2016 Brings New Changes in Regulation of Section 501(c)(4) Organizations
Recent developments and changes to the tax law have created a shifting regulatory environment for section 501(c)(4) organizations in 2016. The new developments include:
New section 501(c)(4) organizations must notify the IRS within 60 days of formation. The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) enacted a new notice requirement for section 501(c)(4) organizations. New section 501(c)(4) organizations have 60 days to notify the Internal Revenue Service (IRS) of their formation. Previously, new section 501(c)(4) organizations could potentially have almost 2 years before making any substantive filing with the IRS. A transition rule gives certain existing organizations a longer 180-day period (until June 15, 2016) to file this notice.
Form 990 disclosures. Under provisions of the PATH Act, section 501(c)(4) organizations must now provide additional information on their first Form 990 or Form 990-EZ that supports tax-exempt status under section 501(c)(4). This requirement initially appears to apply even if the organization has already applied for tax-exempt status with the IRS.
Exemption application process for section 501(c)(4) organizations. The new notice and Form 990 requirements under the PATH Act do not replace the exemption application process for section 501(c)(4) organizations, and section 501(c)(4) organizations may still file a separate application to request formal recognition of their exemption from the IRS.
State level disclosures of Schedule B. A recent Ninth Circuit case has given the California Attorney General access to the donor list (on Schedule B to the Form 990) for nonprofit organizations registered in California. This case will likely be appealed to the U.S. Supreme Court, which may or may not grant certiorari. Some organizations are concerned that providing access to the donor list for state agencies could chill donor involvement and support of section 501(c)(4) organizations.
Declaratory judgments made available to section 501(c)(4) organizations. The PATH Act now allows section 501(c)(4) organizations to ask a court to award tax-exempt status if the IRS refuses to do so within 270 days. Prior to the PATH Act, a section 501(c)(4) organization had little recourse if the IRS refused to process its exemption application, meaning that an organization could spend years in tax limbo while the IRS delayed its exemption determination.
The new notice requirement and additional Form 990 disclosure
Notice contents and deadlines. Section 501(c)(4) organizations are now required to file a notice with the IRS within 60 days of their formation that includes:
The organization’s name, address and taxpayer identification number;
The date the organization was formed; and
A statement of the organization’s purpose.
Although this information presumably will be easy to provide, the deadline for the notice may be extended for reasonable cause.
Transition deadline for existing organizations. A transition rule applies to organizations that were already in existence on December 18, 2015. For a section 501(c)(4) organization created on or before December 18, 2015, the organization must only file a notice if, on or before December 18, 2015, the organization had filed neither of the following:
A Form 990-series return (including the ePostcard); or
A Form 1024 exemption application.
In other words, if a new section 501(c)(4) organization already filed either Form 990 (including the ePostcard or Form 990-EZ) or had already filed Form 1024, then the new notice requirements do not apply to the organization.
Notice form. The IRS has not yet released a notice form but is expected to do so soon.
Notice fee. The PATH Act allows the IRS to impose a reasonable user fee for the notice, but no fee has been set. Interestingly, the PATH Act also provides that the fees collected from the notice cannot be expended by the IRS until permitted by an appropriations act.
Penalties. The penalty on the section 501(c)(4) organization for failing to file a required notice is $20 per day, with a maximum penalty of $5,000. A fee of $20 per day is also applicable to managers of the section 501(c)(4) organization if they fail to file a notice after a written demand from the IRS. The fee on all managers is also capped at $5,000. In other words, the maximum aggregate applicable penalties for not filing the required notice for a new section 501(c)(4) organization is $10,000.
Additional Form 990 disclosure. The PATH Act created a new requirement for section 501(c)(4) organizations to provide supporting information on their first Form 990 or Form 990-EZ for claiming section 501(c)(4) tax-exempt status. The specific information to be required will be set forth by Treasury Regulations. (Note: Treasury Regulations can take years, even decades, to be issued, so it is currently unclear how this requirement will apply in 2016, as the IRS has already released the Form 990 and Form 990-EZ for the 2015 tax year.) This disclosure requirement appears to apply even for an organization that has filed an exemption application with the IRS. Organizations filing the ePostcard are not currently subject to this requirement.
The notice does not replace the exemption application process. The new notice and disclosure obligations for section 501(c)(4) organizations do not replace the exemption application process. Section 501(c)(4) organizations may still seek an exemption determination from the IRS. Many organizations seek this determination so they can assure donors of tax-exempt status, or to receive other benefits such as state tax exemption or nonprofit mailing privileges. Interestingly, the legislative history of the PATH Act suggests that Congress intends for the IRS to develop a new exemption application for section 501(c)(4) applicants. (The current application is made on Form 1024, which is the same application used by a number of other section 501(c) groups, including veterans organizations, credit unions, trade associations, labor organizations, and others.) However, the plain text of the law does not require the IRS to develop a new application. An IRS representative informally assured us on the phone that Form 1024 will continue to be accepted by the IRS for the time being. (Note: Telephone advice is not binding on the IRS.)
Donor privacy potentially threatened
Recent Ninth Circuit ruling requires disclosure of donors to section 501(c)(4) organizations to the California Attorney General. The Ninth Circuit recently ruled that the California Attorney General could require disclosure of a section 501(c)(4) organization’s donors by obtaining a copy of the Schedule B when the organization provides a copy of its Form 990 for state registration purposes. This ruling is potentially troubling, as Schedule B is typically kept private. Although the California Attorney General has stated that the Schedule B will not be subject to public disclosure or improperly used, it remains to be seen how things develop.
1956 NAACP case established privacy rights for supporters of nonprofit organizations. Privacy protection for supporters of nonprofit organizations has a long history. In 1956, the Supreme Court of the United States upheld the right of the National Association for the Advancement of Colored People (NAACP) to avoid disclosing the names of its Alabama members to the state of Alabama (NAACP v. Alabama, 357 U.S. 449). In a case with a very convoluted procedural history—with the NAACP repeatedly facing an uphill battle in Alabama state courts until the U.S. Supreme Court stepped in to resolve the case—the Supreme Court held that Alabama could not force disclosure of the NAACP’s members. The opinion stated: “Immunity from state scrutiny of petitioner’s membership lists is here so related to the right of the petitioner’s members to pursue their lawful private interests privately and to associate freely with others in doing so as to come within the protection of the Fourteenth Amendment. The State has failed to show a controlling justification for the deterrent effect on the free enjoyment of the right to associate which disclosure of petitioner’s membership lists is likely to have.”
State filings of Form 990. Many states require nonprofit organizations, including section 501(c)(4) organizations, to file copies of their Form 990 or Form 990-EZ (which is an IRS form) with a state agency or the office of the state Attorney General. This requirement is typically in connection with fundraising registrations. The Schedule B of Form 990, which lists donors giving more than $5,000 and is not part of the public copy of the form, is usually withheld or redacted for these filings.
California requests for Schedule B. Recently, the California Attorney General began requiring Schedule B to be included with Form 990 filings in her office. Americans for Prosperity Foundation and the Thomas More Law Center challenged this requirement, asserting that disclosure would infringe free speech rights and deter donors from associating with or supporting their organizations. Although the Foundation and the Law Center won a preliminary injunction in the California District Court, the Ninth Circuit reversed and held that the Attorney General could require submission of Schedule B to her office. However, the Ninth Circuit did uphold an injunction against public disclosure of the information.
National impact. The California case has far-reaching implications because Schedule B lists not only California residents, but nationwide donors. Although the donor list is supposed to be kept private by the Attorney General, it is not clear what recourse, if any, an individual donor to a section 501(c)(4) organization would have if Schedule B were leaked or otherwise made public. A few other states claim to require an unredacted Schedule B, but California and New York currently appear to be the only states that enforce this requirement.
No improper disclosures currently known by state agencies. While the California Attorney General’s insistence on the donor list could trouble some privacy-minded donors, we are not aware of any significant examples of improper disclosure of donor names to the public by the California Attorney General or any other state agency.
Declaratory judgment process allowed for section 501(c)(4) organizations and gift taxes clarified
Declaratory judgment process available for section 501(c)(4) organizations. The PATH Act extends declaratory judgment procedures, which were already available for section 501(c)(3) organizations, to section 501(c)(4) and other 501(c) organizations. If the IRS does not act on an exemption application from a section 501(c)(4) organization within 270 days, the organization may ask a court to declare it exempt. This process gives a section 501(c)(4) organization a way to force an exemption determination if the IRS refuses to act.
Gift tax clarification. Prior to the PATH Act, the tax laws did not clearly exempt donations to section 501(c)(4) organizations from gift tax. While the IRS previously issued a statement promising not to enforce gift tax on donations to section 501(c)(4) organizations, the PATH Act provides certainty that gift tax will not apply.
In 2016, the regulatory landscape for section 501(c)(4) organizations looks very different than it did in 2015. In sum, the new developments include:
A 60-day notice requirement for new section 501(c)(4) organizations.
Additional Form 990 disclosure to support tax-exempt treatment on the initially filed Form 990 or Form 990-EZ by a section 501(c)(4) organization.
Access to a declaratory judgment process if the IRS does not process an exemption application within 270 days.
Clarity that gift tax will not apply to donations to section 501(c)(4) organizations.
The Ninth Circuit has allowed the California Attorney General to require copies of Schedule B (listing an organization’s donors) to be filed from nonprofit organizations registered in California, although Schedule B is still not subject to public disclosure.