The IRS recently issued a draft of a new Form 1023-EZ which, for many small organizations, would greatly simplify the process of obtaining tax-exempt status under Code Section 501(c)(3). The name of the form is “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code”, and some have joked that the name is longer than the form itself.
Among other requirements, a Form 1023 filer must currently:
- Submit a copy of the organization’s governing documents and bylaws;
- Provide budgetary information; and
- Provide a narrative description of the proposed activities.
The application is then reviewed by the IRS and, in many cases, the organization is required to make changes and/or further representations as a condition to obtaining tax-exempt status.
The current draft of the 1023-EZ is two and one half pages long and does not require any of the items listed above. Instead, the organization would essentially receive 501(c)(3) status automatically.
As currently proposed, there are several prerequisites to filing the 1023-EZ. The most significant is likely to be that the organization must anticipate annual gross receipts of $200,000 or less and total assets of $500,000 or less.
The proposal to introduce the 1023-EZ has been subjected to quite a bit of criticism. For example, the National Council of Nonprofits wrote a nine-page comment letter on the proposed Form 1023-EZ, urging the IRS to withdraw it. Some of the most common criticisms are as follows:
- Most organizations that complete the 1023-EZ will fail to fully understand the form’s questions, some of which are quite detailed and technical.
- Organizations will routinely underestimate their budgets in order to qualify to file the 1023-EZ.
- Completing the current version of the 1023 is an excellent educational tool, because it requires organizations to address a number of issues up front and often can serve as a “reality check.”
- The Form 1023-EZ will encourage a proliferation of small tax-exempt organizations.
- The form will create an avenue for the easy approval of fraudulent organizations.
As a seasoned tax adviser for tax-exempt organizations, I believe that the critics make a lot of very good points. My concern is that people will file Form 1023-EZ without understanding the nature and extent of what is required to operate a charitable organization. Fortunately, I have only very rarely had to deal with individuals who wanted to set up 501(c)(3) organizations for underhanded reasons. However, I regularly advise people who greatly underestimate the many complexities of establishing and operating a charity. Having to go through the Form 1023 process provides an excellent education regarding these complexities and helps make sure that all of the important issues are addressed.
In addition, in my experience people seeking to establish a 501(c)(3) organization do not realize that some philanthropic activities simply do not qualify for 501(c)(3) status. Currently, when these organizations file a Form 1023, problems are generally be identified up front, rather than potentially after the organization has been operating improperly for years. Here are some examples, all of which were proposed for purely altruistic reasons:
- The classic “feeder organization” situation, where a run-of-the-mill business is committed to pay all of its net profits to 501(c)(3) organizations. These organizations typically do not qualify for 501(c)(3) status,
- Organizations set up to raise funds for specific named individuals with very large medical expenses. These organizations are not eligible for 501(c)(3) status.
- Organizations that are funded to operate their own scholarship programs. These organizations need to adopt and follow rigorous application processes and selection criteria. In the case of private foundations, the process needs to be pre-approved by the IRS.
If the new Form 1023-EZ is adopted, organization such as these could easily obtain 501(c)(3) status for which they do not qualify, and unraveling the ensuing mess would have onerous consequences for the organizations themselves and for their donors and employees. The 1023-EZ could eliminate the ounce of prevention that, under our current system, almost routinely saves a pound of cure.