Proposed New Guidance for Group Rulings Indicates Future Changes for All Groups

Proposing sweeping reform and updating archaic guidance for organization's holding group rulings, the IRS issued Notice 2020-36 proposing changes in the rules applicable to group rulings.  The guidance is issued in advance of a final revenue procedure that may be issued on the topic later this year. 

Not updated since 1980, guidance for organizations hosting a group ruling has been outdated for many years.  The new proposed guidance promises to be an all inclusive "how to" as it applies to central organizations hosting group rulings.  Group rulings are common in every area of exempt organizations but have not received great attention over the years.  Several years ago, the IRS performed a compliance initiative directed at group rulings.  While no formal report was issued, the proposed guidance more than like addresses concerns raised through the initiative.  Virtually all groups will be affected by the proposed guidance including church denominational group rulings.

Group rulings consist of a central organization (Central) that obtain its own exemption and then obtain special permission from the IRS to share its exemption with subordinate organizations (Subordinate).  Many well known organizations operate with group rulings including professional membership organizations, parent-teacher organizations, student/alumni groups and youth organizations.

Changing the Qualifications

A central organization has been able to obtain a group ruling determination as long as it has at least 1 subordinate organization.  The proposed guidance requires a new group have 5 members for the central organization to qualify for the group ruling.  Additionally, a group must always have at least one subordinate member to maintain the group.

A central organization will only be allowed to have one group exemption ruling. 

Preexisting groups will be required to comply with the above two provisions within one year after the final revenue procedure is published in the Internal Revenue Bulletin.

Strengthening Oversight

The IRS has long been frustrated by the lack of oversight provided by central organizations to subordinates.  Addressing this lack of oversight, the new guidance defines required oversight functions. Central must either exercise "general supervision" or "control" over its subordinates. 

• The Central must exercise general supervision by:
• Annually, obtaining, reviewing and retaining information on Subordinates' finances, activities and compliance with annual filing requirements. In other words, Central is obtaining proof that each subordinate required to file Form 990 is filing the appropriate return as well as obtaining other operational information.  
• Central will actively educate Subordinates on the Form 990 filing requirements in writing. This requirement addresses the consistent issue with Subordinates losing tax exempt status due to the auto revocation requirements. 
• Control - Control is accomplished when Central appoints the majority of Subordinate's officers, directors or trustees; or a majority of Subordinate's officers, directors or trustees are officers, directors or trustees of Central. 

New Inclusion Requirements

Tightening the requirements for who may be included in the group ruling, the new guidance restricts inclusion to: 

• Central and all subordinates must be exempt under the same 501(c) section.  For example, if Central is a 501(c)(4), then all the subordinates must be classified under 501(c)(4).  
• Further restrictions for 501(c)(3) organizations require all subordinates to be classified  as public charities under the same 509(a) classification, but it is not necessary that they all be classified under the same 170(b)(1)(A) classification.  For example, a church's denominational ruling may cover schools, churches and hospitals.  All of these are classified under 170(b)(1)(A) under different subsections. Subordinates may be publicly supported under 509(a)(1) and 170(b)(1)(A)(vi) interchangeably with a public charity classification under 509(a)(2) and still maintain membership in the group.  However, it does not appear that organizations classified under 509(a)(3), supporting organizations, could be included in a ruling unless it solely consists of 509(a)(3) supporting organizations.  Additionally, Type III supporting organization are banned from inclusion in any group rulings. 
• For groups outside the 501(c)(3) arena, all subordinates must also share a the same primary purpose and the same NTEE classification code. 
• All subordinates must adopt a uniform governing document.  Providing a "suggested" document is not sufficient.  If a 501(c)(3) group contains differing organizations; i.e., churches, schools, hospitals, a uniform document must be adopted for each group. Subordinates do not have to be corporations, but they must have a governing document.  (Note:  Due to varying state requirements, it will be interesting to see the final format of this particular requirement.)

Effective Dates 

Except for the items discussed under "Changing the Qualifications" above, the new rules are generally effective when the final revenue procedure is published.  For new subordinates, the effective date is immediate upon the publication of the revenue procedure.  While other transition relief is granted for preexisting subordinates for some of the rules allowing them to continue in the group, the application of the new rules to all new subordinates may restrict who may join the group.  Additionally, there does not appear to be a proposed transition for applying the new oversight rules.  

Summary

Long over due, it is time for all groups to reexamine the way they operate.  Some groups will have to restructure due to the matching requirements.  While the old rules still apply, groups are best served by transitioning to the proposed new rules.  Starting June 17, 2020, the IRS will no longer accept any requests for group rulings until after the publication of the final revenue procedure. Comments on the proposed new rules may be submitted to the IRS until August 16, 2020.  Due to the potential restructuring involved to institute some of the new guidance, the IRS should expect a lot of comments between now and August 16th.