications with the IRS for recognition of tax-exempt status. But for more than 70 years, the IRS has also had procedures permitting certain affiliated organizations to obtain recognition of their exemption on a group basis, rather than by filing separate applications. Under the group procedure, an organization (called the central organization) submits a request for recognition of exemption for a group of organizations that are affiliated with it and under its general supervision or control (called the subordinate organizations). If the IRS grants this request, the central organization is authorized to add other similar subordinates to the group, as well as to delete subordinates that no longer meet the group exemption requirements. As a result of the group exemption procedure, subordinate organizations covered by group exemptions are relieved from filing their own individual applications for recognition of exemption with the IRS.
There are currently more than 4,300 group exemptions covering some 500,000 subordinate organizations. These statistics do not include church group exemptions because they are not required to file annual information reports with the IRS regarding additions and deletions of subordinate organizations from their group exemptions. Some church group exemptions cover thousands, and even tens of thousands, of subordinate organizations. ACT estimates that there are 100,000 to 150,000 churches covered by group exemptions. About 700 of the more than 4,300 non-religious central organizations holding group exemptions elect to file group Form 990 information returns on behalf of some or all of their subordinate organizations.
The group exemption procedure has simplified the process for obtaining exempt status for hundreds of thousands of organizations over the years. However, there have been some significant changes in the law over the years that are not reflected in the current group exemption procedure that dates back to IRS Revenue Procedure 80-27 in 1980 (see table 1, page 13).
In 2006, the IRS issued Publication 4573, which contains a series of questions and answers about group exemptions. That publication, most recently revised in 2007, provides basic information about some of the most important aspects of group exemptions. Publication 4573 made one substantive change in the group exemption procedure—it states that churches holding group exemptions are not required to file an annual report updating the IRS on changes in their subordinates. The obvious impact of this change has left the IRS without updated and accurate information about the identity of the subordinates covered by church group exemptions, at least for those churches that do not, voluntarily, submit such annual reports.
In 1994, the Exempt Organizations Committee of the Section of Taxation of the American Bar Association submitted comments to the IRS recommending that Revenue Procedure 80-27 be modified to remove the requirement that the central organization have "general supervision or control" of subordinates, at least in the case of churches and religious organizations, and to replace that with a requirement that the central organization have sufficient "affiliation bonds" that it will be able to provide accurate, timely, and regular information to the IRS regarding the subordinates covered by the group exemption.
These comments were prompted by several considerations, including the following:
many churches and other religious organizations are prohibited by theological doctrine or practices from controlling or supervising other entities within the denomination or religious association; and
central churches and religious associations should not have to represent that they control or supervise affiliated entities, since such representations are frequently used against the central church or religious association in tort litigation.
The latter consideration is reflected in the case of Barr v. United Methodist Church, 153 Cal. Rptr. 322 (1979), in which a court used information from a central organization's group ruling application to hold that the entire denomination could be sued in a dispute involving some retirement homes affiliated with a regional body of the church.
ACT concluded that the group exemption procedure should be retained. Its final report states:
ACT believes that the group exemption process provides an appropriate mechanism for central organizations to seek recognition of exemption on a group basis for organizations under their general supervision or control. The original objective of the group exemption procedures was to lessen the administrative burden on subordinate organizations and on the IRS, and we believe that remains a valid rationale for subordinate organizations and the IRS alike ….
If group rulings were eliminated, hundreds of thousands of (former) subordinate organizations would need to file individual exemption applications with the IRS. These applications would be in addition to the already significant normal volume of applications currently being processed with limited IRS resources ….
The group exemption process provides another benefit to the IRS with respect to its administration of the tax laws in the case of organizations that are not required to seek recognition of exemption on an individual organization basis, including churches …. Under the group exemption procedures, all categories of exempt organizations (including churches) must apply to the IRS to obtain a group exemption for their subordinate organizations. This provides the IRS with a base of information that it might not otherwise have about a significant cadre of exempt organizations. This is particularly the case with respect to churches, which would otherwise be invisible to the IRS. Moreover, even though churches are not required to file an annual report to the IRS listing organizations added to and deleted from the group exemption, some voluntarily choose to do so, which provides the IRS with updated information about their subordinates that can be incorporated into the Exempt Organizations Business Master File (EOBMF) ….
In summary, ACT believes that group exemptions should be retained because they significantly lessen the administrative burden on the IRS and group ruling members, they provide an additional level of oversight that would not be present otherwise, and they insure (sic) consistent treatment of similarly situated entities. We do recognize that, to some degree, there would be more transparency, accountability, and responsibility if there were no group rulings. But we believe the benefits gained by eliminating group rulings would not justify an incredibly difficult and disruptive transition process for all involved. Instead, as we discuss below, we believe that these benefits can be largely achieved through smaller, more targeted reforms of the current group ruling procedures.
In the process of reviewing existing group exemption procedures, ACT members met with representatives of church group exemption holders. The principal issues raised by church group exemption holders included:
the challenge associated with providing donors with acceptable levels of assurance as to the deductibility of contributions made to subordinate organizations covered by a group exemption;
applying the general supervision or control standard of Revenue Procedure 80-27 in the context of churches;
some church group exemption holders expressing complaints about inadequate training given to IRS personnel who respond to calls from donors and others, inquiring about the tax-exempt status of their subordinate organizations;
some church group exemption holders expressing frustration regarding numerous incidents related to inaccurate information in IRS databases concerning their subordinate organizations.
The ACT report concludes with the following nonbinding recommendations to the IRS:
1. Eliminate Group Returns
Prohibit central organizations from filing annual information returns (Form 990) with the IRS. Churches and most other religious organizations are exempt from the Form 990 requirement, and so this recommendation will not affect them.
2. Define General Supervision or Control
The ACT report recommends that the concept of "general supervision or control" (that central organizations must exercise over their subordinates) be clarified. The report notes that the purpose of the "supervision and control" requirement in the group exemption procedure is not supervision and control per se, but rather "to insure (sic) that the central organization has sufficient information about the on-going operations and activities of the subordinate organizations so that it may act to bring non-compliant subordinates into compliance, and if necessary, remove them from the group."
The report lists several factors that the IRS could consider in determining if general supervision and control exists, and it recommends that the IRS issue a new revenue procedure listing these and other factors.
The report addressed two key issues in applying a supervision-and-control requirement in the context of group exemptions for churches: (i) recognition that middle-level or "subunits" of a church, rather than just the central organization, can exercise the requisite level of supervision or control over the subordinate organizations, and (ii) the level of supervision or control over subordinate organizations should vary depending on the type of subordinate organizations (e.g., churches, integrated auxiliaries of a church, or other church-affiliated organizations). The report addresses these issues as follows:
(i) General Supervision or Control by Subunits of the Church
As a testament to the autonomy granted by the First Amendment, churches are organized in a countless variety of ways, many of which do not fit into a conventional legal or corporate paradigm of supervision or control. At one end of the spectrum are purely hierarchical denominations where one entity has complete control over all the constituent entities of the church. At the other end of the spectrum are purely congregational denominations where the constituent entities share common beliefs, but otherwise operate independently of one another. And there are church polities that lie virtually everywhere between the two ends of this spectrum …. 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, 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. These subunits would then provide the central organization with the basic information necessary for it to determine whether to remove a particular subordinate organization from the church group exemption.
(ii) General Supervision or Control that Varies Depending on the Type of Subordinate Organization
We believe that there should not be any specified level of general supervision or control over subordinate organizations that are churches, integrated auxiliaries of churches, or conventions or associations of churches. For other types of church-affiliated subordinate organizations, the requisite level of general supervision or control should be similar to the standard required for non-church group exemptions (with subunits of the church, rather than just the central organization, being permitted to exercise the requisite general supervision or control, as discussed above).
There are several reasons for applying this liberal standard for subordinate organizations that are churches, integrated auxiliaries of churches, or conventions or associations of churches. First, this standard would permit virtually all churches, even congregational churches, to have a group exemption covering these types of entities. Second, in many denominational group exemptions, individual local churches (for doctrinal reasons) and integrated auxiliaries (for financial reasons) typically already have a close, oversight-type of relationship with the central organization or some other subunit of the church. Finally, the IRS is not losing any transparency, accountability, or responsibility by having a more liberal standard for these types of subordinate organizations.
On this last point, one concern about section 501(c)(3) group exemptions is that the IRS is delegating to the central organization the determination of whether a given subordinate organization is indeed tax-exempt. But by statute, churches, integrated auxiliaries of churches, and conventions or associations of churches are not required to apply to the IRS for recognition of their exempt status. Also, there is the concern about ongoing monitoring of the operations and activities of subordinate organizations in group exemptions. But again, by statute, churches, integrated auxiliaries of churches, and conventions or associations of churches are not required to file annual information returns to the IRS. Thus, with respect to these types of organizations, the group exemption process does not deprive the IRS of any information it would otherwise have in the absence of group exemptions. Indeed, the application for the church group exemption provides the IRS with more information about these types of subordinate organizations than it would have otherwise. The group exemption application provides the IRS insight into the structure, organization, and activities of the subordinate organizations, and assists the IRS in preventing abuse by organizations improperly claiming church status.
In summary, a liberal general supervision or control standard for subordinate organizations that are churches, integrated auxiliaries of churches, or conventions or associations of churches would permit virtually all types of churches to have group exemptions at little or no "cost" to the IRS in terms of losing transparency, accountability, and responsibility. Moreover, because these types of organizations do not file annual information returns, the ongoing oversight provided within the church group exemption is more than what the IRS would be able to do itself. Indeed, this additional level of oversight is one of the advantages of group exemptions, which can be particularly significant in the church context.
As for subordinate organizations other than churches, integrated auxiliaries of churches, or conventions or associations of churches, the calculus of balancing the interests of churches with the interests of the IRS is different. In the absence of group exemptions, many of these types of subordinate organizations would have to file individual applications for recognition of exemption. Thus, in this case, the IRS is deprived of some information about these organizations it would otherwise have in the absence of group exemptions. (On the other hand, some of these church-affiliated subordinate organizations that are not churches, integrated auxiliaries of churches, or conventions or associations of churches are required to file annual information returns.)
In balancing these interests, we believe that the standard for general supervision or control in church group exemptions with respect to subordinate organizations that are not churches, integrated auxiliaries of churches, or conventions or associations of churches should be similar to that for non-church group exemptions. However, because of the unique circumstances presented by church group exemptions, we recommend that the standard allow for consideration of additional facts and circumstances similar to those listed in Treasury Regulations section 1.6033-2(h)(2).
3. Donor Reliance
The report notes that one of the principal concerns that many section 501(c)(3) group exemption holders have is that their subordinate organizations are not listed in the official directory of tax-exempt organizations (IRS Publication 78). This is a frustration for donors as well, since many donors have become reliant on Publication 78 to confirm that prospective donees are eligible to receive charitable contributions. The ACT report concludes:
ACT believes that the inclusion of section 501(c)(3) subordinate organizations in Publication 78 would further the goals of transparency and make it possible for a variety of stakeholders readily to confirm the exempt status of subordinate organizations. Publication 78 is intended, first and foremost, as a service to donors to facilitate the making of contributions to qualified section 501(c)(3) organizations. The fact that donors lack this service with respect to more than 250,000 section 501(c)(3) organizations (not counting 100,000 – 150,000 churches) that have recognition of exemption under the group exemption procedures is a source of concern to subordinate organizations and their donors. We understand that this is a source of concern to the IRS as well, which is one reason it issued Publication 4573. But group exemption holders have told the ACT that while Publication 4573 is helpful in some cases, it is not sufficient to address the problem.
If it is not possible to include subordinate organizations on Publication 78, ACT recommends that the IRS work with affected organizations to consider additional ways to enhance the reliance by donors on the section 501(c)(3) status of subordinate organizations covered by group exemptions. Possible options might include the following:
(1) Make sure that all church group exemption holders are aware that the IRS will input and update information about their subordinate organizations on the EOBMF if that information is provided in the required format. Work with churches that are interested in this option to develop a process for obtaining and inputting such information.
(2) Have a separate "group exemption" page on the IRS website that includes a list of central organizations and their subordinates (to the extent the IRS has such information) with an explanation that the subordinates received recognition of exemption under the group exemption procedures and confirmation that donors can rely on such exemption. Also include an explanation of how donors may search the EOBMF for names of subordinate organizations, and explain that in the case of subordinate organizations under church group exemptions, they may not be included on the EOBMF.
(3) Include a list of the names and contact information (including Internet address) of central organizations on a separate "group exemption" page of the IRS website, with an explanation of the group exemption procedures and confirmation that donors may rely on information they receive from the central organizations as to the exempt status of their subordinate organizations.
The ACT report comes as welcome news for churches. If its findings are adopted, this will lead to the following positive results:
1. The group exemption procedure will be retained, and the exempt status of the thousands of churches covered by a denominational group exemption will be preserved. As the report points out, churches are not required to apply for exemption from federal income taxes. Their exemption is automatic, so long as they comply with the conditions listed in section 501(c)(3) of the tax code. But, obtaining official recognition of exemption, either by applying for exempt status directly or by being included in a group exemption ruling, has several advantages. Most notably, donors are assured that their donations are tax-deductible.
2. The report recognizes the difficulty of applying the group exemption procedure's "general supervision and control" requirement to religious organizations, and in particular to those that are "congregational" rather than "hierarchical" in polity. It affirms: "ACT believes that the centralized, conventional legal or corporate model of general supervision or control simply does not work for church group exemptions." The report makes welcome suggestions to resolve this dilemma, including allowing "middle-level entities or subunits of the church … to provide the requisite level of ongoing supervision or control over the subordinate organizations …. These subunits would then provide the central organization with the basic information necessary for it to determine whether to remove a particular subordinate organization from the church group exemption."
3. The report recommends that "there should not be any specified level of general supervision or control over subordinate organizations that are churches, integrated auxiliaries of churches, or conventions or associations of churches." This recommendation would greatly resolve the difficulty encountered in applying the current group exemption procedure (with its general supervision and control requirement) to denominations that are congregational in polity. This would also reduce if not eliminate the ability of trial attorneys to use the "general supervision and control" requirement in the group exemption procedure as a basis for imposing tort liability on denominational agencies for the acts or obligations of affiliated churches.
4. The report notes that the "general supervision and control" requirement may be construed in light of ecclesiastical rather than temporal governance, thereby reducing the risk that a group exemption ruling can be used to find denominations liability for the acts and obligations of affiliated churches.
In 1994 the IRS issued its first Tax Guide for Churches and Religious Organizations (the "Guide"). The Guide clarified that "a church or other organization with a parent organization may wish to contact the parent to see if the parent has a group exemption letter." The Guide further explained:
An organization has a parent if, for example, another organization manages, financially or ecclesiastically, the first organization. If the parent holds a group exemption letter, then the organization seeking exemption may already be recognized as exempt by the IRS. Under the group exemption process, one organization, the parent organization, becomes the holder of a group exemption ruling naming other affiliated churches as included within the ruling. Under these rules, a church is recognized as exempt if it is included in the annual update of the parent organization. If the church is included on such a list, it need take no further action in order to obtain such recognition.
This language was significant because it explicitly recognized that the control needed in order to qualify for a group exemption could be ecclesiastical. Unfortunately, all subsequent editions of the Guide delete this helpful recognition of ecclesiastical control. The current Guide contains the following discussion of group exemption rulings:
A church with a parent organization may wish to contact the parent to see if it has a group ruling. If the parent holds a group ruling, then the IRS may already recognize the church as tax-exempt. Under the group exemption process, the parent organization becomes the holder of a group ruling that identifies other affiliated churches or other affiliated organizations. A church is recognized as tax-exempt if it is included in a list provided by the parent organization. The parent is then required to submit an annual group exemption update to the IRS in which it provides additions, deletions and changes within the group. If the church or other affiliated organization is included on such a list, it does not need to take further action in order to obtain recognition of tax-exempt status.
This language needlessly exposes denominations that are congregational in polity, and that have obtained a group exemption, to increased risk of liability for the acts and obligations of their affiliates. This is unfortunate, because many of these denominations do not exercise any supervision or control over affiliated congregations. The ACT report provides several options that would avoid this result.
The current group exemption procedure that grants favored status only to connectional church organizations is suspect under the Supreme Court's interpretation of the First Amendment's nonestablishment of religion clause. In 1982 the court invalidated a Minnesota law that imposed certain registration and reporting requirements upon religious organizations soliciting more than 50 percent of their funds from nonmembers. Larson v. Valente, 410 U.S. 437 (1982). The court observed that "when we are presented with a state law granting a denominational preference, our precedents demand that we treat the law as suspect and that we apply strict scrutiny in adjudging its constitutionality." The court concluded that any law granting a denominational preference must be "invalidated unless it is justified by a compelling governmental interest, and unless it is closely fitted to further that interest."
Similarly, a federal appeals court, in construing section 6033 of the tax code, observed: "If 'church' were construed as meaning only hierarchical churches such as the Catholic Church—[this] would result in an unconstitutional construction of the statute [IRC 6033] because favorable tax treatment would be accorded to hierarchical churches while being denied to congregational churches, in violation of the First Amendment." Lutheran Social Services v. United States, 758 F.2d 1283 (8th Cir. 1985).
No conceivable governmental interest would justify the government's stated preference for connectional church organizations in the present group exemption procedure.
5. The ACT report addresses another significant concern—demonstrating the tax-exempt status of churches covered by group rulings. Such churches are not listed in the IRS directory of exempt organizations (Publication 78), and this can act as a disincentive for some donors to contribute. The report provides some creative ways to resolve this dilemma.
|"Central organization … must establish that the subordinates to be included in the group exemption letter are affiliated with it."|
|"Central organization … must establish that the subordinates to be included in the group exemption letter are … subject to its general supervision or control."|
|"Central organization … must establish that the subordinates to be included in the group exemption letter are … all exempt under the same paragraph of section 501(c) of the tax code."|
|"Central organization … must establish that the subordinates to be included in the group exemption letter are … not private foundations."|
|"Central organization … must establish that the subordinates to be included in the group exemption letter are … all on the same accounting period."|
|"Each subordinate must authorize the central organization to include it in the application for the group exemption letter."|
|The application for a group exemption must include "a sample copy of a uniform governing instrument (charter, trust indenture, articles of association, etc.) adopted by the subordinates."|
|The application for a group exemption must include "a detailed description of the purposes and activities of the subordinates."|
|The application for a group exemption must include "an affirmation that … the purposes and activities of the subordinates are as set forth" in requirements 8 and 9.|
|The application for a group exemption must include "a list of subordinates to be included in the group exemption letter."|
|The application for a group exemption must include "the information required by Revenue Procedure 75-50" (pertaining to racially nondiscriminatory policies of schools).|
|The application for a group exemption must include "a list of the … employer identification numbers of subordinates to be included in the group exemption letter."|
|"The central organization must submit with the exemption application a completed Form SS-4 on behalf of each subordinate not having" an employer identification number.|
|Each year the central organization must provide the IRS with lists of "(a) subordinates that have changed their names or addresses during the year, (b) subordinates no longer to be included in the group exemption letter because they have ceased to exist, disaffiliated, or withdrawn their authorization to the central organization, and (c) subordinates to be added to the group exemption letter."|