Over the course of the past year, many nonprofits have been operating in a state of uncertainty, concerned that their tax-exempt status may be challenged or stripped entirely. Recent executive orders and presidential memoranda have signaled that nonprofits misaligned with the administration’s priorities may face significant scrutiny over the work they do and the source of their funding.
While nonprofits are right to be concerned, it is important to remember that stripping an entity of its tax-exempt status cannot be done by decree; there are specific, multistep processes that must be adhered to, and organizations can generally appeal unfavorable decisions. This article examines a few of the recent policy directives affecting nonprofits, the statutory requirements for maintaining IRC section 501(c)(3) tax-exempt status, and the process of an IRS examination, which is the primary way a nonprofit can lose its tax-exempt status.
Presidential Memoranda and Executives Orders Affecting Non-Profits
On September 25, 2025, the President issued National Security Presidential Memorandum 7, “Countering Domestic Terrorism and Organized Political Violence” (90 Federal Register 47725, Sept. 25, 2025). The memorandum directs the Commissioner of the IRS to “take action to ensure that no tax-exempt entities are directly or indirectly financing political violence or domestic terrorism,” and to refer any “such organizations, and the employees and officers of such organizations, to the Department of Justice for investigation and possibly prosecution.” The memorandum further directs the Treasury Department, the IRS, and the DOJ to “investigate and disrupt” organizations with ties to domestic terrorist organizations and states that, as a result of these investigations, the Attorney General “may recommend that any group or entity whose members are engaged in activities meeting the definition of ‘domestic terrorism’ … merits designation as a ‘domestic terrorist organization.’” Though not explicitly stated in the memorandum, the reference to designating an entity a “domestic terrorist organization” is likely meant to invoke IRC § 501(p), the (very rare) process through which tax-exempt status is indefinitely suspended when an organization is deemed a terrorist organization or as supporting terrorism or terrorist activity.
Presidential Memorandum 7 came in the wake of other orders targeting nonprofits. For example, on Jan. 21, 2025, the President issued Executive Order (EO) 14173 “Ending Illegal Discrimination and Restoring Merit-Based Opportunity” (90 Federal Register 8633). EO 14173 requires every federal grant or contract recipient to certify compliance with “anti-discrimination” laws and to certify that “it does not operate any programs promoting DEI that violate” anti-discrimination laws. Furthermore, EO 14173 required a report by the Attorney General wherein each agency was required to identify “up to nine potential civil compliance investigations of public traded corporations, large nonprofits or associations, foundations with assets of 500 million dollars or more, State and local bar and medical associations, and higher education institutions with endowments of over 1 billion dollars.” To date, none of these reports have been released to the public. Continuing such DEI programs risked both the loss of federal funding and the potential of investigation by the federal government, with an implicit threat directed toward the organization’s tax-exempt status.
Tax-Exempt Organizations: Brief Overview of Section 501(c)(3)
To understand how an organization’s tax-exempt status may be threatened, one must understand how an organization qualifies for tax-exempt status in the first place. While there are various types of tax-exempt organizations, this article will focus on the most common type in the United States: a 501(c)(3) organization (IRS, 2024 Internal Revenue Service Data Book, p. 23, 2025, https://tinyurl.com/2z6uhkm9).
In order to qualify for tax exempt status under IRC § 501(c)(3), the following conditions must be met: 1) the organization must be organized and operated exclusively for exempt purposes (such as religious, charitable, scientific, testing for public safety, literary, or educational purposes), 2) the organization’s earnings must not inure to the benefit of any private shareholder or individual, 3) no substantial part of the organization’s activities may attempt to influence legislation, 4) the organization may not participate in any political campaign, and 5) the organization’s exempt purpose must not be illegal or violate fundamental public policy [IRC § 501(c)(3); Revenue Ruling 80-278, 1980-2 C.B. 175].
Challenges to an organization’s taxexempt status are almost always conducted via IRS examination, a fact-intensive, multi-step process that includes multiple opportunities to appeal an unfavorable outcome.
To satisfy the first point above, the entity’s organizing documents “must limit the organization’s purposes to exempt purposes in section 501(c)(3) and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that are not in furtherance of one or more of those purposes” (IRS, “Organizational Test – Internal Revenue Code Section 501(c)(3),” Aug. 20, 2025, https://tinyurl.com/mryzwvvs). The organization must also engage primarily in activities that further exempt purposes (IRS, “Operational Test – Internal Revenue Code Section 501(c) (3),” Jan. 30, 2026, https://tinyurl.com/33atj5fb). An organization risks losing its tax-exempt status if the IRS determines it is noncompliant with these essential elements.
Common areas of exempt organization noncompliance include:
- Engaging in activities that are inconsistent with an exempt purpose
- Benefitting private interests (e.g., excessive compensation of insiders or abusive related-party transactions)
- Engaging in lobbying as a more than insubstantial part of the organization’s activities or otherwise engaging in political activity (for policy-oriented organizations, this is a particular area of potential vulnerability)
- Earning too much income from activities unrelated to the organization’s exempt purpose
- Failing to file required forms (such as an annual Form 990, Return of Organization Exempt from Income Tax); beginning in June 2011, the IRS automatically revokes the tax-exempt status of organizations that fail to file a Form 990 for three consecutive years (when the IRS first enforced this provision, roughly 275,000 organizations lost their tax-exempt status)
- Lack of internal controls and governance policies (IRS, “How to Lose Your 501(c)(3) Tax-Exempt Status (Without Really Trying),” https://tinyurl.com/3f7vedw4).
While many of these areas of noncompliance will not necessarily result in revocation of tax-exempt status (a lack of proper internal controls and policies, for example, is often fixable), some forms of noncompliance—like activities inconsistent with an exempt purpose—are more likely to lead the IRS to propose revocation. These irregularities are typically detected through an IRS examination.
IRS Examinations of Tax-Exempt Status
Though the presidential memorandum and executive order discussed above pose genuine risks to 501(c)(3) organizations, “no section 501(c)(3) organization can lose its exemption by executive branch or even IRS fiat, except in the rarest of situations” (Ellen P. Aprill, “Once and Future Revocation of Tax Exemption for Pursuit of DEI and Other Alleged Violations of Section 501(c)(3),” UCLA School of Law, Public Law Research Paper 25-15, p.3, 2025). Instead, organizations typically have their tax-exempt status challenged via an examination.
An examination of an organization’s tax-exempt status is typically conducted by the Tax Exempt & Government Entities (TE/GE) division of the IRS (IRS, “Tax-Exempt & Government Entities: Compliance Program and Priorities,” Feb. 22, 2026, https://tinyurl.com/bxjehdnz). To initiate an examination, TE/GE sends a letter to the exempt organization advising them that it is auditing one or more of the entity’s tax returns. Through this examination, TE/GE tries to determine whether the entity’s returns were accurate and reflected full compliance with the requirements of maintaining tax-exempt status (Jeffrey Scott Tenenbaum, “How the IRS Can – and Cannot – Revoke Federal Tax-Exempt Status,” American Bar Association, May 6, 2025, https://tinyurl.com/4jkaenkp).
Given the fact-intensive nature of such a determination, TE/GE will send the organization various Information Document Requests (IDR). The following documents may be requested:
- Organizational documents (e.g., articles of incorporation, by-laws, and board minutes);
- Financial statements and internal accounting records;
- Payroll records, employment tax, and information returns;
- Deeds and title documents;
- Lease and loan agreements, and vendor contracts (particularly if such contracts exist with insider or related parties);
- Correspondence with donors and potential donors; and
- Newsletters, annual reports, advertising, and website page printouts (e.g., “Charity and Nonprofit Audits: Exempt Organizations Audit,” Oct. 9, 2025, https://tinyurl.com/2p9t5u68).
In some cases, TE/GE may decide to conduct an in-person (field) examination. Field examinations typically take place where the organization’s books and records are located, with the IRS revenue agent personally visiting the organization’s office (IRS, “Charity and Nonprofit Audits: In Person (Field) Examination Audit,” Jan. 30, 2026, https://tinyurl.com/3rh28xbx). In the case of a large, complex organization, a team examination program audit may occur, requiring a “team of specialized revenue agents, as well as coordination between IRS functions and other government agencies” (IRS, “Exempt Organizations Examination Procedures,” Jan. 30, 2026, https://tinyurl.com/yeyt8prz).
At any point in the process, if the organization believes a disputed issue has not been addressed in published precedent or has been treated inconsistently by the IRS, the organization may ask for the matter to be referred to the IRS Associate Chief Counsel’s office for advice or guidance. The Associate Chief Counsel may then issue a technical advice memorandum on the issue. In matters concerning tax-exempt status, however, that memorandum will be considered final and binding on the IRS Independent Office of Appeals (Appeals), so it is important to understand the risks before taking this step (IRS Publication 892, Cat. No. 46844C, https://tinyurl.com/mrx4nm2c).
After the examination is complete, the IRS can:
- Issue a no-change letter to the organization, leaving its exempt status intact;
- Issue a no-change letter with an advisory (and later follow up to see if the identified issue has been addressed);
- Impose a tax (e.g., on business income unrelated to the organization’s exempt purpose) and potential penalties; or
- Propose revocation of the organization’s exempt status (IRS, “Exempt Organizations – Potential Examination Consequences,” Jan. 30, 2026, https://tinyurl.com/y68byevr).
Regardless of what the IRS determines, it will notify the organization of the examination’s outcome by letter. If a revocation of the organization’s tax-exempt status is proposed, the organization then has 30 days from the date of the letter to file a written protest for consideration by Appeals (see IRS Publication 892, note 18). A protest should include the following information:
- The organization’s name, address, employer identification number, and a daytime phone number;
- A statement that the organization wants to protest the proposed determination;
- A copy of the 30-day letter and a list of the findings the organization disagrees with;
- An explanation of the reasons for disagreement, including any supporting documents;
- The law or authority, if any, the organization is relying on; and
- If the organization wants an appeals conference, an affirmative statement to that effect (IRS Publication 892).
The protest will be reviewed by Appeals along with the examination casefile and any rebuttal submitted by the exam team. Appeals’ review will also generally include an informal conference with the assigned Appeals Officer and the organization. If the Appeals Officer believes that a settlement is possible, they may ask the organization to submit an offer of settlement or propose the terms of a settlement themselves (IRS Publication 892).
Ultimately, if an agreement cannot be reached with Appeals, the IRS will issue a final determination of revocation of exempt status. Once that is issued, the organization’s exempt status is officially revoked. Under IRC § 7428(b)(3), the organization has 90 days from the date of the final determination to file a declaratory judgment action challenging the revocation in either the: 1) US District Court for the District of Columbia, 2) US Tax Court, or 3) US Court of Federal Claims (IRS Publication 892). Choosing the forum requires the organization to make an individualized analysis of various factors including, but not limited to, the facts and circumstances, the precedent in each court, and the experience and expertise of the judges.
IRC § 501(p) Suspensions: A Rare Occurrence
In very rare cases, an organization may have its tax-exempt status suspended under IRC § 501(p). This provision was enacted in the wake of 9/11 as part of the Military Family Tax Relief Act of 2003 out of concern that certain charities and nonprofit organizations were raising money for, or otherwise supporting, terrorism (IRS Publication 5588, Cat No. 74075N, Feb. 1, 2024, https://tinyurl.com/b7u8tw8f). Under IRC § 501(p), an organization designated a “terrorist organization … supporting or engaging in terrorist activity … [or] supporting terrorism” will have its tax-exempt status suspended indefinitely, unless and until the designation is rescinded.
Documents like the presidential memorandum on domestic terrorism discussed above have raised significant concern in the nonprofit world about having one’s tax-exempt status suspended under IRC § 501(p). While an in-depth discussion of this section is outside the scope of this article (though there are other, recent articles which closely examine this topic), it is important to note that suspension of tax-exempt status under 501(p) is extremely rare (see, e.g., Sharon L. McCarthy, et al., “Examining the Authority for Suspending Tax-Exempt Status Under Section 501(p),” TaxNotes, Dec. 19, 2025, https://tinyurl.com/4c6ve9ph). Since the law’s inception, there have been fewer than a dozen 501(p) suspensions, and only nine organizations are currently listed as suspended on the IRS’s website (IRS, “Suspension Pursuant to Code Section 501(p),” Dec. 28, 2025, https://tinyurl.com/4rjhvkvm). Therefore, for the vast majority of organizations, the primary focus should remain on ensuring that the organization can withstand a traditional IRS audit.
Moving Forward
Given the current political environment, many nonprofits are facing significant uncertainty. Though fear of suddenly losing tax-exempt status is understandable, it is important to keep things in perspective. Challenges to an organization’s tax-exempt status are almost always conducted via IRS examination, a fact-intensive, multi-step process that includes multiple opportunities to appeal an unfavorable outcome. While IRS examinations can be time-consuming and divert resources from the organization’s core mission, the issues involved are not insurmountable. Organizations that want to ensure they are audit-ready should consider consulting with a tax professional with experience defending these types of audits for a pre-audit “check-up.” Doing so could provide reassurance that the organization is, in fact, in compliance and ready to defend against any allegations of impropriety.
