While often used interchangeably, “nonprofit,” “tax-exempt,” and “501(c)(3)” have distinct meanings under the law and different legal obligations. Nonprofit organizations are created under state law but are not automatically tax-exempt from state sales and income taxes without filing for such an exemption through the Franchise Tax Board. Additionally, organizations are given tax-exempt status from federal income tax under federallaw, through the Internal Revenue Service.
A group exemption affords the opportunity for a nonprofit organization to share the tax-exemption of another 501(c)(3) without the need for each entity to seek its own tax exemption. To do so, the following conditions must be met:
- There must be a parent, or central, organization that will be considered the umbrella holder;
- There must be two or more subordinate nonprofits that will make up the group members;
- Each subordinate organization must be affiliated with the parent organization;
- Each subordinate must be subject to the central organization’s general supervision or control;
- Each subordinate must be exempt under the same paragraph of Internal Revenue Code 501(c), though not necessarily the paragraph under which the central organization is exempt;
- Each subordinate must be an independent entity with regard to corporate structure and governance, i.e., it is a separate legal entity with its own board of directors.
The primary advantage is that each subordinate does not have to submit to the IRS Form 1023 application and review process to receive tax-exempt status. Once they are legally formed, usually by incorporation, a parent entity that already has group status can simply add them to their list of oversight subordinates, and report that addition to the IRS.
A group exemption letter is a ruling or determination that is issued to a central or parent organization which holds that one or more subordinate organizations are exempt from federal income tax by virtue of being subordinate organizations of a central or parent organization. To obtain a group exemption letter, a parent must follow the procedures outlined in Rev. Proc. 80-27. The revenue procedure provides that the parent must submit certain information on behalf of the subordinates and that information must include a letter signed by an authorized representative that the subordinate has met the foregoing five-factor test. In addition, the following representations must be submitted over the signature of an authorized representative of the parent:
- a detailed description of the principal purposes and activities of the subordinates, including financial information;
- a sample copy of the subordinates’ uniform governing instrument which has been adopted by the subordinates (alternatively, a representative instrument may be
- an affirmation that the subordinates’ purposes and activities are as set forth in the representations furnished in (1) and (2) above;
- a statement that each subordinate has furnished a written authorization to be included in the group exemption letter; and
- a list of the subordinates who have been previously recognized as exempt from federal income tax.
With limited exceptions, churches are subject to the same general requirements relating to group rulings as other organizations. However, churches are not required to file annual updates notifying the IRS of changes in the composition of the group.
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Disclaimer: Every situation is different and particular facts may vary thereby changing or altering a possible course of action or conclusion. The information contained herein is intended to be general in nature as laws vary between federal, state, counties, and municipalities and therefore may not apply to any given matter. This information is not intended to be legal advice or relied upon as a legal opinion, course of action, accounting, tax, or other professional services. You should consult the proper legal or professional advisor knowledgeable in the area that pertains to your particular situation.