The IRS has special procedures in place for recognizing a group of organizations as tax-exempt if they are affiliated with a central organization. A group exemption can reduce the administrative burden on multiple related organizations, but it can also be difficult to navigate if there is a breakdown in communications or the relationship between the central organization and one of the subordinate entities.
So just how does the group exemption work? And how can organizations avoid pitfalls in navigating this complex relationship?
Practice Note: The IRS has proposed new rules governing group exemptions. Until the new rules are finalized, the IRS is not currently accepting new group exemption letters.
What are the requirements for the group exemption?
There must be a central organization that supervises or controls the subordinate entities. Group exemptions are commonly used by churches, fraternal organizations, and other national non-profits that operate through local chapters. Additionally, certain characteristics will disqualify a subordinate entity from participating in a group exemption. Entities that are organized and operated in foreign countries are excluded, as are private foundations. Finally, while each affiliate must have its own organizing document, the IRS does not require that each affiliate entity be incorporated at the state level. (However, Incorporation is usually a good idea regardless.)
How does a parent organization apply for group exemption?
The parent entity applies for the group exemption by applying for recognition of tax-exempt status (if it hasn’t already done so), submitting a letter to the IRS requesting group exemption, and paying the associated filing fees. The letter requesting group exemption should include:
Practice Note: Churches are unique organizations when it comes to tax-exempt status. Churches are generally not required to apply for recognition to be considered tax-exempt. (Many do for a variety of reasons, not least of which is it just makes life easier when you have your recognition letter from the IRS.) However, a central church organization that wishes to apply for group exemption must first apply for recognition of its own tax-exempt status in order to request a group exemption for local affiliate churches.
How does the parent organization maintain a group exemption?
As you can see, getting a group exemption requires a certain level of attention to detail, but is not an overly complex process. The problems I tend to see, whether from parent organizations or their subordinates, often come from maintaining the group exemption. Once the IRS grants group exemption, the central organization is expected to make sure that the subordinate entities continue to qualify for recognition as tax-exempt organizations (and/or verify that new organizations qualify).
The central organization is also required to submit an annual update to the IRS. This update must include:
Practice Note: Churches are not required to file these annual updates with the IRS, but questions about affiliation can arise when the central organization isn’t keeping good records of who is included in their group exemption.
What do I need to know if my organization is a subordinate entity?
Local organizations that are part of a group exemption are also still required to submit their annual Form 990 information return, as is the parent organization. However, the parent organization may also choose to submit a group return on behalf of some or all of the local organization. Depending on your activities, you may also still need to file tax returns on any unrelated business income.
What are some practical problems to be aware of?
Whether you are a large national organization or a small local affiliate, funders often want to see a copy of your determination letter from the IRS to prove that you are in fact a recognized tax-exempt organization. If you fall under a group exemption, you won’t have this letter. Instead, you will need a copy of the group exemption letter from your parent organization. And if your parent organization is less than organized or is dealing with internal strife and dysfunction, you might find it difficult to get the required documents when you apply for funding.
If the central organization dissolves or loses its tax-exempt status for any reason, then the subordinate entities automatically lose their tax-exempt status as well. Conversely, the parent organization can make its own determination that an affiliate no longer qualifies for exemption. Either way, the subordinate would then have 27 months to submit its own application for recognition of tax-exempt status. In addition to general disorganization, internal organization politics can play a major role here.
If you have questions about your group exemption: