Advance Determination Ruling Details

The majority of ADRs that the Internal Revenue Service deals with are the tax status of employee benefit policies and nonprofit organizations. Here, we will concentrate on ADRs concerning nonprofit organizations.

Subsection 501 (c) (3) of the Internal Revenue tax code establishes that public charities and private foundations are exempt from federal tax. A 501 (c) (3) exemption status is highly prized, so an organization will seek an ADR that establishes the organization's status as tax-exempt. This subsection of the tax code also allows donors to deduct the donation from their tax liability. This helps the organization to raise more money. Many individual states also exempt these organizations from sales tax on purchases and property taxes.

To qualify as a 501 (c) (3), a nonprofit organization must dedicated its mission to one or more of the following purposes:

  • Charitable
  • Educational
  • Literary
  • Religious
  • Scientific
  • Promotion of amateur sport
  • Prevention of cruelty to animals
  • Prevention of cruelty to children

This may look simple enough, but decisions on tax-exempt status can be controversial. The Internal Revenue Service closely monitors organizations that have 501 (c) (3) status to ensure that their activities stay within the established definition of tax-exempt status. To apply for tax exemption, an organization must submit Form 1023 to the Internal Revenue Service. There are two versions of this form: an organization with a complicated structure will submit the standard 1023, whilst a simple nonprofit should choose 1023-EZ. The standard 1023 can take up to a year to process; the 1023-EZ can take as little as two weeks. It is very important to submit the correct form as not doing so can cause considerable difficulties in the future.

Advance Determination Ruling Example

Sara and Rob live and work in California. They are both English as Second Language teachers and make a reasonable income from their classes. Living in California, they know that the state attracts a lot of immigrants, some of whom have little or no English language skills. Many cannot afford to pay for classes right away. There are organizations in California to help, such as the San Francisco-based Intercultural Institute, but Sara and Rob believe there is room for more.

They could, of course, simply give a few people classes as and when time permits but Sara and Rob are more ambitious. They want to attract other teachers to work with them and build a state-wide network supported by donations from individuals and companies. They decide to establish the Sarob Center, based in San Bernardino. Sara and Rob are setting up a simple structure that clearly qualifies as an educational charity. They submit Form 1023-EZ to the Internal Revenue Service, and, three weeks later, they receive an ADR confirming their status.

As the Internal Revenue Service has established that the Sarob Center is federally tax-exempt, the procedure they have to follow to establish tax-exemption in California becomes easier.