The IRS has recently released a revised Revenue Procedure giving tax exempt entities greater flexibility.  Previously an organization needed to decide at the onset where they wanted to be incorporated for the long haul, knowing that any future adjustment to the organization’s home state would require that organization to file the IRS Form 1023 “Application for Exemption” all over again.  These restrictions were unambiguous in the 40 and 50 year-old Revenue Rulings 67-390 and 77-469 which spelled out the requirements and provided clear examples.  As a result, it was unusual to see a charity switch locations due to the associated paperwork and hassles involved.

But now the IRS has expressly abandoned the restrictions of those Revenue Rulings and opened the door to new strategic possibilities for charities to consider.

With the same stroke the named regulations also stated that entities moving from one qualifying exempt structure to another would be excused from the need to reapply.  For example, an unincorporated association that has been approved for exemption and later becomes incorporated would – under the old rules – be required to apply all over again because a new legal entity had been created.  The rules now do not require reapplication in that scenario.

Rationale.  The rationale given for these changes is one of consistency.  The previous rules governing when an organization must re-apply for a FEIN, and when it must re-apply for exemption were not in line with one another, leading to somewhat irrational results.

Presumably this change will simplify matters for the IRS by creating a reduction in its workload once the redundant examination of “old-but-newly-headquartered” charities is eliminated.  The old law requiring a thorough examination of a charity which had changed nothing in terms of its exempt purposes, but merely its address may not have been the best allocation of scarce IRS resources – especially since the exempt organization would have already been scrutinized by the Service in determining qualification for exemption.

State Law.  This change in the rules will highlight the different corporate codes of the various states.  It will now be state rules that govern whether a charity can successfully transfer operations in one fluid motion, as opposed to the herky-jerky dissolution and reincorporation process.  The state tools to be used to make changes to an entity’s jurisdiction are the articles of domestication and articles of conversion, options currently available on a state-by-state basis.  It remains to be seen whether any changes to state codes or attempts at uniform protocol will follow this change in an effort to make the new IRS’s Procedure more seamless.

Potential Pitfall?  A conceivable area where the gate-keeping function might fall through the cracks, however, is in the case of a true “reincorporation” into another state, rather than just the filing of articles of conversion which could move the corporation to its new home under the same charter.  When unsupervised charities are writing their own articles of incorporation, things tend to go amiss.  One of the most-cited reasons for the rejection of a Form 1023 application is that the founding document either didn’t have a proper purpose clause or the required dissolution clause.

On the other hand, to the average visionary the idea of moving state locations might appear to be just the sort of legal matter that might warrant hiring an attorney for the process, which would (generally) lower the incidence of improperly scribed articles of incorporation.  Additionally, it might be assumed that an organization that was originally required to get it right in the first state would have a higher likelihood of getting it right in the second state, but time will tell.

It will be interesting to watch whether the added privileges of movement will lead to increased productivity in the exempt world, or if the released grip of IRS oversight will simply allow early-stage carelessness to sneak into the process.  Mistakes made in founding documents can lead to undesirable results.  If an entity builds on an improper foundation, the tax consequences can be bleak when the error is finally discovered.  Of course, the new IRS guidelines make clear that the organizational and operational tests are still required for any relocated entity, but how will this compliance be verified?  A relocated entity will, of course, be required to report the change on the following annual report to the IRS (Form 990), but the level of scrutiny given to the new incorporation documents remains to be seen.

Anecdotally, when the IRS made the Form 1023-EZ available, the rules regarding proper formation were still in place, but many start-up founders breezed right over these requirements.  This resulted in many improperly formed “charities” that had false assurances of status because they had forked over the $275 and gotten an official notice from the IRS.  The appeal of the “EZ” form has made it altogether too easy for well-intended charities to develop on improper foundations.

It will be interesting to watch guidance emerge to accompany this new latitude in the nonprofit world.

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