IRS denies a charter school’s request to avoid Form 990 filing

Plain-English summary

The IRS denied a charter school’s request to be excepted from filing Form 990 as a governmental affiliate. The school operated under a charter approved by a school district, but its board was elected by the school community rather than the public at large, and the school did not have the required IRS ruling recognizing it as a governmental affiliate. The IRS also found that the school did not possess enough affiliation factors under Rev. Proc. 95-48 and that excusing the filing was not shown to promote efficient tax administration. The determination states that the school must file Form 990 and discusses the consequences of failing to file for three consecutive years.

Ruling snapshot

• Question: Did the charter school qualify for an exception from Form 990 filing as a governmental affiliate?
• Outcome: denied
• Key authorities: IRC §§ 501(c)(3), 6033, 115, and 170; Treas. Reg. § 1.509(a)-4(g)(1)(i); Rev. Proc. 95-48.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Release Number: 201217025 Contact Person:
Release Date: 4/27/2012
Date: January 20, 2012 Identification Number:
Contact Number:
Employer Identification Number:
Legend: UIL Index:
6033.01-00
B= State 6033.00-00
C = School
Dear

We have considered your request for a ruling that you are not required to file annual
information returns on Form 990, Return of Organization Exempt From Income Tax,
pursuant to Rev. Proc. 95-48, 1995-2 C.B. 418. Based on the information provided, we
have concluded that you do not meet requirements to be excepted from filing Form 990.

The basis for our conclusion is set forth below.

Issue:

Do you meet the requirements to be excepted from filing Form 990 as a governmental
affiliate? No, for the reasons explained below.

Facts:

You were incorporated under the laws of B. You subsequently filed an application with C
School District to operate a charter school. Based on the information provided, you were
recognized as a charter school exempt under Code §501(c)(3). You offer a full range of
educational programs for basic kindergarten though twelfth grade as well as preschool,

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special, vocational, gifted and talented programs, bilingual education and many other
services and programs.

Each charter school in your district has a separate governing board; however, the Board of
Education must approve all charter school applications and budgets. The charter schools
are discretely presented components of the C School District’s annual reports because the

district is accountable for your financial reporting.

C School District approved your application to form and operate a charter school. Your
governing body consists of five members elected by your school community. Section 7 of
your charter contract indicates that your Board of Directors shall be accountable for the

governance and operations of your school.

Section 7.9.1 of your charter contract provides that your Board of Directors have the
authority to act independently when contracting for goods and services, selecting
personnel, procuring equipment and furniture, and that you are to be solely responsible for

purchases and/or financial agreements.

According to your school handbook, your board election procedures consist of an annual
election held by your existing Board of Directors. You will send notices in your school
handbook informing parents that a seat or seats are up for election at your annual meeting
of members. A couple weeks prior to the election, information regarding voting will be
distributed to parents. Candidates receiving the most votes at your annual meeting shall be

elected.

Your budget is annually reviewed and approved by your School District. Your school is
responsible for providing the school district with written revenue and expenditure reports in
addition to annual financial statement that reports detailing the costs of administration,
instruction and other spending categories, consistent with the format required by state law.

You stated that you do not have a ruling or determination letter from the Internal Revenue
Service (Service) recognizing you as an affiliate of a governmental unit.

Law:

Section 501(a) of the Code provides, in part, that organizations described in section 501(c)
are exempt from federal income tax. Section 501(c)(3) of the Code describes, in part, an
organization which is organized and operated exclusively for religious, charitable, scientific,
testing for public safety, literary, or educational purpose, no part of the net earnings of
which inures to the benefit of any private shareholder or individual.

Section 6033(a)(1) of the Code generally requires the filing of annual information returns by
exempt organizations.

Section 6033(a)(2)(A) of the Code provides certain mandatory exceptions to filing annual
information returns.

Section 6033(a)(2)(B) of the Code provides discretionary exceptions from filing such
returns where the Secretary “determines that such filing is not necessary to the efficient
administration of the tax laws.”

Rev. Proc. 95-48 provides an exception from filing for governmental units or affiliates of
governmental units that are exempt from federal income tax under section 501(c)(3).

Section 4.02(a) of Rev. Proc. 95-48 provides that an organization will be treated as an
affiliate of a governmental unit if it is described in section 501(c) and it has a ruling from the
Service that:

(1) Its exempt purpose income is excluded under section 115;

(2) It is entitled to receive deductible contributions under section 170(c)(1) because

the contributions are for the use of a governmental unit, or
(3) It is a wholly owned instrumentality of a state or political subdivision for
employment tax purposes; or (b) it meets the requirements of Section 4.02(b).

Section 4.02(b) of Rev. Proc. 95-48 provides the following criteria to be used to determine

whether an organization meets the requirements of Section 4.02(b):
(1) The organization is either operated, supervised or controlled (within the meaning
of section 1.509(a)-4(g)(1)(i) of the regulations) by governmental units or by an
organization's governing body that is elected by the public at large;
(2) The organization possesses two or more affiliation factors listed under Section

4.03 of the revenue procedure; and
(3) The organization's filing of Form 990 is not otherwise necessary to the efficient

administration of the internal revenue laws.
Section 4.03 of Rev. Proc. 95-48 describes among the affiliation factors the following:

(a) the organization was created by one or more governmental units, organizations
that are affiliates of governmental units, or public officials acting in their official
capacity.

(b) The organization's support is received principally from taxes, tolls, fines,
government appropriations, or fees collected pursuant to statutory authority.
Amounts received as government grants or other contract payments are not
qualifying support under this paragraph.

(c) The organization is financially accountable to one or more governmental units.

This factor is present if the organization is:
(i) required to report to governmental unit(s), at least annually, information

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comparable to that required by Form 990; and

(ii) is subject to financial audit by the governmental unit(s) to which it reports.
A report submitted voluntarily by the organization does not satisfy clause (i).
Also, reports and audits pursuant to government grants or other contracts do

not alone satisfy this paragraph (c).

(d) One or more governmental units, or organizations that are affiliates of
governmental units, exercise control over, or oversee, some or all of the
organization's expenditures (although it is not financially accountable to
governmental units as described in paragraph (c) of this section).

(e) If the organization is dissolved, its assets will (by reason of a provision in its
articles of organization or by operation of law) be distributed to one or more
governmental units, or organizations that are affiliates of governmental units within
the meaning of section 4 of this revenue procedure.

Section 4.04 of Rev. Proc. 95-48 provides that in making a ruling or determination whether
the organization's filing of Form 990 is otherwise necessary to the efficient administration of
the internal revenue laws under section 4.02(b)(iii), all relevant facts and circumstances

shall be considered.

Relevant facts and circumstances suggesting that filing is necessary for efficient tax
administration include the extent to which the organization has taxable subsidiaries or
participates in joint ventures with non-exempt entities; whether it engages in substantial
public fund-raising efforts; and whether its activities provide significant benefits to private

interests.

Application of Law:

Based on the information you submitted, and for the reasons explained below, we have
concluded that it is not in the interest of sound tax administration to approve your request

for exception from filing Form 990 as a governmental affiliate.

In order to qualify for the exception from the 990 filing requirement, you must demonstrate
that you are:

1. A governmental unit, or
2. Closely affiliated with a governmental unit.

You are not a governmental unit, so we have considered whether you are closely affiliated
with a governmental unit. Section 4.02(a) and 4.02(b) of Rev. Proc. 95-48 provide the
circumstances under which an organization will be treated an affiliate of a governmental

unit.

Section 4.02(a) requires that you have a ruling or determination from the Service that you
are “an affiliate of a governmental unit.” You do not have the necessary ruling.

You, also, do not meet the exception provided by Section 4.02(b) because:
(i) Your officers, directors or trustees are not appointed or elected by a

governmental unit or the public at large.
(ii) You do not possess more than 2 of the affiliation factors under section 4.03:

e You were not created by a governmental unit, affiliate or public official;

e The payments you receive from the school district are based on
contractual obligation rather than statutory authority;

e The annual reports you provide to the school district are provided pursuant
to your contract, not statutory financial accountability to the school district;
and

e There is no evidence that any governmental unit has the right to exercise
control over your expenditures beyond the terms of your contract with the
school district.

e Finally, the fact that your assets will be distributed to a governmental unit
on your dissolution is a single factor that is not sufficient to ensure that
your current operations are subject to the supervision and control of C
School District.

(iii) The Service has not found that the efficient administration of the internal
revenue laws will be promoted if you or similar organizations are granted relief
from the Form 990 requirement.

Applicant’s Position:

You assert that your charter contract shows that you are operated, supervised or controlled
(within the meaning of section 1.509(a)-4(g)(1)(i) of the regulations) by governmental unit(s)
or by an organization's governing body that is elected by the public at large. You assert that
the school district you are affiliated with has the authority to terminate your charter contract
for non-compliance under any of its terms.

Service’s Response to Applicant’s Position:

Your organization is not operated, supervised or controlled (within the meaning of section
1.509(a)-4(g)(1)(i) of the regulations) by governmental units or by an organization's
governing body that is elected by the public at large. Your annual election is restricted to
parents of your student body and is not open to the public at large. Your affiliated
governmental unit does not exercise the control and discretion over your governing body
comparable to that of a parent and subsidiary.

Conclusion:

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Based on the information you submitted and in accordance with Rev. Proc. 95-48, we deny
your request for exception from filing Form 990 as a governmental affiliate as it is not in the
interest of sound tax administration.

As explained above, you are not a government unit, and you are not closely affiliated with a
governmental unit.

Accordingly, we conclude it is not in the interest of sound tax administration to grant your
request for exception from filing Form 990 as a government affiliate.

Filing Penalties and Revocation of Tax-Exempt Status:

If a Form 990 or Form 990-EZ is not filed, the IRS may assess penalties on the
organization of $20 per day until it is filed. This penalty also applies when the filer fails to
include required information or to show correct information. The penalty for failure to file a
return or a complete return may not exceed the lesser of $10,000 or 5 percent of the
organization's gross receipts. For an organization that has gross receipts of over $1 million
for the year, the penalty is $100 a day up to a maximum of $50,000. The IRS may impose
penalties on organization managers who do not comply with a written demand that the
information be filed.

Section 6033(j) of the Code provides that failure to file Form 990, Form 990-EZ, or Form
990-N for 3 consecutive years results in revocation of tax-exempt status as of the filing due
date for the third return. An organization whose exemption is revoked under this section
must apply for reinstatement by filing a Form 1023 and paying a user fee, whether or not
the organization was originally required to file for exemption. Reinstatement of exemption
may be retroactive if the organization shows that the failure to file was for reasonable
cause. Information with respect to the implementation of Section 6033(i) is available at

www.irs.gov/eo.

If you have any questions, please contact the person whose name and telephone number
are shown in the heading of this letter.

Sincerely,

Lois G. Lerner
Director, Exempt Organizations

Enclosure: Notice 437
A redacted copy of this letter