Inactive Organizations & Revocation of State Tax Exemption – California FTB

I recently responded to a comment on a listserv regarding an action by the California Franchise Tax Board (FTB) to revoke a charity's state tax-exempt status for reporting no income on its annual registration renewal for several years running.  The charity reported zero income between 2006 and 2009, resulting in the FTB revoking tax-exempt status without advance notice retroactive to 2006.  Consequently, the organization was subject to the $800 minimum annual franchise tax plus penalties and interest for 2006- 2009.

Tax Headache

I have reproduced my response below (with a few added clarifications):

California Admin. Code Sec. 23701(d)(2)(A) provides in part that "an inactive organization is not operated for exempt purposes and therefore is not entitled to exemption from tax."  Sec. 23701(d)(2)(B) provides that "[o]rganizations that commence exempt operations and later become inactive are subject to loss of exempt status unless they include an attachment on their annual report to explain that their inactivity is temporary and to outline their plans for becoming active in the future."

What I believe the FTB is failing to take into account is that an organization may be actively furthering its exempt purpose(s) without having financial activity.  The annual registration renewal (Form RRF-1) only asks for financial activity and not exempt purpose activity.  So, I agree that the FTB may be revoking exempt status without any evidence that the organization is not operating exclusively for an exempt purpose.  

On a case-by-case basis, an organization may be able to persuade the FTB to reverse its decision if it can provide details and some evidence of exempt purpose activities.  But going back to the regulation, it may be helpful if a financially inactive organization includes an attachment with its Form RRF-1 stating that it is continuing to engage in exempt purpose activities.