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group exemption pitfalls

Group Exemption Pitfalls: What to Watch Out For

A group exemption offers a way for a central parent organization to share its IRS tax-exempt status with its subsidiary/chapter member organizations.  They’re convenient and offer organizations a savings in time and money, and a means to manage a chapter organization.  Everything has its downsides, however, and group exemptions are no exception.

There’s still paperwork.

A group exemption saves you from having to file an IRS exemption application (Form 1023 or 1024) for each of your chapter organizations, but that doesn’t mean those subsidiaries never have to check in with the IRS.  The IRS requires all nonprofits to submit a 990-series information return annually. While some group exemption holders consolidate their 990 return, including all the subsidiaries on the parent organization’s tax return, often each chapter/affiliate must file its own IRS tax return.   

And there the problems begin.  If a nonprofit fails to file a Form 990 for three consecutive years, the IRS automatically revokes its tax exemption. As a result, group exemption holders see many “new” chapters get revoked at the three-year mark because no 990 returns are filed.  Another reason affiliate chapters forget to file IRS Form 990 is the loss of “corporate history” each time a chapter’s officers turn over.  The need to file the 990 return, and when the deadline is, often gets “lost” in the volunteer shuffle.  National organizations with affiliate chapters often see thirty (30%) or more of their chapters revoked at any given time.

Immediate revocations?

And crazy as this sounds, sometimes the IRS revokes chapters immediately upon their addition to the national organization's group exemption list.  How can a brand new chapter lose its tax status before ever being tax-exempt?  The reason is that the IRS looks to the date an organization receives its Employer Identification Number (EIN) to determine when the organization should start filing 990 returns. So, if a chapter obtained an EIN three or more years ago, never filed a tax return, and then a national organization tries to add the chapter to their group exemption, the IRS immediately revokes the organization’s exemption for failure to file the past due returns. It’s like getting revoked before you ever got tax-exempt! The bottom line is that knowing the date a chapter obtains their EIN becomes critical to group exemption holders.

The best way to avoid these issues is awareness.  Central organizations must make sure someone understands the rules and monitors the statuses of their subsidiaries.  This includes double-checking the formation documents for each affiliate before adding them to a group exemption. Central organizations also need to continuously train chapter leadership on Form 990 and the importance of its timely filing.

Grant funding will take time.

Private foundations and other organizations that provide grants to nonprofits typically verify eligibility (501(c)(3) status) by reviewing the IRS’s Business Master File (BMF), a list of every recognized tax-exempt organization in the country.  The IRS adds organizations to the BMF when it approves their application for tax exemption.  Since subsidiary organizations don’t file applications, their process isn’t as straightforward—they have to wait until their central organization files their annual group exemption update and wait further still for the IRS to process the update.  This usually takes 3-6 months to complete.  If a central organization has recently filed its annual group exemption update, a subsidiary that joins may find themselves looking at up to a year and a half delay before they’re added to the BMF.

IRS rules provide that grant providers may rely on the central organization, rather than the BMF, to confirm the tax-exempt status of their subsidiaries.  For this reason, the “central” or parent organization should provide their group members with documentation to help “prove” their IRS tax exempt status.  RENOSI recommends providing members with a dated membership certificate and a copy of the parent organization’s IRS determination letter that indicates the subsidiary is part of the group exemption.

In practice, however, grant-making foundations rarely rely on the parent organization’s membership list.  This leaves new subsidiaries of group exemptions in limbo until the IRS gets the organization in the BMF.  There is no way to speed up the IRS processing time.  However, RENOSI keeps the process moving by sending the IRS more frequent updates (e.g. quarterly).  This ensures that subsidiaries don’t have to wait any longer than necessary to receive grant funding. In addition, some parent organizations may process grants for their subsidiaries as “pass-throughs” until the subsidiary is in the IRS BMF list.

Names and EINs get confused.  A lot.

Another snag with relying on the BMF beyond processing times: it’s not the most organized document.  The BMF is essentially a spreadsheet.  The columns are easy to understand for single nonprofits that are not part of a group exemption.  However, they can cause major headaches for members of group exemptions.  


ABHAB
1EINNAMEGROUPSORT_NAME

The columns in question: EIN (A), NAME (B), GROUP (H), and SORT_NAME (AB)

The four columns that cause the biggest misunderstandings are A, B, H and AB. 

  • A contains the organization’s EIN;
  • B, its name;
  • H, its group exemption number; and
  • AB contains any DBA names the organization uses.

If an organization is a subsidiary, interpreting the information in these columns can be tricky.  For instance, whose name goes in column B—the chapter organization’s, or its parent’s?  The answer is either.  If all goes according to procedure, the IRS puts the central organization’s name in column B, NAME, and the subordinate’s name as a DBA in column AB, SORT_NAME.  Unfortunately, the IRS does not follow this procedure consistently and sometimes places the subsidiary’s name in column B.  This makes it difficult to accurately interpret the data in the BMF.

What does this mean? 

Grants go to the parent organization instead of its appropriate chapter.  IRS 1099-misc forms wind up at the wrong organization.  Government agencies send documents to an incorrect address.  In short: chaos and delays.  Unfortunately, the only way to mitigate these issues is to ensure that those who are reviewing incoming documents train on how to spot misaddressed communications and reroute them to their proper destination.  Processing must require a deliberate examination of the “to” line on a letter, for example, or the memo line on a check.  If someone isn’t explicitly taught where to look for these indications of correspondence gone awry, they are easily missed.

IRS Supervision and Control Rule

The group exemption procedure is established by the IRS as an “administrative convenience”.  As a result, the IRS monitors the group exemption procedure to determine if it remains in the best interests of the IRS.  The IRS has concerns because it sees a large number of subsidiaries under group exemptions fail to timely file IRS Form 990 tax returns, leading to higher than average revocation rates among members of group exemptions.  In addition, the IRS monitors whether group exemption holders properly “supervise and control” their subsidiaries.  Unfortunately, the IRS has yet to detail the requirements of proper “supervision and control”.

Groups exemptions are both convenient, and complicated.  RENOSI manages the group exemptions of national organizations, including tracking IRS and state government nonprofit status, filing IRS Form 990 returns and required state registrations and fundraising documents, and interfacing with the IRS to add and delete members of group exemptions, and handle compliance issues.  Learn more at myrenosi.com.

Questions about group exemptions? 

Reach out to us.

More detailed information on topics covered in this post:

Form 990 Information and Resources

The Exempt Organizations Business Master File

IRS Publication 4573, Group Exemptions