Q&A #175 – Can a nonprofit organization’s 501(c)(3) tax-exempt status be revoked by executive order?

Question: My nonprofit organization is confident that we’ve always operated in compliance with the requirements of our 501(c)(3) status, but we are concerned about the possibility of being targeted for revocation. Is it possible to lose our 501(c)(3) status via executive order by the President, and if so, would there be any process to appeal this decision with the IRS?

Answer: It is well-established that a nonprofit organization’s tax-exempt status cannot be revoked by the mere issuance of an executive order. Revocation generally requires an individualized examination by the IRS with a notice of determination and opportunities for organizations to appeal, both within the IRS and in federal courts (subject to certain specific exceptions such as automatic revocation for failure to file Forms 990 for 3 consecutive years).

There has been much discussion in recent months regarding the possibility of the executive branch seeking to revoke the 501(c)(3) status of particular organizations, or groups of organizations, on the grounds of engaging in activities alleged to constitute a “substantial illegal purpose” or violation of “fundamental public policy.” The substantive merit of these theories is currently the subject of debate, as recently addressed in detail by law professor Ellen Aprill in an article titled “Revoking Tax-Exemption for Pursuit of DEI.” The procedures through which these attempted revocations would proceed, on the other hand, are well-established.

Section 7217 of the Internal Revenue Code prohibits most senior executive branch officials (including the President and Vice-President) from requesting that the IRS audit or investigate any particular taxpayer, with limited exceptions for the Attorney General and the Secretary of the Treasury.

Federal law also provides multiple opportunities to appeal most revocation decisions, as set forth in Section 7803 of the Internal Revenue Code (addressing rights to appeal within the IRS) and Section 7428 of the Internal Revenue Code (addressing rights to appeal revocation of tax-exempt status in federal courts). A basic familiarity with this process appeals is important for any organization that wants to be prepared in the event it is targeted for revocation.

Almost all revocations (except for automatic revocations for failure to file Forms 990 for 3 consecutive years) begin with an examination by the IRS, colloquially referred to as an IRS “audit.” During this process, an organization’s records, including tax filings, financial records, governing documents, and meeting minutes, are scrutinized for compliance with the federal tax laws governing tax-exempt organizations. While many examinations are resolved without issue (concluding with the IRS providing a “no-change letter”), one possible outcome of this process is the proposed revocation of the organization’s tax-exempt status.

In the event revocation is proposed, the organization will be so notified in a letter that includes the reasons for the proposed revocation and the organization’s right to appeal this decision with the IRS Independent Office of Appeals. A helpful summary of this process is included in IRS Publication 557.

If the proposed revocation is upheld by the Independent Office of Appeals, organizations have the right to contest the decision in federal court. These petitions can generally be brought in either the U.S. Tax Court, U.S. District Court, or the U.S. Court of Federal Claims, depending on the specific circumstances. The deadline for filing a petition in federal court is generally 90 days from the date the IRS mails the final notice of revocation, but organizations should consult an attorney experienced in handling tax controversies to be advised about the full array of rules and strategic decisions that may apply.

Planning Tip – In any IRS examination (or “audit”) of an organization’s compliance with the tax laws governing its tax-exempt status, having clear, complete, and contemporaneous documentation (including financial statements, employee time sheets, meeting minutes, etc.) is one of the most important factors protecting an organization from an adverse determination. Consequently, the first step to getting prepared for a potential IRS examination is to work with an attorney, CPA, and/pr other qualified professionals to review your documents, policies, and recordkeeping habits to identify potential issues and help you shore up any weak spots.

Note that while there have been legislative proposals to expand the power of the Secretary of the Treasury to strip tax-exempt status from organizations deemed by the Secretary of the Treasury as “terrorist supporting organizations” in ways that would impact the current processes, these proposals have not been passed into law as of the date of this writing.

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