This article discusses an IRS rule change for associations seeking formal IRS recognition of their tax-exempt status. The goal of obtaining exemption is to minimize tax risk and to get the most financial tax benefit in future year savings. But, refunds can be claimed too.
When the IRS sends out its favorable determination letters they now generally use the date the association mails in its form as the effective date of recognition. This started beginning in 2013 with a new rule in Rev. Proc. 2013-91. IRS says this rule will not apply when the association meets a 27 month deadline. This policy for filing within 27 months of formation is an IRS “invention” for non-501(c)(3) tax-exempts. Organizations like these do not have to file for IRS approval to get exempt status. This is similar to a rule for churches.
To explain, since the Tax Reform Act of 19692 gave us Code Section 508, the IRS has specific power to impose a filing deadline. But as written, it is only about “charities”, which are organizations that get tax-deductible contributions as 501(c)(3) tax-exempt groups. This is not the form of exempt status that associations can expect to get.
Restated, the IRS does not want to give written “recognition” of retroactive exempt status when that means looking back more than 27 months. This is a new position that seems to revoke IRS policy dating back to the year 1962. This can be important to HOAs that want a formal IRS letter to say the HOA is tax-exempt back to the time when it started. One reason to get that formal letter is to support a tax refund claim.
For HOAs the exempt status is usually based on Code § 501(c)(4) as a “social welfare organization.” This 2013 Revenue Procedure doesn’t mean an association can’t qualify as a section 501(c)(4) organization, or prevent it being self-declared for the pre-postmark period. It just means the IRS does not want to rule on that time period. This new position appears, at first reading, to put tax refund claims at risk to be denied.
The IRS holds and delays processing most applications. The processing time is currently running approximately 18 months to two years. Most applications are processed on a first come, first served basis. And the backlog is very long. So, when the IRS letter does come in it will have an effective date at least back to when the application got mailed in. For refund rights, this means at least the IRS should refund taxes paid during the processing time.
So, to get refunds for the three open years without question we want the IRS letter to have the full recognition back to the date an association was organized. Because that may not be in the letter approving recognition, it is allowable for a qualifying association.
There is also the prospect the IRS may seek to collect taxes owed for the period before the application is filed. And again, that will not be right for a qualifying association.
Note also, the potential for triggering a change in status taxable gain on appreciated assets. It might be argued by the IRS because of how the new in 1999 Treas. Reg. § 1.337(d)-4 is phrased to deal with a change in status from taxable to tax-exempt. Also referred to as the General Utilities doctrine repeal part of the Tax Reform Act of 1986.
So, to keep from triggering a taxable gain (as if this were a change in status from taxable to tax-exempt because of how Treas. Reg. § 1.337(d)-4 might apply) we want the IRS letter to have the recognition back to the date an association was organized. There are arguments based on standing IRS precedent for allowing fully retroactive recognition with the Form 1024.
The association should consider wisdom of the association filing Form 1120-H before filing the Form 1024.
Consider filing amended prior returns asserting the self-declared basis. Plus disclose the self-declared status in the first Form 990 and final Form 1120 filed after the favorable IRS letter is issued. A Board will be well advised to be prepared with precautions in the event the IRS might assert Treas. Reg. § 1.337(d)-4 to trigger taxable gain. Then it can have a strategic plan beyond the scope of this brief note.
Discussions with the IRS staff that wrote Rev. Proc. 2013-9 inform the view that the new “requirement” does not mean that your association will not be respected as exempt before the pre-postmark period. It just means that they do not want to rule on that. The IRS may respect a private letter ruling request, and perhaps shorten time for final action. Before filing that, an association Board will be well advised to engage a tax professional with experience in the area. A more in-depth planning to do beyond the scope of this brief article.
Different offices of the IRS handle the private letter ruling request. This is not the same office based in Cincinnati that receives the exempt status recognition applications.
Concepts of tax law have been referred to above in a manner to speed up reading. Doing that, however, relies on the reader to bring more background knowledge than some may feel sure about. So, feel free to open a line of contact. Be sure of meanings before taking action.
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Footnotes:
1 Discussed in June 2013 issue of HOAPulse. See at:
2 More famous for setting private foundation rules, including a minimum charitable payout requirement and a 4-percent excise tax on net investment income.
