United States: New Federal Tax Deal Brings A Few Early Holiday Gifts For The Tax-Exempt Community

Last Updated: January 11 2016
Article by Jeffrey S. Tenenbaum, Matthew T. Journy and Lindsey M. Avedisian

On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act of 2015. The PATH Act contains several provisions affecting federal tax-exempt organizations. Specifically, it establishes a mandatory, streamlined application process for 501(c)(4) tax-exemption recognition (which requires action by existing 501(c)(4) entities as well); it permits all existing or would-be tax-exempt entities to seek judicial review in federal court of any revocation or denial of (or failure to act on) exempt status recognition; it requires the IRS to create procedures under which a 501(c) tax-exempt organization facing an adverse determination may request an administrative appeal to the IRS Appeals Office; it exempts contributions to 501(c)(4), (c)(5), and (c)(6) tax-exempt organizations from federal gift tax; it makes permanent a number of federal tax "extenders," including several beneficial to charitable organizations; and it makes permanent the fair-market value exception from unrelated business taxable income for certain payments from controlled subsidiaries to their parent tax-exempt organizations.

Mandatory Application Process for Recognition of 501(c)(4) Tax-Exempt Status

The PATH Act imposes a new mandatory application process for all 501(c)(4) organizations. Until now, organizations intending to operate under 501(c)(4) were not required to file a tax-exempt status application with the IRS. Potential 501(c)(4) organizations could either self-certify their exemption qualification or complete the 19-page IRS Form 1024 (which such organizations frequently opt to do) in order to receive an IRS determination letter recognizing their tax-exempt status. The PATH Act establishes a streamlined process for organizations to obtain IRS recognition of 501(c)(4) status. Potential 501(c)(4) organizations formed after the PATH Act's enactment (December 18, 2015) must file a one-page notice of registration with the IRS within 60 days of formation. In turn, the IRS must provide a letter acknowledging the registration within 60 days of receiving the one-page notice. This letter is proof of IRS recognition of the organization's exempt status. 501(c)(4) organizations already in existence as of December 18, 2015 that have never filed a Form 1024 or a Form 990 must file a one-page notice of registration with the IRS within 180 days of December 18, 2015. This means that all 501(c)(4) organizations must either have previously filed a Form 1024 or Form 990, or file the one-page notice of registration within the appropriate time frame. The IRS is expected to release the one-page notice of registration form early in 2016. The existing Form 1024 process will still be available – using a new version of the Form – to would-be 501(c)(4) organizations that want more certainty regarding their exempt status determination.

Declaratory Judgments Available to All Section 501(c) Organizations

The PATH Act extends the ability of tax-exempt organizations to obtain declaratory judgments from a federal court to all organizations exempt or seeking exemption under Internal Revenue Section 501(c). By providing all 501(c) organizations with the ability to obtain a judicial declaratory judgment, the PATH Act provides greater recourse for organizations whose tax-exempt status the IRS has revoked, denied, or failed to issue a final determination.

IRS Required to Issue Procedures for Administrative Appeals to the IRS Appeals Office

The PATH Act requires the IRS to create procedures under which a tax-exempt organization facing an adverse determination may request an administrative appeal to the IRS Office of Appeals. This includes determinations relating to the initial or continuing classification of an organization as tax-exempt under Section 501(a), an organization under section 170(c)(2), a private foundation under Section 509(a), or a private operating foundation under Section 4942(j)(3). The provision applies to determinations made after May 19, 2014.

Contributions to 501(c)(4), (c)(5), and (c)(6) Organizations Not Subject to Federal Gift Tax

In the PATH Act, Congress finally addresses the issue of whether contributions to 501(c)(4), (c)(5), and (c)(6) organizations are subject to federal gift tax. For years, this issue has been a murky one, and the IRS has declined to directly rule on the matter. Now, the PATH Act explicitly states that any contributions made to 501(c)(4), (c)(5), and (c)(6) organizations are not subject to federal gift tax. This applies to any contributions made after the PATH Act's date of enactment (December 18, 2015). Because of IRS administrative forbearance, contributions made prior to December 18, 2015 are likely not subject to gift tax either.

Tax Extenders Made Permanent

The PATH Act permanently extends a number of federal tax provisions intended to incentivize charitable giving, including:

  • The ability to take tax-free distributions from individual retirement plans (IRAs) when donated to a tax-exempt charity (subject to certain limitations, such as a $100,000 per tax year limit, a minimum 70-1/2 age requirement, and the fact that the recipient charity may not be a supporting organization or a donor-advised fund);
  • Increased charitable deduction limits for contributions by individuals or corporations of real property interests for conservation purposes (the normal 30% of adjusted gross income limit for appreciated property gifts is increased to 50% and the carryforward limit is extended from five years to 15 years);
  • The enhanced charitable deduction for charitable contributions of excess food inventory (of "apparently wholesome food") (the deduction is the lesser of twice the basis or basis plus one-half of the appreciation; the deduction limit is raised to 15%); and
  • The adjustment of basis in S corporation stock when an S corporation makes a charitable contribution of property (when a Subchapter S corporation gives appreciated stock or land to charity, only the basis of the S corporation in the donated asset will be used to reduce the shareholder basis, even though the full fair-market value deduction is claimed by the shareholder).

Certain Payments by Controlled Subsidiaries to Parent Tax-Exempt Organizations

The Act also makes permanent the favorable tax treatment for certain payments made by a controlled taxable or tax-exempt entity to the controlling tax-exempt organization. Under Section 512(b)(13), certain payments by a controlled subsidiary to a tax-exempt parent, such as rent, royalties, annuities, or interest, produce unrelated business taxable income to the parent. Control is defined as the parent having over 50% of the stock or beneficial interests in the controlled entity. The PATH Act makes permanent the arm's-length transaction exception; if such payments meet a fair market value standard, there will not be any unrelated business taxable income to the parent.

Note that the PATH Act slightly modifies previous iterations of some of these federal tax provisions. Thus, anyone intending to take advantage of the PATH Act's permanent tax extenders should be sure to fully review the details of such extenders under the Act, rather than merely rely upon past use of similar tax provisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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