We have blogged and otherwise published previously about the extensive processing delays at the IRS that are affecting many new charitable organizations. As wait times increase, more organizations and attorneys are raising the possibility of using a declaratory judgment action as an alternative to letting the IRS process play out. Unfortunately, for many charities this is not a practical option, though some may be able to utilize it.
Filing for 501(c)(3) Status
The route to 501(c)(3) status generally begins with an organization filing a Form 1023 with the IRS (though some organizations are exempt from this filing requirement). Processing time for the Form 1023 varies depending on an organization’s structure and activities, but in general, the IRS initially sorts applications to determine if the agency needs more information to complete its review. If so, it assigns that application to an Exempt Organizations agent who then will work up the application in more detail. The organization may get follow-up questions it needs to answer, and ultimately a successful organization will receive a determination letter that sets out its exemption from federal income tax under Section 501(c)(3).
However, the backlog at the IRS has gotten to the point where the IRS is assigning for further review applications that it received in April 2012. Many organizations have been waiting for more than a year now with no word or direction from the IRS (apart from a letter that confirms that the application has been received). These organizations often face difficulties with fundraising, since many individuals and funders want a determination letter in hand before contributing. They may have been struggling to develop and carry out their programs, and likely have been looking into alternatives like fiscal sponsorship or consolidation with an existing nonprofit. And some may be considering looking to the courts for their next step.
Considering the Declaratory Action Option
Under the tax code, an organization can seek a court’s declaratory judgment in an actual controversy involving a determination by the Secretary with respect to initial qualification under 501(c)(3), or a failure by the IRS to make a determination. This is not a new process by any means, but it is getting more attention due to delays.
In a nutshell, in order to seek a declaratory judgment that it qualifies for exemption under Section 501(c)(3), an organization that has filed a Form 1023 with the IRS needs to have exhausted its administrative remedies, which—in a case where no determination has been issued—generally requires (i) the expiration of 270 days after the date of the request and (ii) taking all reasonable steps to secure a determination letter.
The exact requirements around “taking all reasonable steps” are not completely clear in a case where there has essentially been no feedback from or interaction with the IRS other than the letter acknowledging receipt of the Form 1023 and that it will be assigned to a reviewing agent. At a minimum, an organization should ensure that it has provided a complete, fully developed application that would support a determination of exempt status. However, it is important to note the reasoning behind the declaratory judgment option as stated by the IRS itself: to permit organizations not having a preferred status (e.g., 501(c)(3) status and non-private foundation status) to obtain a prompt determination of their status and to provide quick recourse through the courts. In addition, some case law supports that “after 270 days have passed a petitioner need only demonstrate that progress is severely hampered due to causes beyond its control.” See Prince Corp., 67 T.C. 318.
One organization, True the Vote, recently did file a complaint seeking declaratory judgment:
True the Vote is entitled to the relief requested because more than 270 days have passed since the filing of the substantially complete Form 1023 on July 15, 2010, and through no fault of True the Vote, the IRS still has not issued a Notice of Determination with respect to the Application. Due to the passage of the statutorily prescribed timeframe, all administrative remedies are deemed exhausted as a matter of law pursuant to 26 U.S.C. 7428(b)(2).
True the Vote submitted its Form 1023 in July 2010. It did actually get assigned to an agent and submitted answers to nearly 300 questions, according to the organization’s founder and president. However, it will be interesting to see if organizations who have not been assigned follow suit and try their hand with the court. Unfortunately, the cost and complexity of seeking a declaratory judgment will likely be a deterrent for many organizations. The pleadings must be filed in U.S. Tax Court, U.S. Court of Claims or U.S. District Court of District of Columbia (all in Washington, D.C.), and organizations that have been hampered with fundraising due to IRS delays would likely require the assistance of pro bono counsel—they likely won’t be in a position to pay additional legal fees related to the court process.
We’ll continue to monitor developments with the IRS and processing of applications, and will update the blog with any news.