Tax Exempt Status Revoked? Here Are the Next Steps

Tax-exempt status frees nonprofit organizations from paying federal income tax and helps them attract donors. However, this status can be withdrawn by the Internal Revenue Service (IRS) for non-compliance, leading to serious financial and operational repercussions. For any nonprofit’s leadership, it is important to understand the reasons for revocation, the immediate effects, and the path to potential reinstatement.

Common Reasons for Revocation

The most frequent cause for losing tax-exempt status is automatic revocation for failing to file a required annual information return, such as a Form 990, for three consecutive years. The specific form depends on the organization’s financial activity. This revocation happens automatically by law without an IRS audit or investigation.

The IRS can also revoke exempt status following an audit for substantive reasons. A primary concern is private benefit and inurement, which is the improper use of a nonprofit’s assets for the personal gain of insiders like officers or board members. Examples include paying excessive compensation or engaging in self-dealing transactions that benefit an insider at the organization’s expense.

Tax-exempt organizations are also prohibited from political campaign intervention. This includes participating in any political campaign on behalf of, or in opposition to, any candidate for public office. Prohibited activities include making financial contributions, endorsing candidates, or publishing statements favoring or opposing a candidate.

Generating excessive unrelated business income (UBI) can also jeopardize an organization’s exemption. UBI is income from a business that is regularly carried on and not substantially related to the organization’s exempt purpose. While nonprofits can have some UBI, they must file Form 990-T and pay taxes on it. If this business activity becomes the organization’s primary purpose, the IRS may revoke its exempt status.

Immediate Consequences of Revocation

The most direct consequence of losing tax-exempt status is that the organization must pay federal income tax. It becomes a taxable entity and must pay corporate or trust income taxes on its net income. For an automatic revocation, the effective date is the original due date of the third missed annual return.

Once the revocation is publicly announced, contributions made to the organization are no longer tax-deductible for donors. This loss of deductibility can severely impact an organization’s financial stability. Organizations must inform their donor base about this change in the tax treatment of their gifts.

The IRS makes the revocation a matter of public record. The agency publishes the names of revoked organizations on its website in the Automatic Revocation of Exemption List. The organization will also be removed from Publication 78, the official list of entities eligible to receive tax-deductible contributions. Since many state and local tax exemptions are contingent on federal status, a federal revocation often triggers a loss of these benefits as well.

Required Filings After Revocation

Once an organization’s tax-exempt status is revoked, it must begin filing federal income tax returns. The specific form required depends on the organization’s legal structure. A revoked organization formed as a corporation will file Form 1120, U.S. Corporation Income Tax Return. If structured as a trust, it must file Form 1041, U.S. Income Tax Return for Estates and Trusts.

This filing requirement begins for the tax year in which the exemption was lost and continues for all subsequent years until the status is reinstated. The due dates for these returns also differ from Form 990. Form 1120 is due by the 15th day of the 4th month after the tax year ends, while Form 1041 has the same deadline.

The organization is responsible for calculating its taxable income and paying any resulting income tax. Failure to file these required income tax returns or pay the taxes due can lead to additional penalties and interest, which compounds the financial difficulty of the revocation.

The Reinstatement Process

An organization must file a new application with the IRS to regain tax-exempt status, as the law does not permit an appeal of an automatic revocation. This involves submitting a complete Form 1023, Form 1023-EZ, or Form 1024, depending on the organization type. The application must be accompanied by the required user fee.

The IRS provides several paths for reinstatement, detailed in Revenue Procedure 2014-11. A streamlined retroactive reinstatement process is available for organizations automatically revoked for failing to file returns. This option is for smaller organizations eligible to file Form 990-EZ or 990-N, have not been previously revoked, and apply within 15 months of the revocation notice. This path restores the exemption back to the date of revocation, creating no gap in exempt status.

Organizations that do not qualify for the streamlined process can still seek retroactive reinstatement. This requires filing the full exemption application and providing a reasonable cause statement explaining the failure to file for at least one of the three years. If the IRS accepts the reasonable cause, it can reinstate the status back to the date of revocation, preserving the deductibility of donations received during the lapsed period.

If an organization cannot establish reasonable cause, it may still apply for reinstatement. However, the new exemption’s effective date will be the application’s post-mark date. This creates a gap period between the revocation and reinstatement during which the organization is treated as a taxable entity.