A panel of tax law experts and Tax Court judges at the American Bar Association (ABA) Virtual Fall Tax Conference highlighted the IRS’ data-driven approach to exempt-organization oversight, emphasizing emerging compliance risks and the importance of exhausting administrative remedies before challenging revocation of tax-exempt status in court.
Exempt-organization Trends
The exempt-organization sector has grown and diversified, speakers said to begin an ABA panel October 22. There are now about 1.9 million recognized IRC § 501(c) organizations, including 1.5 million charities and 71,000 social welfare organizations. The IRS has responded to this growth by adopting more sophisticated, risk-based approaches to identify likely non-compliant tax-exempt organizations.
The agency’s Compliance, Planning and Classification (CP&C) office now uses data analytics, compliance strategies, and referrals to select cases for audit. This is a shift away from random selection. Timothy Berger, member at Caplin & Drysdale, said the IRS “undertakes examinations of 501(c) organizations to ensure that they are meeting the requirements to be exempt.”
A major focus of the panel was the IRS’ scrutiny of new organizational models, especially name, image, and likeness (NIL) collectives. Berger explained that NIL collectives —organizations formed to pool funds and pay college athletes for use of their name, image, and likeness — have sought recognition as tax-exempt IRC § 501(c)(3) charities. But many collectives seeking exempt status “were raising funds and paying those amounts to athletes in various ways,” Berger said.
He added that the IRS issued a Chief Counsel Memo “that suggests that in most cases, those types of organizations are not going to qualify for exemption … presumably there is compliance work being done pursuant to that.”
The panel also discussed the role of public referrals in case selection. Form 13909, Tax-Exempt Organization Complaint (Referral), is a key tool for whistleblowers and the public to alert the IRS to potential noncompliance.
In fiscal year 2024, the IRS closed about 136,000 applications for exemption. It approved approximately 87.5% and disapproved less than 1%. About 13.2% fell into an ‘other’ category, which may include withdrawals or incomplete applications.
Examination
The IRS Tax Exempt and Government Entities (TE/GE) Division, through its Exempt Organizations (EO) Office, is responsible for both granting and monitoring tax-exempt status. The examination process begins with case selection by CP&C. This office uses compliance strategies, data analytics, and referrals — including public complaints via Forms 13909 — to identify organizations for audit.
Once selected, the IRS initiates the audit with an opening conference and issues “a flurry of” information document requests (IDRs) for a wide range of records. Melissa Wiley, partner at Kostelanetz LLP, explained that for this process, the “normal examination procedures largely apply.” She said to also expect “third-party contacts, interviews, and site visits,” which is all “very similar to what we would see in representing a taxable client.”
Common areas of noncompliance that may trigger a proposed revocation include private benefit or inurement, lack of internal controls, activities inconsistent with exempt purpose, failure to file required returns, and inaccurate reporting of unrelated business income. According to Wiley, smaller organizations often struggle to implement best practices, which can inadvertently lead to noncompliance.
At the end of the audit, the IRS may issue a no-change letter, negotiate a closing agreement, or propose revocation of exempt status. If revocation is proposed, the organization receives a “30-day letter” and has 30 days to respond. The case may then be forwarded to the IRS Independent Office of Appeals. This office is separate from the examination function and authorized to review the administrative record and consider the hazards of litigation.
Wiley recommended keeping printed copies of key IRS guidance and using the ‘Wayback Machine’ to research historical website content. “Take a look at all of your controls and procedures you have in place and make sure you really need all of them, because the last thing you want are a bunch of policies not legally required … especially because a lot of the exempt organizations we work with are on the smaller side.”
Challenges
The panel noted the statistical rarity of revocation cases in the Tax Court. Chief Special Trial Judge Zachary Fried explained that “[d]eclaratory judgment cases are very rare, and even smaller subset involves the revocation of tax-exempt status. Just get a picture of how few cases make their way to the Tax Court.” He reported that for 2024, only three declaratory judgment cases were filed, and just one involved a revocation out of more than 20,000 total cases.
If the IRS proposes revocation, the organization receives a 30-day letter and may file a protest. The case is then reviewed by Appeals, as it is separate from the examination function. Appeals can settle cases based on the hazards of litigation, but there is no “middle-ground” on revocation, as Berger mentioned. Appeals either sustains or does not sustain the revocation. The appeals process includes a preliminary review, an opportunity for conference (phone, video, or in-person), and the issuance of an Appeals Case Memo (ACM) explaining the decision.
If Appeals sustains the revocation, a final adverse determination letter is issued. The organization is then considered taxable. The organization may file a declaratory judgment action in federal court within 90 days. Tax Court Judge Courtney Jones explained jurisdiction lies “here at the Tax Court, the U.S. District Court for the District of Columbia, and the Court of Federal Claims in determination and revocation cases. In the [IRC § 7611] procedural context, jurisdiction can lie in other U.S. district courts.”
Judge Jones emphasized the importance of clear and discrete pleadings in litigation. She advised petitioners to separately address issues such as organizational deficiencies, operational failures, private benefit, and political activities. She reminded practitioners that the Internal Revenue Manual “does not carry the force of law, and it does not confer legal rights.”
She also warned about the risks of relying on AI-generated legal citations. “Artificial intelligence is an emerging area, and we’re just starting to learn all of its promises and all of its potential perils,” said Jones. When using AI, be “very, very careful to confirm citations,” Jones urged, as there have already been “a number of unfortunate incidents in which practitioners have presented to the court filings with citations that were obviously the product of AI hallucinations.”
For more on the Tax Court’s jurisdiction in tax-exempt status challenges, see Checkpoint’s Federal Tax Coordinator 2d ¶ U-3801.
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