Tax Law Blog

Navigating IRS Scrutiny: Ensuring Compliance for Tax-Exempt Entities

Healthcare executives are advised to consider the significance of a ruling issued in 2024 by the Internal Revenue Service (IRS) which revoked the tax-exempt status of a non-profit organization. In Private Letter Ruling* 202437007, the IRS determined that a non-profit organization had failed the “operational test” and revoked its tax-exempt status.

The entity in question had indicated no charitable activities or related expenses, leading the IRS to conclude that the organization was not operating exclusively for tax-exempt purposes.

Implications for Healthcare Organizations

For health care organizations of any size, particularly larger ones, the maintenance of non-profit entities can be essential to achieving broader social, charitable and educational objectives. Some healthcare organizations will maintain dormant (or virtually dormant) tax-exempt corporate entities, holding out the possibility that they will be fully utilized in the future. If an alternative or future need is identified, it could then be legally repurposed for similar, allowable activities.

This Private Letter Ruling (PLR) suggests that the IRS may be paying closer attention to whether these non-profit groups are carrying out their tax-exempt purposes or if they are dormant shells, lacking the required governance and operational independence. It seems the IRS is keen to put parent organizations on notice they are on the lookout for tax-exempt subsidiaries that don’t faithfully align with their stated purposes.

The PLR could also signal a potential shift towards a general heightened scrutiny of non-profit subsidiaries within healthcare systems. The agency may be reinforcing its legacy principle that tax-exempt status is always contingent upon demonstrable operational activity and genuine pursuit of the organization’s mission.

Recommendations for Maintaining Compliant Non-Profit Entities

To lower the risk of IRS scrutiny and enforcement actions, including the possible revocation of tax-exempt status, consider the following:

• Conduct Regular Operational Reviews – It’s highly recommended that healthcare organizations carefully review the status and activities of each of their subsidiary non-profits to ensure that they’re engaged in activities aligning with their tax-exempt purposes. This includes a forensic review of IRS Form 990 (Return of an organization exempt from income tax), financial statements, operational reports and related corporate communications.
• Document All Operational Activities – Ensure that a detailed, comprehensive record is kept for all activities, expenditures, contributions, communications and other evidence which shows that a tax-exempt entity is furthering its stated purpose. This documentation could become critical if a demonstration of compliance is required in the course of an IRS inquiry or audit.
• Repurpose Dormant Entities – If a non-profit is no longer serving its original purpose, consideration should be given to repurposing the entity for a similar, allowable charitable mission. Repurposing can be an alternative strategic path for adapting to an organization’s evolving needs while preserving its tax-exempt status.
• Engage Legal Counsel – Given the increased level of IRS scrutiny for tax-exempt entities, specialized legal assistance is recommended. Their expertise can help pilot non-profits through the ever-changing maze of IRS regulations and requirements, while empowering them to focus on charitable objectives.

Expect More IRS Scrutiny, Tighter Compliance Oversight for Tax-Exempt Entities

As noted, it may no longer be advisable to simply file an annual informational tax return if a non-profit’s activities can’t satisfy the IRS operational test. It appears that dormant non-profits may now be in jeopardy of losing their tax-exempt status.

Whether expanding into new areas of public health education, supporting underserved populations or fostering innovation, non-profit entities are still among the most powerful tools available in fulfilling a healthcare organization’s philanthropic and social aspirations.

Going forward, close oversight and strict adherence to all IRS regulations will be paramount in guaranteeing that non-profit entities can remain operational and relevant.

Foster Swift’s Health Care Practice Group has a team of seasoned health law experts who have served the industry for decades. Our specialized attorneys have the regulatory background to help ensure that non-profit health care organizations and foundations are fully compliant with IRS rules and flexible enough to evolve with changing community needs. If you have any questions or concerns regarding the tax-exempt status of a non-profit organization or other issues related to IRS regulations or compliance, please contact Jennifer Van Regenmorter at jregenmorter@fosterswift.com/616-796-2502 or Mike Zahrt at mzahrt@fosterswift.com/616-796-2223.

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*Private Letter Ruling (PLR) – An IRS Private Letter Ruling is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer’s represented set of facts.

Categories: Entity Selection, Organization & Planning, Nonprofit, Tax, Tax-Exempt Organizations