Final Regulations Issued on Required Notice by Organization of Operation as a §501(c)(4) Organization

July 21, 2019 Ed Zollars, CPA

The IRS has released final regulations[1] regarding the notice requirement for organizations planning to operate as §501(c)(4) organizations that as added by the Protecting Americans from Tax Hikes (PATH) Act of 2015.

Organizations exempt from tax under §501(c)(4) include the following:

Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.[2]

However, the exemption does not apply unless no part of its earnings inures to the benefit of any private shareholder or individual.[3]

IRC §506, added by the PATH Act, requires organizations described in IRC §501(c)(4) to notify the IRS within 60 days after the entity is established, notify the IRS that it is operating as that type of organization.[4]

The statute provides the notice is to contain the following items:

The name, address, and taxpayer identification number of the organization.
The date on which, and the State under the laws of which, the organization was organized.
A statement of the purpose of the organization.[5]

The IRS is directed to acknowledge the receipt of this notice within 60 days.[6] As the well, the IRS is directed to impose a user fee for this submission.[7]

A penalty of $20 per day, up to $5,000 maximum, is imposed on an organization that does not timely file this notice, measured from the due date of the notice until the date the organization finally files the notice.[8]

Following the addition of this section to the law in December of 2015, the IRS issued the following interim guidance:

Notice 2016-09, which provided that the notice was to be due no earlier than 60 days after implementing regulations are finally issued. As well, entities that are looking for a ruling that they qualify as a §501(c)(4) organization (something not provided by the IRS when the basic notice is filed) were directed to continue to file Form 1024, Application for Recognition of Exemption Under Section 501(a), until further guidance was issued. This Notice as issued in January of 2016.
Temporary[9] and identical proposed regulations[10] were released on July 8, 2016 and published on July 12, 2016 with regard to these additions to the law. The temporary regulations provided that the notice was to be submitted to the IRS on Form 8976, Notice of Intent to Operate Under Section 501(c)(4), or its successor. The Form 8976 is to be submitted electronically via the IRS website.[11] The temporary regulations were effective and applicable on July 8, 2016.
At the same time as the temporary and proposed regulations were issued the IRS issued Revenue Procedure 2016-41. The procedure contained detailed information on filing the notice with the IRS and an example of what would qualify for a reasonable cause exception under IRC §506(d) to the penalty for a failure to timely file the form.

The final regulations adopt the proposed regulations without any significant revision.

The regulations provide that the notice must be provided via Form 8976 prepared in accordance with the instructions for the form, as well as with guidance provided in the Internal Revenue Bulletin—which, at this point, would be Revenue Procedure 2016-41.[12]

The regulations define the “date of organization” as the date on which the entity was formed as a legal entity.[13] Note that even if the organization does not actually initially begin operating as a §501(c)(4) organization, even if it decides to begin operating that way months or years later, the notice date still will refer back to the date of organization. The IRS rejected a request found in comments to change the date to the date the change in status is accomplished.

In the preamble, the IRS states:

The section 506(a) notification requirement applies no later than 60 days after the organization is established. Section 506(b)(2) further provides that the 506(a) notification shall include the date on which, and the state under the laws of which, the organization was organized. Section 506 did not indicate that any difference was intended between the use of “established” in section 506(a) and the reference to “organized” in section 506(b). Accordingly, the temporary regulations provided that, except as provided in paragraph (b) of the section, an organization (whether domestic or foreign) described in section 501(c)(4) must, no later than 60 days after the date the organization is organized, notify the Commissioner that it is operating as an organization described in section 501(c)(4) by submitting a completed Form 8976. See § 1.506-1T(a)(1). Following the longstanding approach on forms used to apply for exemption and for entering data into the IRS system, the temporary regulations in § 1.506-1T(a)(2)(ii) clarify that the date an organization is “organized” for section 506 purposes is the date on which it is formed as a legal entity.[14]

This creates a problem if the organization decides more than 60 days after the date of formation to operate as a §501(c)(4) organization—the application would be late even if filed on the date the organization began operating as a §501(c)(4) organization.

The IRS concludes this problem can be dealt with by the organization seeking reasonable cause relief under §506(d). In Revenue Procedure 2016-41 the IRS provided the following example of a case that would allow for reasonable cause relief:

Example

Reasonable Cause Under §506(d) per Revenue Procedure 2016-41

Organization O is formed under the laws of a foreign country and operates for a number of years during which it conducts no activities in the United States and has no income from U.S. sources. In October 2016, O commences operations in the United States from which it anticipates income that will be reported on a Form 990 (or require the filing of a Form 990-N) and promptly notifies the IRS of its intent to operate as a section 501(c)(4) organization by submitting Form 8976. Because the date of submission of Form 8976 is more than 60 days after its Date of Organization, O receives a penalty letter from the IRS. Based on these facts, O's failure is due to reasonable cause, and O may obtain relief from the penalty described in section 8.01(1) of this revenue procedure by submitting a request in accordance with the instructions in the correspondence from the IRS regarding the penalty.

The IRS explains why the agency believes a request for reasonable cause relief should be adequate based on the example found in the Revenue Procedure:

Although the final regulations do not provide for a procedure for automatic reasonable cause relief, organizations (including organizations formed before December 18, 2015, foreign organizations, small organizations, and organizations that originally operated under sections other than section 501(c)(4)) may seek reasonable cause relief by following the instructions in the penalty letter, as provided in Rev. Proc. 2016-41. Rev. Proc. 2016-41 includes an example of a situation in which reasonable cause relief would be appropriate regarding foreign organizations. The reasonable cause example included in Rev. Proc. 2016-41 is just one example of reasonable cause for purposes of section 506 only. Similar to the foreign organization discussed in the example provided in Rev. Proc. 2016-41, an organization (other than a section 501(c)(3) organization) that did not originally intend to operate under section 501(c)(4) is subject to the requirement to submit Form 8976 once it begins to operate as a section 501(c)(4) organization. Such an organization that files a Form 8976 within 60 days of amending its organizing document to be described in section 501(c)(4) would have reasonable cause for not filing a Form 8976 within 60 days of formation.[15]

Unfortunately the IRS notes that this request is to be made after the IRS sends correspondence regarding a penalty.[16] Considering that correspondence will come with a penalty already stated on the notice (most likely $5,000 if the organization has been in existence for any significant period of time), advisers aren’t likely to consider this the best approach the IRS could have taken with regard to this issue.

The final regulations continue to require any organization that wants a ruling on its qualification for §501(c)(4) status to file Form 1024, Application for Recognition of Exemption Under Section 501(a) separate from the Form 8976. Note that the filing of the Form 1024 does not serve as the required notice under §506, so the Form 8976 must be timely filed even if the organization is looking for a determination on their qualification for §501(c)(4) status.

[1] TD 9873, Publication date 7/23/19, https://s3.amazonaws.com/public-inspection.federalregister.gov/2019-15614.pdf, Retrieved July 21, 2019

[2] IRC §501(c)(4)(A)

[3] IRC §501(c)(4)(B)

[4] IRC §506(a)

[5] IRC §506(b)

[6] IRC §506(c)

[7] IRC §506(e)

[8] IRC §6652(c)

[9] TD 9775

[10] REG-101689-16

[11] https://www.irs.gov/charities-non-profits/electronically-submit-your-form-8976-notice-of-intent-to-operate-under-section-501c4, Retrieved July 21, 2019

[12] Reg §1.506-1(a)