IRS Revocation Process

Obtaining and keeping federal tax-exempt status under Section 501(c)(3) is fundamental to the operations of charitable organizations. This designation allows donors to claim tax deductions and ensures the entity does not pay corporate income taxes on its core mission income. Despite this protection, news reports frequently discuss calls for the immediate IRS revocation of status from high-profile non=profit institutions, including major educational organizations. These threats cause real concern, but organizational leaders must know one truth: the IRS is obligated to follow a long and formal process to revoke an organization’s tax exemption. Learn more about the IRS revocation process.

Legal Constraints on Revocation

The authority to challenge a nonprofit’s tax status rests exclusively with the Internal Revenue Service (IRS). There exists no legal mechanism for the President, the Department of the Treasury, or any other government official to dissolve an entity’s tax exemption with a unilateral order.

The procedures require a detailed, individual review for every entity under scrutiny. There is simply no lawful way for any administration to revoke the 501(c)(3) tax-exempt status of nonprofits without adhering to this established, formal process.

The Initiation of an Examination

When the IRS questions an organizations tax-exempt status , it begins an audit, formally called an “examination.” The examination focuses on determining if the entity has fully complied with the rules of the Internal Revenue Code. As part of the process, the IRS will review the organization’s filed Forms 990 to ensure the entity has maintained full nonprofit compliance throughout the tax years under review.

Common Risks That Trigger Scrutiny

Perhaps the greatest risk 501(c)(3) organizations rests in their violation of the core operating rules, some of which include:

• Insider Benefit (Private Inurement): This occurs when directors, officers, or key people improperly profit from the nonprofit’s income or assets. The law strictly forbids net earnings from flowing to an insider.
• Private Benefit: Giving substantial benefits to any private interest outside the organization’s mission.
• Political Campaign Activity: The law strictly forbids participating in campaigns for or against political candidates.
• Excessive Lobbying: While some work to influence legislation is allowed for public charities, it must not become a “substantial part” of the organization’s activities.
• Unrelated Business Income: Earning too much profit from activities not related to the charitable purpose can trigger issues.

Note on Automatic Revocation: It is crucial to remember that if a nonprofit fails to file its required annual information return (Form 990 series) for three consecutive years, its tax-exempt status is automatically revoked by law without the need for an audit or formal administrative review.

The Audit Outcomes and Right to Appeal

An IRS examination can be lengthy, often taking months, especially if it is a field audit. After the review, the IRS issues one of four potential results. Most outcomes, like a “no-change” letter or a closing agreement, allow the organization to keep its status. If the IRS proposes revocation, the organization may file a protest, which begins the administrative IRS appeals process.

Crucially, the organization retains its tax-exempt status throughout the entire administrative appeal. The organization’s representatives meet with an independent IRS appeals officer, who has the authority to settle the dispute or reverse the initial audit findings. This ensures a measure of due process before any final determination is made.

Final Legal Recourse and Operational Status

If the appeals officer upholds the proposed revocation, the entity receives a final letter and officially loses its federal exemption. Even at this final stage, the organization maintains the right to appeal to a federal court, such as the U.S. Tax Court, within ninety days.

If the nonprofit ultimately loses the court case, it simply becomes a private, taxable corporation. The IRS cannot shut down the corporation or confiscate its assets. The organization would then be required to file an annual corporate tax return (Form 1120).

Compliance

Through careful governance and compliance, organizations hold the power to protect their status and their mission.  Coupled with accurate recordkeeping, it is imperative for management to understand the rules and maintain a commitment to the non-profit’s stated principles. 

Contact RJS LAW | IRS Revocation Process

If you or your clients are concerned about the status of your tax-exempt organization, the experienced tax and compliance attorneys at RJS LAW in San Diego can help. We provide guidance regarding an entity’s non-profit standing and how to effectively resolve IRS audits to keep and preserve tax-exempt status. To schedule a complimentary consultation call us today at (619)-595-1655 or visit RJS LAW on the web. 

Written by Chandara Diep, Esq., LL.M.