Strategic Considerations for Tax-Exempt Status Revocation IRS Examinations

At the outset, the IRS does not threaten tax-exempt status revocation whenever it examines a tax-exempt organization. But revocation should always be viewed as a possibility when the IRS enters the picture. Tax-exempt organizations facing the possibility of tax-exempt status revocation must navigate a complex administrative and legal landscape that offers multiple opportunities for defense. Understanding the procedural process that can lead to revocation is crucial for organizations seeking to preserve their tax-exempt status and continue their charitable missions.

The IRS cannot arbitrarily revoke tax-exempt status—it must follow established procedures that provide organizations with a multitude of protections before the harsh result of revocation can occur.

One of the most important stages of the process is the IRS examination. During an IRS examination, the IRS examiners (also known as “auditors” or “revenue agents”) will often visit the location of the organization. This can be a great opportunity to demonstrate the good work of the organization and can be considered one of the most important steps in the examination. The “site visit” is a wonderful opportunity to dispel any misconceptions about the organization and demonstrate the organization’s charitable purpose.

During the examination, there will usually also be a series of IRS requests for documents and information about the organization. This process usually takes many months.

After the IRS examiners have reviewed the documents and information provided by the organization, the IRS will then make a decision regarding whether tax-exempt status revocation is proper. When the IRS proposes to revoke an organization's exempt status following an audit, it must issue a formal written notice explaining the basis for the proposed determination. This "30-day letter" triggers the organization's right to appeal within 30 days and begins a multi-stage process that can extend for months or even years.

One of the unique aspects of a tax-exempt organization IRS examination is a requirement that organizations exhaust all administrative remedies before being allowed to seek recourse in court. One such remedy is seeking a managerial conference—i.e., discussing the content of the 30-day letter with the IRS examiner’s manager—before challenging the 30-day letter. Traditionally, some practitioners have lacked optimism that a managerial conference could be beneficial, but that has not been my experience.

Organizations can face revocation proposals when the IRS determines they no longer operate for exempt purposes, operate for illegal purposes, engage in prohibited political activities, or provide excessive private benefits to organization insiders.

Revocation of tax-exempt status, which often can be retroactive, can be a death knell for an organization. For one, the organization may no longer qualify for certain grants. Second, if donors find out they can no longer receive a charitable contribution deduction for donations to the organization, they are unquestionably less likely to donate. Revocations are made public.

Still, there are opportunities to challenge a revocation before it is finalized. I intend to write further about the process to challenge IRS determinations to revoke an organization’s tax-exempt status in a subsequent blog post. In the meantime, if you have any questions regarding IRS tax-exempt examinations, or any other civil or criminal tax issues, please contact me at 214-749-2417 or jglassman@meadowscollier.com.