Some nonprofits have been forced to restructure their organizations due to the economic challenges of the COVID-19 pandemic. Fortunately, IRS rule changes from a couple of years ago make the restructuring process far easier than it once was. If you’re considering such a change, here’s what you need to know.
How have the rules changed?
Under previous IRS rules, a tax-exempt organization was required to file a new exemption application when it made certain changes to its structure. Each of these circumstances was seen as creating a new legal entity that must file an exemption application. An unincorporated association that incorporated was generally considered a new legal entity required to file an application, as well.
To apply for new exempt status, a restructuring organization would need to file a final Form 990 under its initial Employer Identification Number (EIN), obtain a new EIN and apply for exemption for the new entity. In addition to being a time-consuming and often expensive process, the new organization risked failing to receive the desired tax-exempt status. This also required changing the EIN on all bank and investment accounts, which is part of the administrative burden of a restructuring.
Then change arrived under IRS Revenue Procedure 2018-15. Restructuring nonprofits are now only required to report significant organizational changes on their Forms 990. However, the restructuring must satisfy certain conditions.
What are the requirements?
To avoid the application process, the original organization must be 1) a U.S. corporation or an unincorporated association, and 2) tax exempt as a 501(c) organization. It also must be in good standing in the jurisdiction where it was incorporated or, in the case of an unincorporated association, formed.
The reorganization must involve one of the following:
- Changing from an unincorporated association to a corporation,
- Reincorporating a corporation under the laws of another state after dissolving in the original state,
- Filing articles of domestication to transfer a corporation to a new state without dissolving in the original state, or
- Merging a corporation with or into another corporation.
The resulting, or “surviving,” organization must carry out the same exempt purpose that the original organization had. If it’s a 501(c)(3) organization, the new articles of incorporation must continue to satisfy the IRS’s organizational test for such nonprofits. The test requires that the nonprofit’s organizing documents (for example, its articles of incorporation) limit its purposes and use of its assets to exempt purposes.
Any exceptions or caveats?
The new rules don’t apply if the surviving organization is a “disregarded entity” (an entity the IRS doesn’t consider to be separate from its owner for tax purposes), limited liability company (LLC), partnership or foreign business entity. They also don’t cover the incorporation of exempt trusts, or mergers of organizations into LLCs. Nor do the new rules include reorganizations in which the surviving organization obtains a new EIN. Surviving organizations that aren’t covered by the new rules must submit a new exemption application to be recognized as exempt.
Covered surviving organizations don’t escape without any reporting obligations, of course. The IRS still requires survivors to report the restructuring on any required Form 990 for the applicable tax year. In the case of a domestication or reincorporation in a different state, the surviving organization also must report its change of address on Forms 8822-B and 990.
Note, too, that the surviving organization will need to reapply for exemption if there’s been a material change to the exempt purpose or type of exemption from the original organization. An example would be switching from providing outreach services to having an advocacy mission.
The new rules apply only to federal income tax exemptions. Your state’s laws could require you to file a new exemption application.
If you’re considering restructuring, contact us. We can guide you through the process and help position your organization for future success.