The District of Columbia District Court recently clarified the circumstances in which the IRS may retroactively revoke an organization’s tax-exempt status. See Democratic Leadership Council, Inc., v. United States, 542 F. Supp. 2d 63 (D.C. DC 2008). Rejecting the IRS’s attempt to retroactively revoke the tax-exempt status of the Democratic Leadership Council (the “DLC”), a 501(c)(4) organization, the Court held that retroactive revocation is only appropriate if either of the requirements of Treasury Regulation Section 601.201(n)(6) are met: One, if the tax-exempt organization was not operating within the terms of its exemption ruling during the years at issue. Two, if the tax-exempt organization omitted or misstated a material fact in its original application for recognition of its exemption.
In this case, the IRS argued that the DLC did not qualify as a 501(c)(4) organization during 1997, 1998, or 1999 and that, as a result, the IRS was entitled to retroactively revoke the DLC’s tax-exempt status as of January 1, 1997. The Court rejected this argument, however, noting that even if the DLC did not qualify as a 501(c)(4) organization during 1997, 1998, or 1999, the IRS could only retroactively revoke its tax-exempt status if the IRS followed the rules set forth in Treasury Regulation Section 601.201(n)(6). Although the IRS argued that the Treasury Regulation only applied in cases, unlike this one, involving a lawsuit for a declaratory judgment regarding tax-exempt status, the Court disagreed, finding that Courts “consistently apply” the Treasury Regulation to decisions regarding retroactive revocation.
Examining the facts of the case, the Court readily determined that the DLC was operating within the terms of its exemption ruling and that it had not omitted or misstated any material fact in its original application for recognition of its exemption. Thus, while the Court noted that the DLC may engage in some activities and operations that are different from those set forth in its original application for recognition of its exemption, the Court found that those differences were not material. In addition, the Court also indicated that the IRS’s attempt to retroactively revoke the DLC’s tax-exempt status relied on the very disclosures set forth in the original application for recognition of its exemption; and the Court refused to allow the IRS to reexamine, on a retroactive basis, the legitimacy of the original decision to recognize the DLC’s tax-exempt status.
Notably, however, the Court specifically acknowledged that its ruling would not prohibit the IRS from prospectively revoking the DLC’s tax-exempt status. Thus, while tax-exempt organizations should be able to rely on Treasury Regulation Section 601.201(n)(6) to protect their tax-exempt status for prior years, it will not protect their tax-exempt status on a going-forward basis.
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