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New Organizations and Grant Makers Take Note: IRS Eliminates Advance Ruling Period For Public Charities

Tax-Exempt Organizations Update Norah L. Jones

On September 8, 2008, the Treasury Department issued temporary and final regulations that eliminate the advance ruling period for new organizations seeking public charity status on the basis of a public support test. These new regulations became effective beginning September 9, 2008,  and apply to taxable years beginning on or after January 1, 2008. The Internal Revenue Service (the "Service") sought these changes because it felt the old process was complex and burdensome for both the organizations and the government. In lieu of the prior procedure, the Service believes it can more effectively and efficiently measure public support of charities through annual reporting on the Schedule A to the new Form 990, Return of Organization Exempt from Income Tax.


Until recently, new organizations that wished to qualify as public charities on the basis of either the public support test in Section 170(b)(1)(A)(vi) of the Internal Revenue Code of 1986 (the "Code") or the public support test in Code Section 509(a)(2) would request an "advance ruling" of such public charity status at the time the organization filed its Form 1023, Application for Recognition of Exemption. Receiving a favorable advance ruling letter allowed donors to the organization to rely on its public charity status for its first five tax years.

The new organization did not need to demonstrate that it actually satisfied the applicable public support test until the end of the five-year advance ruling period. At that time, the organization filed a Form 8734, Support Schedule for Advance Ruling Period, with the Service. The Form 8734 required the organization to show that, over the aggregate of the prior five-year period, it had met at least one of the applicable public support tests.

If the organization failed to meet a public support test, it would be reclassified as a private foundation. If the organization satisfied one of the public support tests, then it would receive a definitive ruling classifying the organization as a public charity. After an organization received a definitive ruling, it was then required to meet one of the public support tests on a rolling four-year basis. (An update discussing the issues related to the recent changes to the public support computation period for organizations with a definitive ruling will be sent out in the upcoming weeks.)

Elimination of the Advance Ruling Period

Under the new regulations, if a new organization can establish in its Form 1023 application that it can reasonably expect to meet one of the public support tests during its first five years of existence, the Service will issue a final determination letter stating that the organization is classified as a public charity. With this ruling, the organization will be classified as a public charity for its first five years, regardless of the level of public support it actually receives. Additionally, the organization will no longer need to file a Form 8734. A new organization that is required to file a Form 990 or Form 990-EZ will instead report its public support on the new Schedule A each year.

Beginning with the organization's sixth year, the organization's public support percentage will be computed on the basis of a five-year period that includes both the reporting year and the prior four-year period. Thus, the 2008 Form 990 will include a public support schedule that considers the filing organization's sources of support for 2004-2008. If the organization meets the public support test on the basis of its support for those years, then the organization will be considered to be a public charity for both 2008 (the reporting year) and 2009 (the immediately subsequent year). Therefore, if in 2009 the organization fails to meet a public support based on its five-year computation period from 2004 through 2009, it will still be a public charity for the 2009 taxable year. If the same organization does not meet a public support test in 2010 based on support received from 2005 through 2010, it will be reclassified as a private foundation as of the beginning of taxable year 2010.

As a result of including the reporting tax year in the public support calculation, a charity may not know that it has lost its public charity status until some time in the following year. In these situations, the Service will not assert private foundation excise taxes for all or part of the first year when the charity is reclassified as a private foundation if it would lead to "unfair or inequitable results." This would include situations where the failure to meet a public support test was unforeseeable or due to circumstances beyond the charity's control.

Effects on Existing Public Charities and Private Foundations

The new regulations affect both new organizations and some that have already received advance rulings under the old regulations. Section 501(c)(3) organizations that received advance rulings that expired or will expire after June 9, 2008, can treat those letters as though they were definitive rulings. Under the new regulations, these organizations will be classified as public charities and will not need to file the Form 8734. Organizations with rulings that expired before June 9, 2008, are still subject to the old regulations and must file the Form 8734 at the end of the organization's advance ruling period to avoid being reclassified as a private foundation.

Donors may rely on these advance rulings to determine if an organization is a public charity. For example, private foundations may rely on these rulings for Code Section 4942  (qualifying distribution) and Code Section 4945 (taxable expenditure) purposes. Smaller organizations that are not required to file a Form 990 may still want to complete the new Schedule A for their own files as a means to demonstrate ongoing compliance with a public support test for potential grant-makers or other donors. Tracking this information may already be required for these organizations in order to comply with state filing requirements.

Finally, although the advance ruling period has been eliminated for new organizations, it may still apply to a private foundation that would like to terminate its private foundation status and qualify as a public charity. The regulations governing this reclassification and the effects of obtaining an advance ruling have not changed.

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This update is intended as a general summary of legal matters and not as specific advice to any particular client. If you have any questions concerning the subject matter of this update, please contact one of the authors of this update, Elaine Waterhouse Wilson at 312-715-5141 / [email protected], Norah L. Jones at 312-715-5052 / [email protected], Krupa Shah at 312-715-5027 / [email protected], or your Quarles & Brady LLP attorney.

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