The Freedom from Religion Foundation and the IRS submitted a motion in federal court on Thursday asking the judge to dismiss the case filed in 2012. The FFRF announced the settlement on Friday.
"This is a victory, and we're pleased with this development in which the IRS has proved to our satisfaction that it now has in place a protocol to enforce its own anti-electioneering provisions," said the group's co-president Annie Laurie Gaylor.
An IRS spokesman for Wisconsin said he was not familiar with the case and had no immediate comment.
The original lawsuit filed in U.S. District Court in Madison in 2012 alleged that the IRS was violating the U.S. Constitution by not enforcing the federal tax code, which prohibits tax-exempt religious organizations from electioneering.
The FFRF argued that churches and other religious organizations have become increasingly more involved in political campaigns, "blatantly and deliberately flaunting the electioneering restrictions."
The lawsuit asked the court to order the IRS to initiate enforcement of the electioneering restrictions against churches and religious organizations.
The IRS has provided proof that investigations resumed last year, Gaylor said. However, she said the IRS is not currently investigating any tax-exempt entities, including churches, because of the Congressional moratorium placed on it while it looks into the agency's operations.
Gaylor said her group could refile the lawsuit later if the IRS does not investigate what she called "rogue political churches."
The IRS had said publicly in 2012 that it was not investigating complaints of partisan political activity by churches, leaving religious groups who make direct or thinly veiled endorsements of political candidates unchallenged.
The Freedom from Religion Foundation, which says it has 19,000 members nationwide, frequently files lawsuits challenging potential violations of the separation of church and state.
In recent years it has challenged the legality of the National Day of Prayer, the placement of a cross on a war memorial in Rhode Island, and praying before sporting events and other activities.