NEW IRS FORM FOR SOME EXEMPT ORGANIZATION DETERMINATIONS And a Refresher Course on Certain Private Foundation/Public Charity Issues
All nonprofits must file either a Form 1023 or a Form 1024 in order to obtain an initial determination of exempt status. The IRS has released a new form that tax-exempt organizations will use to request certain determinations about their tax exempt status. The new Form 8940, Request for Miscellaneous Determination, will be used to obtain advance approval of certain activities, exemption from Form 990 filing requirements and certain private foundation status issues. (Private foundations are a less favored category of charitable organizations, which are subject to stricter rules and certain excise taxes.) Use of Form 8940 is expected to be simpler, cheaper and faster than a formal request for a private letter ruling.
There is an eight-page set of instructions for the completion of Form 8940. These instructions specify what information needs to be submitted to support each of the nine types of requests that may be submitted. A user fee must accompany most requests. For the following three miscellaneous determinations, the user fee is $1,000:
- Advance approval of set-asides by private foundations;
- Advance approval of voter registration activities;
- Advance approval of scholarship procedures of private foundations.
For the other six types of miscellaneous determinations for which this form may be used, the user fee is $400:
- Exemption from Form 990 filing requirements;
- Advance approval of “unusual grants;”
- Determination of type of section 509(a)(3) supporting organizations;
- Reclassification of foundation status, including a voluntary request from a public charity for private foundation status;
- Termination of private foundation status – advance ruling request;
- Termination of private foundation status – 60 month period ending.
Minimum Distribution Rules Applicable to Private Foundations
One of the requirements applicable only to private foundations is that they must make a minimum amount of “qualifying distributions” each year. An amount set aside for a specific project may be treated as a qualifying distribution in the year it is set aside, rather than in the year that it is actually paid, if at the time it was set aside the foundation establishes that:
(1) The amount will actually be paid for the specific project within 60 months from the date of the first set-aside, and either
(2) (i) The set-aside satisfies the suitability test; that is, that the project is one that can be better accomplished by a set-aside than by immediate payment, or
(ii) the foundation has satisfied certain relatively complicated cash distribution rules in the past.
Private foundations may use Form 8940 to obtain advance approval of these set-asides.
Voter Registration Activities
Private foundations may not make any payments to carry on any voter registration drive. “Nonpartisan” activities are permitted. Activities that satisfy all of the following conditions are considered nonpartisan:
(1) The organization conducting the voter registration drive is an exempt § 501(c) (3) organization;
(2) Its activities are nonpartisan, are not confined to one specific election period and are carried on in at least five states;
(3) The organization spends at least 85% of its income directly for the active conduct of the exempt purpose for which it is organized and operated;
(4) The organization receives at least 85% of its support (other than gross investment income) from exempt organizations, the general public, and/or governmental units;
(5) It does not receive more than 25% of its support (other than gross investment income) from any one exempt organization;
(6) It does not receive more than 50% of its support from gross investment income; and
(7) Contributions to the organization for voter registration drives are not subject to conditions that they may be used only in specified localities of the United States or that they may be used only in one specific election period.
In determining whether the organization meets the support test in items (4), (5) and (6), the support received during the tax year and the four immediately preceding tax years of the organization is taken into account. For organizations with less than four years of operational experience, support tests may be determined by taking into account all available years the organization has been in existence. Again, a private foundation may use Form 8940 for advance approval of its voter registration activities.
Grants to Individuals
If a private foundation makes grants to individuals, such as scholarships, they must be awarded in accordance with procedures approved in advance by the IRS. To secure such approval, the private foundation must demonstrate in its request for advance approval that:
(1) Its procedure awards grants on an objective and non-discriminatory basis;
(2) The procedure is reasonably calculated to result in performance by the grantees of the activities that the grants are intended to finance; and
(3) The foundation will supervise the grants to determine whether the recipients have fulfilled the grant terms.
Approval is based on an evaluation of the foundation’s entire system of standards, procedures and follow-up. Therefore, separate approval for each grant program is not required. Once obtained, such approval applies to any subsequent grant program so long as the procedures under which it is conducted do not differ materially from those described in the original request for approval. A private foundation may use Form 8940 to obtain advance approval of its scholarship procedures.
Exemption from Filing Forms 990
Most organizations must file an annual information return (Form 990 or Form 990-EZ). However, organizations affiliated with one or more churches are exempted from filing Form 990, so long as they satisfy the requirements of 26 C.F.R. § 1.6033-2(g) and (h) (2011), as well as Revenue Procedure 96-10. In addition, organizations that are affiliated with a governmental unit are exempt as long as they qualify under the requirements of Revenue Procedure 95-48. An organization may request a determination that it is not required to file the annual information return when it applies for exemption by providing information requested on the application form (Form 1023 or 1024). If an organization does not request this determination at that time, or its initial request is not approved, it may request a ruling on its filing requirement by using Form 8940.
Publicly Supported Public Charities
Two types of public charities obtain that status based on their sources of support. If an organization receives a substantial part of its support in the form of contributions from other publicly supported organizations, governmental units and/or the general public, it may qualify under §170(b)(1)(a)(vi). For example, a human service organization whose revenue is generated through widespread public fundraising campaigns, United Way drives or government grants is considered a publicly supported charity. In addition, an organization that receives no more than one-third of its support from gross investment income and more than one-third of its support from contributions, membership fees and gross receipts from activities related to its exempt functions is also considered a publicly supported charity under § 509(a)(2). For example, a non-profit theater with box office revenue would usually qualify as a public charity under §509(a) (2).
The difficulty with these support tests is that they include in the definition of “support” contributions from each donor only up to two percent of the organization’s total support. This two percent limitation does not apply if a grant is considered an “unusual grant.” An “unusual grant” is one that is attracted because of the publicly supported nature of the organization, in an unusual or unexpected amount that would otherwise adversely affect the status of the organization as normally being publicly supported. An organization may use Form 8940 for an advance determination that a potential contribution is an unusual grant, excluded from these public support calculations.
Another type of public charity is a § 509(a) (3) supporting organization. This is an organization that carries out its exempt purposes by supporting other exempt organizations, usually other public charities.
A supporting organization must be organized and operated exclusively to support specified supported organizations. Moreover, it must have one of three relationships with the supported organizations, all of which are intended to ensure that the supporting organization is responsive to the needs of the supported organization and intimately involved in its operations and that the public charity is motivated to be attentive to the operations of the supporting organization. No supporting organization may be controlled by “disqualified persons,” usually substantial contributors. The following are the three types of supporting organizations:
- Type I – the supporting organization is operated, supervised or controlled by the supported organization;
- Type II – the supporting organization is supervised or controlled in connection with the supported organization;
- Type III – the supporting organization is operated in connection with the supported organization.
Because Type III relationships are less formal than a Type I or Type II relationship, Type III organizations must meet both a responsiveness test and an integral part test. These tests are designed to ensure that the supporting organization is responsive to the needs of the public charity and that the public charity oversees the operations of the supporting organization.
If a Type III supporting organization changes its governance or operational structure, it may qualify under as a Type I or Type II supporting organization. A supporting organization in that situation may use Form 8940 to request a determination in the change of type of supporting organization it is.
Reclassification of Private Foundation/Public Charity Status
Sometimes a private foundation expands its sources of support or operations so that it may in the future qualify as a public charity. On the other hand, a public charity may also change its organizational structure or sources of support and no longer qualify as a public charity. In both of those situations, the organization may request reclassification of its foundation status using Form 8940.
Once an organization is classified as a private foundation, it may only terminate that status under the provisions of § 507. Under § 507, there are four ways to terminate private foundation status, two of which involve tax liability:
(1) Voluntary termination by notifying the IRS of the intent to terminate and paying a termination tax. Unless the organization requests abatement, it must pay the tax at the time the statement is filed.
(2) Involuntary termination for either repeated or flagrant violation of the private foundation excise tax provisions, in which case the organization also becomes subject to a termination tax.
(3) Transfer of all its assets to one or more organizations that have been determined to be public charities under § 509(a) (1). The recipient organization must have been in existence and described under § 509(a) (1) for a continuous period of at least 60 months.
(4) An organization may operate as a public charity for a continuous period of 60 months after giving appropriate notice to the IRS. In this way it may terminate its private foundation status as long as it meets the requirements of § 509(a)(1), (2) or (3) for a continuous 60 month period beginning with the first day of any tax year. It must notify the IRS before beginning the 60-month period that it is terminating its private foundation status. The organization also must establish immediately after the end of the 60-month period that it has met these requirements. The organization may use Form 8940 both to give prior notice to the IRS as well as to demonstrate how it has satisfied the requirements at the end of the 60-month period.
If your organization is grappling with issues covered by Form 8940, this simplified process may expedite resolution of your concerns. However, if your organization is experiencing other issues, like how to handle a material change in its operations, it may have to fall back on the old, time-consuming and relatively expensive private letter ruling process.