This entry comes to you with the help of my colleague Wendy Tauriainen.
In our office, we enjoy the inside jokes of the pension and benefits world (yes there actually are jokes). One of them is the label “bitaxual” for those entities that are lucky enough to be both exempt from tax based on the fact that they are an “instrumentality” of government and because they have received a tax-exemption from the IRS as a Code section 501(c)(3) organization. One example of a governmental entity that might hold this special status is a public hospital district. So-called bitaxual entities are special because they can simultaneously maintain an eligible deferred compensation plan under Code section 457(b) and a Code section 403(b) plan.
We want to alert our readers to a development that is taking some governmental entities by surprise. Recently, a number of our governmental clients, which are also 501(c)(3) tax-exempt organizations, have come to us after the IRS revoked their 501(c)(3) tax-exempt status for failing to file a Form 990 – Return of Organization Exempt from Income Tax. This can be especially alarming for governmental 501(c)(3) entities that sponsor a 403(b) plan – a type of plan that can be sponsored only by a
501(c)(3) entity or a public education employer. Without that 501(c)(3) status, a 403(b) plan that is sponsored by a governmental employer that is not a public education employer has suddenly lost its tax-favored status with potentially disastrous results for plan participants.
Here’s how it happens. The IRS maintains a list of 501(c)(3) entities. These entities, with certain exceptions, are required to file an annual Form 990. Generally, governmental entities meet one of those exceptions and are not required to file a Form 990. However, the IRS checks its database of 501(c)(3) entities looking for charities that haven’t filed their Form 990. If the IRS finds one, and doesn’t know that the 501(c)(3) is also a governmental entity, it will automatically revoke the entity’s 501(c)(3) status if no Form 990 was filed for three consecutive years.
How does the IRS know if your 501(c)(3) is also a governmental entity exempt from filing a Form 990? It doesn’t, unless you apply to the IRS for a ruling on that question. While such a ruling is not required for the Form 990 governmental entity exemption to apply, it may be worth considering. Also pay careful attention to any letter you receive from the IRS demanding that your 501(c)(3) file a Form 990. Ignoring these letters could result in an automatic revocation of 501(c)(3) status and the attendant consequences to your ability to raise funds or sponsor a benefit plan available to 501(c)(3) entities only. Further, once 501(c)(3) status is automatically revoked, reinstatement can be an arduous process with no assurance that the reinstatement application will be successful.
To sum up, if you are a governmental 501(c)(3), consider applying to the IRS for a ruling that you are a governmental entity exempt from filing Forms 990. Also, keep a close eye on the mail and make sure to let the IRS know of your governmental status if the IRS starts asking for Forms 990. It is much easier to deal with the IRS before it revokes your 501(c)(3) status than after it has taken that step.