WASHINGTON - The Senate Finance Committee on Wednesday approved legislation that bond lawyers said would be helpful for nonprofit organizations in the municipal bond market.
The bill would require the Internal Revenue Service to notify a nonprofit before it revokes its tax-exempt status for failing to file annual Form 990 information returns. The proposal, backed by Sens. Dan Coats, R-Ind., and Ben Cardin, D-Md., was one of several bipartisan, noncontroversial bills that the committee approved by voice vote.
Nonprofits such as universities and hospitals can be the beneficiary of tax-exempt 501(c)(3) bonds. But those bonds can become taxable if a nonprofit loses its 501(c)(3) status at any point while the bonds are outstanding.
Under federal tax law, a 501(c)(3) organization automatically has its tax-exempt status revoked if it fails to file the required Form 990 returns or notices for three consecutive years. The nonprofit would have to apply to the Treasury Secretary to have its tax-exempt status reinstated. The tax-exempt status can be reinstated retroactively or prospectively.
The legislation would require the IRS to send notices to nonprofits that failed to file the annual information returns for two consecutive years. The notices would state that the IRS has no record of the organizations filing the Form 990s and would explain the consequences of failing to file a return by the date of the next filing deadline. The IRS would have to send the notices to nonprofits no later than 300 days after the date of their second failure to file Form 990, according to a description of the bill from the Joint Committee on Taxation.
The bill also would allow the Treasury Secretary to retroactively reinstate the tax-exempt status of any organization that had its status automatically revoked if the organization can demonstrates that it didn't receive a notice from the IRS and it files an annual return or notice for the current year, JCT said.
The proposal would be effective for returns and notices that nonprofits have to file after Dec. 31, 2014. It would have a negligible budgetary effect, according to JCT.
"The pre-revocation warnings to entities would help to minimize qualification problems when qualified 501(c)(3) bonds are issued and avoid continuing tax compliance problems that could affect existing qualified 501(c)(3) bonds," said Matthias Edrich, a shareholder at Greenberg Traurig.
Edrich and other bond lawyers said that the bill would be particularly beneficial for new and/or smaller nonprofits.
Linda Schakel, a partner at Ballard Spahr in Washington, said that there are many small organizations that are unaware of the revocation provision before they receive a revocation notice.
"Obviously the IRS has a system that triggers a notice if three filings have not been made and it would not seem much of a burden on the IRS to send a notice after two years. The notice burden is much less than the amount of time the IRS and organization have had to spend reinstating exempt status," she said.
Tom Vander Molen, a partner at Dorsey & Whitney, said, "I believe the proposal, if enacted, would be very helpful to small exempt organizations that have not been filing the required returns or notices, because it would give them a warning 65 days prior to an automatic revocation. Currently, such organizations typically are not aware of the pending revocation. If they used the 65 days to file a current return, they could avoid the revocation and not need to apply for reinstatement."
Ed Oswald, a partner at Orrick, Herrington and Sutcliffe in Washington, said that "there are events that could arise which could disrupt, delay or interfere with the filing," and that these events may be more common for new, smaller nonprofits.
"Overall the proposal is thoughtful and helpful to the 501(c)(3) community," he said.
Edrich said that it remains to be seen what the bill would mean for organizations' chances of receiving retroactive reinstatement after they failed to file returns for three consecutive years. Under a provision of federal tax law, tax-exempt status can be retroactively reinstated if the organization can show a reasonable cause for failing to file the returns.
"It is unclear whether reasonable cause for purposes of that provision can be shown if the entity has received a pre-revocation warning as contemplated by the bill but failed to act on that warning," he said.
The IRS recently established a standardized voluntary closing agreement program for issuers whose 501(c)(3) bonds benefited organizations that had their tax-exempt statuses prospectively reinstated after being revoked due to the failure to file returns for three consecutive years. The VCAP would allow the organizations to pay a penalty to settle the tax issue without jeopardizing the tax-exempt status of the bonds.
