Tax-exempt organizations may be entering a new era of heightened scrutiny of their tax-exempt status. Michael Waalkes, Caroline D. Ciraolo, and Melissa Wiley co-authored a piece for Procedurally Taxing/Tax Notes discussing potential legal avenues through which an exempt organization might challenge its designation as an organization supporting terrorism and the resulting automatic suspension of its tax-exempt status under section 501(p).
As the trio lay out in the piece, “Some organizations and their representatives are concerned that the administration may invoke a little-used and somewhat controversial provision: section 501(p), which suspends an organization’s tax-exempt status if, among other things, the president designates ‘in or pursuant to an Executive order issued under the authority of any Federal law’ an organization as ‘supporting or engaging in terrorist activity’ or ‘supporting terrorism.’ A designation results in automatic suspension of tax-exempt status as a matter of law, leaving no discretion to the IRS.”
The use of the terrorist-support designation presents several unique challenges for organizations that want to dispute the designation and the loss of their tax-exempt status. As the article states, “A suspension of tax-exempt status under section 501(p) results in a parade of horribles.”
As Kostelanetz has previously written, revocations of tax-exempt status provide organizations with a variety of potential avenues for challenges. However, section 501(p) provides very limited options. As such, “when an organization’s exempt status is suspended pursuant to section 501(p), the organization may not challenge the suspension under section 7428 or in other proceedings related to the organization’s federal tax liability.”
Section 501(p) has not yet been interpreted by the courts, which creates a large unknown for exempt organizations questioning how they might move forward procedurally with a challenge. Michael, Caroline, and Melissa, however, lay out a few avenues by which a tax-exempt organization might pursue a challenge to a terrorist designation. For example, lawsuits challenging such a designation might rely on arguments about the damage to organizations separate and apart from the income tax consequences, such as reputational damage, loss of donors, etc.
As they note, “exempt organizations suspended under section 501(p) have options. However, the immediate, adverse impact of a designation and section 501(p) suspension will lead to fast-paced litigation. Organizations should take steps now to prepare contingency plans for operations and consult with counsel to develop their legal strategy.”
Michael, Caroline, and Melissa walk readers through how exempt organizations should handle such designations in the immediate term, starting with notifying donors, complying with income tax laws, and preparing for the possibility that the organization and its key staff could face additional investigatory or regulatory enforcement scrutiny from other federal agencies. Importantly, organizations should also be aware that a terrorist-support designation could prompt financial institutions to take action, such as declining to extend banking and financial services to designated organizations.
Read the full article here.