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Form 990 Schedule B Disclosure Update: New IRS Rule Invalidated

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Form 990 Schedule B Disclosure Update: New IRS Rule Invalidated

A Montana federal district court judge recently set aside the IRS’s Revenue Procedure 2018-38, which had eliminated IRS Form 990 Schedule B disclosure requirements for Section 501(c)(4) and other tax-exempt entities but left intact such requirements for Section 501(c)(3) organizations.  Issued on July 30, 2019 and effective immediately, the court’s ruling rested entirely on procedural grounds and effectively reinstates prior Schedule B filing requirements. 

New Disclosure Rule – Not So Fast?

Section 6033(a)(1) of the Tax Code requires tax-exempt organizations to file an annual return “stating specifically the items of gross income, receipts, and disbursements, and such other information for the purpose of carrying out the internal revenue laws as the [U.S. Treasury] Secretary may by forms or regulations prescribe.”  Such requirement is evidenced as the IRS Form 990.  But under the Code’s counterpart Section 6033(a)(3)(B), the Secretary is afforded some leeway (i.e., through IRS rules and regulations) to “relieve [most exempt organizations] . . . from filing such a return where he determines that such filing is not necessary to the efficient administration of the internal revenue laws.” For example, the IRS may allow for flexibility of Form 990 versions (990, 990-EZ, and 990-N), as well as within the many Form 990 accompanying schedules.

What was the big change here?  Previously, the IRS required all tax-exempt organizations to both (a) collect names, addresses, and donation amounts for donors who contributed more than $5000 per year (or $1000 for Section 501(c)(7) social clubs and certain other tax-exempt entities), and (b) report such information to the IRS on Schedule B of their IRS Form 990 information returns. Through Rev. Proc. 2018-38 issued about a year ago, the IRS deleted the reporting requirement for tax-exempt entities other than Section 501(c)(3) public charities, requiring them only to collect such data in case of a later IRS inquiry.[1]

The key question before the Montana federal court, on the IRS’s initial motion to dismiss, was whether the IRS may make such adjustments (a) unilaterally as a regulatory interpretative matter, or (b) as a quasi-legislative function and therefore only after a public “notice and comment” period as required under the federal Administrative Procedure Act (APA). In other words, should Rev. Proc. 2018-38 stand as the applicable nationwide rule, or must the IRS first proceed more slowly through the notice-and-comment period?

“Interpretive” Rule or “Legislative” Rule?

So just when does the notice-and-comment requirement apply to federal agencies like the IRS?  The answer depends on the type of rule involved. Per Section 533(b)(3)(A) of the APA, the requirement does not apply to “interpretative rules, general statements of policy, or rules of the agency organization, procedure, or practice . . . or when the agency for good cause finds . . . that notice and public procedure are impracticable, unnecessary, or contrary to the public interest.”

On the other hand, the notice-and-comment requirement applies if an agency rule “effects a change in existing law or policy that imposes general, extra-statutory obligations.”  For example, as the court found applicable here, the requirement applies if a rule effectively amends a prior legislative rule.  Such notice-and-comment affords “interested persons, organizations, and entities an opportunity to participate in the rulemaking process by submitting written data, opposing views, or arguments.”  Further, “[t]his procedural date holds government agencies accountable and ensures that these agencies issue reasoned decisions.”  This process involves first publication in the Federal Register, then a time period for public comments to be submitted (typically 30 to 60 days), possible hearings and further comments, and then finally either a final rule or termination of the rulemaking.

Applying these administrative law principles, the court rejected the IRS’s argument that Rev. Proc. 2018-38 was only an “interpretative” rule. Instead, the court agreed with the Montana government (with New Jersey chiming in) that Rev. Proc. 2018-38 constituted a significant change in the existing law and therefore was more legislative in nature.  As the court determined, Rev. Proc. 2018-38 “explicitly upends [a] fifty-year practice and effectively amends the existing rule.”  Consequently, as the court held, the IRS may change the Schedule B disclosure requirements only after proceeding through the notice-and-comment period.

Why Do the States Want Schedule B Donor Information?

The Montana and New Jersey Departments of Revenue, as well as Montana’s governor, filed suit to challenge Rev. Proc. 2018-38, arguing that they need such donor information for effective government administration. New Jersey argued that it needs such donor information to “protect the public from fraud, deceit, and misrepresentation by charitable organizations operating in or raising money in the State.” (Never mind the fact that Rev. Proc. 2018-38 excludes applicability to public charities.)  Montana argued that it needs such information to check on exempt organizations’ compliance with “legal obligations such as the ban on private inurement, limitation on political activity, or the requirements of state charities.” (Never mind the fact that, again, Rev. Proc. 2018-38 does not concern charities, and it is the IRS’ province to enforce on inurement and political activity bans). 

The court accepted these arguments and granted the government parties legal “standing” to sue the IRS. In essence, the court recognized state governments’ interest in access to federal tax administration for their own tax administration purposes. Such access is consistent with the federal Tax Code’s Section 6103, which the court identified as “facilitat[ing] a century-long policy of information sharing between the IRS and state tax officials.”

What Now?

As a result of the court’s ruling, all tax-exempt organizations thus should continue with Schedule B preparation and submission to the IRS.  The IRS may seek anew to change the Schedule B requirements, but only after the time-consuming notice-and-comment period.  Alternatively, the IRS may appeal the trial court’s ruling and thereby seek to preserve Rev. Proc. 2018-28, although such appeal could take longer than the notice-and-comment period.

Regardless of next steps, the political and practical lessons are apparent. First, the Executive Branch appears to have overplayed its political hand in issuing Rev. Proc. 2018-38 without the notice-and-comment period.  Whether it will succeed or not, if pursued through the notice-and-comment period, is anyone’s guess. Second, this decision serves as a powerful practical reminder to all tax-exempt organizations and their donors that sensitive donor information is still very much of interest to the government at the federal and state level.  Related donor disclosure concerns arise as well in light of the general trend of state attorneys’ general to increasingly request more donor information from tax-exempt organizations and even to require public disclosure of such donor information.[2]

[1] For further background on Rev. Proc. 2018-38’s issuance, related policy considerations, and Congressional activity, see our prior blog article. To read Rev. Proc. 2018-38 itself, see here.

[2] E.g., California and New Jersey, as reported in this Wagenmaker & Oberly blog article.

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