BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 404 - Eng
Amended: April 14, 2009
Hearing: July 8, 2009 Fiscal: Yes
SUBJECT: Non-Profit organizations do not have to apply
for state tax exemption after approval from
federal tax exemption
EXISTING LAW greatly simplified the process to obtain
exemption under California law for certain entities that
are treated as tax-exempt organizations under the Internal
Revenue Code (IRC) Section 501(c) (3). With the passage of
AB 897, effective January 1, 2008, the Franchise Tax Board
(FTB) may approve a 501(c) (3) organization's tax exempt
status based on the Internal Revenue Service's (IRS)
approval of the organization's tax-exempt status.
Existing Federal Law:
Under the Internal Revenue Code (IRC), certain
entities are treated as tax-exempt organizations. These
entities are classified under the IRC 501 (c) (3). To
qualify for exempt status, an organization that is
classified as a 501 (c) (3) must be organized under state
law as a corporation, community chest, fund, or foundation.
Churches, conventions, or associations of churches, and
any organization other than a private foundation normally
having annual gross receipts of less than $5000 annually,
are exempt automatically if they meet the requirements of
the IRC 501 (c)(3). Organizations that are not
automatically exempt by federal law must apply for
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tax-exempt status by submitting an application to the IRS.
Included in the application is a copy of the
organization's Article of Incorporation, a full description
of the proposed activities and description of anticipated
receipts and contemplated expenditures, financial
statements, and a user fee.
Group exemption:
The IRS may recognize a group of organizations as
tax-exempt if they are closely affiliated with a central or
parent organization that qualifies for the exemption under
IRC Section 501(c) (3).
State Law:
The FTB is allowed to use the IRS's ruling to
determine an organization's tax-exempt status at the state
level. IRC section 501 (c) (3) organizations that are
tax-exempt may submit a submission of its IRS determination
letter and they are automatically granted state tax-exempt
status.
Group exemption:
The California group exemption process is independent
from the federal law and procedures with respect to the
qualification for a central organization and its
subordinates. Existing law was unclear as to whether an
organization that is part of a federal group exemption can
apply for state exemption on the basis of the federal group
exemption if the central organization and all of its
subordinates are IRC section 501 (c) (3) organizations.
THIS BILL provides a mechanism which allows the FTB to
issue an acknowledgement letter when documents are
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submitted to the FTB to verify an organization's exemption
based on the federal determination.
AB 404 also clarifies which organizations exempt under
a federal group exemption letter may rely upon the
simplified procedure to be recognized as an exempt
organization under California law.
The effective date of an organization's exemption from
state income tax shall be no later than the effective date
of the organization's recognition of exemption from federal
income tax.
The FTB would not be prevented from revoking an
organization's state tax-exempt status if the IRS suspends
or revokes the organization's tax exemption or the
organization fails to meet certain California provisions
governing exempt organizations. The organization's state
tax exemption status would be reinstated only upon
compliance with Revenue and Taxation Code section 23701,
regardless of whether the organization can establish
federal exemption.
If a central organization's exemption status is
withdrawn or revoked, all of the supporting or affiliated
group members' status will be similarly revoked immediately
and can be reinstated only upon compliance with Revenue
Taxation Code section 23701.
FISCAL EFFECT:
The FTB states this bill would not extensively impact
the department's costs.
COMMENTS
A. Purpose of the bill
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This bill is to clarify the uncertainties that were
raised by AB 897. This bill does not change existing law.
Making it easier for organizations tax exempt under federal
law to become exempt under California law will allow more
of such organizations' resources to be used for exempt
purposes than for administrative purposes and may attract
more exempt organizations to form and operate in
California, which would have a positive fiscal impact.
B. How AB 897 changed non-profit filing
According to the author's office, the purpose of AB
897 is to remove the double qualification process for
organizations who are applying for tax-exempt status by
allowing entities that are tax-exempt under federal law be
tax-exempt for state purposes.
Once a 501(c) (3) organization is granted tax-exempt
status under federal law, they are allowed to submit a copy
of their IRS tax-exempt status notice to FTB to establish
their state exemption.
Tax-exempt organizations would continue to receive a
letter by FTB verifying the organization status.
Organizations that are not issued a federal determination
letter would have to file an application with the state.
C. Questions raised by AB 897, Answers given by AB 404
The author's office identified some issues that were
raised by the AB 897. First, AB 897 did not provide for
anything from the FTB that could be relied upon by others.
Other California agencies rely upon a determination of tax
exemption by the FTB, but AB 897 did not allow the FTB to
make a determination because the discretion required to
issue a determination letter was removed by AB 897.
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Second, the FTB tried to repair the first problem by the
use of an "acknowledgment letter". An "acknowledgement
letter" is not a public document under current law and the
FTB is unable to provide a copy of the letter upon request.
Third, it was unclear whether a group organization was
able to take advantage of AB 897. Fourth, it is unclear
whether an organization's, whose status has been revoked by
the FTB, can reinstate its status by submitting a
determination letter to the FTB by the IRS.
The author's office has stated that AB 404 would
clarify the issues that were raised by AB 897 in the
following ways:
1) AB 404 allows the FTB to issue an acknowledgement letter
when the organization relies upon AB 897 (and current Form
3500A) and a determination letter when the organization
relies upon the traditional application for tax-exempt
status (current Form 3500).
2) It provides that any documents submitted to the FTB to
verify an organization's exemption from taxation under
501(c) (3) of the IRC and the acknowledgement letter or
other document issued by the FTB shall be open to public
inspection.
3) It also would allow organizations granted federal
tax-exemption on the basis of a federal group exemption to
be tax-exempt for state purposes.
4) Finally, it makes clear that an organization whose
exempt status is revoked by the FTB must apply for exempt
status under the procedure that requires a determination by
the FTB and cannot seek to be reinstated by simply
submitting a copy of their IRS determination letter.
D. Stringent Federal Requirements
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An organization that files an application with the IRS
for tax-exemption status undergoes a stringent and strict
scrutiny process. The state's application process is less
rigorous, therefore the elimination of the state
application requirement will not increase claims by
organizations that are attempting to fraudulently claim
tax-exemption status.
Support and Opposition
Support:
Nonprofit & Unincorporated Organizations Committee of
the Business Law Section of the State Bar of
California (sponsor)
Opposition:None reported.
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Consultant: Gina Le