Obtaining tax exemption just got easier for some nonprofit organizations. On July 1, 2014, the IRS began accepting the Form 1023-EZ, a streamlined application for exemption from federal income tax under Internal Revenue Code Section 501(c)(3). Since its release in April, the Form has received widespread criticism in the philanthropic community, concerned that the process is nothing more than a rubber stamp, increasing the risks for fraud and other misuse of charitable assets.
While it is true that the new 1023-EZ creates a possibility for abuse, it also paves the way for more charitable work. Over the last three weeks, we have organized a handful of new charitable organizations that likely would have been unable to afford legal counsel to complete the full 1023 application. The 1023-EZ helps lessen that initial burden, allowing such organizations to obtain legal advice on properly organizing and operating the new legal entity and securing tax-exemption at a reduced cost.
Who Can Use the 1023-EZ?
The 1023-EZ is available for many corporations, unincorporated associations, or charitable trusts that qualify for tax-exemption under Section 501(c)(3). The following organizations, however, may not use the 1023-EZ:
· Organizations with gross receipts of more than $50,000 in any of the past three years or projected for any of the next three years, or with total assets of more than $250,000.
· Organizations formed under the laws of a foreign country or that have a mailing address in a foreign country.
· Organizations that were formed:
o as an LLC;
o as a successor to a for-profit entity; or
o as a successor to, or under the control of, an entity suspended from tax-exemption as a terrorist organization.
· Organizations that had their tax status previously revoked for any cause other than the failure to file a Form 990 for three consecutive years.
In addition to the foregoing limitations, the IRS has also placed restrictions on the use of the 1023-EZ based on the types of activity in which the organization engages. These restrictions relate to a long list of organizations, including, but not limited to, the following:
1) Churches and conventions or associations of churches;
2) Schools, colleges, and universities;
3) Hospitals, medical research organizations, and cooperative hospital service organizations;
4) Supporting organizations;
5) Credit counseling organizations;
6) Health Maintenance Organizations (HMO’s) and Accountable Care Organizations (ACO’s);
7) Organizations with donor-advised funds; and
8) Private operating foundations.
How Does It Work?
The first step for an organization wanting to use the new streamlined form is to complete an Eligibility Worksheet, available on the IRS website. Using the worksheet, organizations answer “yes-or-no” questions relating to the restrictions above. The answers to these questions determine eligibility to use the form. The organization must then complete the 1023-EZ form online. The form requests basic information, such as the name, address, and Employer Identification Number of the organization, as well as information regarding officers and directors and the organizational structure of the organization. The rest of the form contains mainly check-boxes and “yes-or-no” questions. The form must be electronically signed by an officer, director, or trustee who attests to its truth, correctness, and completeness. The current user fee to file the 1023-EZ is just $400, compared to the $850 user fee of the typical 1023 application, and is paid online at the time the form is submitted.
Should I File Form 1023-EZ?
Even if an organization meets the restrictions above, the organization does not automatically qualify for tax-exemption. While the IRS has indicated that the new form will enable applications to be processed more quickly, the agency may ask for further information or deny the application if it does not qualify. The 1023-EZ changes the method for obtaining tax-exempt status, not the laws that govern how a nonprofit organization is to be organized and operated to secure tax-exemption under Section 501(c)(3). Organizations should not file Form 1023-EZ without first consulting a knowledgeable attorney about whether the organization qualifies for 501(c)(3) status. Consulting an attorney well versed in the law of tax-exempt organizations will ensure that the organization is properly organized and operated in accordance with IRC Section 501(c)(3). This takes careful planning and guidance at the onset.
Directors of a nonprofit should be extremely mindful about the legal and operational information to which they are attesting when submitting a 1023-EZ. The officer, director, or trustee signs the form under penalties of perjury. Thus, while the questions on the form may appear to be a simple “yes” or “no,” the answers given are significant. For example, the signer attests to the legal conclusion that the organization is organized and operated exclusively to further one or more exempt purposes, which instead is determined by the IRS when the longer 1023 is submitted. Exemptions are granted based on the information provided to the IRS. In some cases, the organization and its leaders may find that filing the longer 1023 application will be preferable to ensure transparency with the IRS from the beginning. This may be particularly helpful when the organization’s operations or structure raise legal complications under 501(c)(3). Filing the full 1023 will protect the organization’s leaders from liability for false statements if it turns out that the IRS determines that the organization does not qualify.
Further, the IRS has indicated that its creation of the 1023-EZ will allow the agency to use more of its resources to monitor charitable compliance of existing organizations. The IRS will also be selecting certain 1023-EZ filers for further investigation at the time of filing.
Finally, the National Association of State Charity Officials (“NASCO”), the state bodies responsible for overseeing charities, has publicly expressed concern over the filing of a 1023-EZ, stating that the reduced review by the IRS will heighten the burden on state regulators to ensure that charities are being operated properly.