Most new charitable nonprofits other than churches will seek 501(c)(3) recognition from the IRS. Since July 2014, qualifying nonprofits have been able to apply for recognition of 501(c)(3) tax-exempt status using either Form 1023 or the much simpler Form 1023-EZ. While Form 1023-EZ has since become the more popular application form, it may not always be the most beneficial to a nonprofit.
Who Qualifies to File the Form 1023-EZ
The Instructions for Form 1023-EZ provide an eligibility worksheet starting on page 11. Among the 26 qualifications necessary to use Form 1023-EZ:
- Projected annual gross receipts must not exceed $50,000 in any of the next 3 years
- Actual annual gross receipts must not have exceeded $50,000 in any of the past 3 years
- Total assets must not exceed $250,000
- The organization must not be a foreign organization, LLC, successor to a for-profit entity, church, school, or hospital
- The organization must not request classification as a supporting organization or a private operating foundation
- The organization must not maintain or plan to maintain one or more donor-advised funds
How are Forms 1023 and 1023-EZ different?
Form 1023 is 12 pages long, not including 8 possible schedules, some of which may or may not need to be completed depending on the type of organization and its circumstances. The schedules are for (A) churches; (B) schools, colleges, and universities; (C) hospitals and medical research organizations; (D) supporting organizations; (E) organizations not filing Form 1023 within 27 months of formation; (F) homes for the elderly or handicapped and low-income housing; (G) successors to other organizations; and (H) organizations providing scholarships, fellowships, educational loans, or educational grants to individuals and private foundations requesting advance approval of individual grant procedures.
There are many questions on Form 1023 that require fairly detailed narrative answers regarding:
- Past, present, and planned activities
- Compensation of directors, officers, trustees, and certain highly paid employees and contractors (“Close Personnel”)
- Compensation of Close Personnel from related organizations
- Sales and/or contracts between the organization and any Close Personnel (including any organizations they have certain affiliations with)
- Family and business relationships among directors, officers, and trustees
- Goods, services, and/or funds (grants) provided to individuals or organizations
- Fundraising programs
In addition, the Form 1023 requires:
- Articles of incorporation
- Conflict of interest policy or explanation of how the organization manages conflicts of interest
- Financials (actual and/or projected) for 3 or 4 years
If you submitted an application on Form 1023, … you can expect to be contacted within 180 days from the date you submitted the application. After 180 days, if you haven’t been contacted, you can call the toll-free Customer Account Services number, Monday through Friday, 8 a.m. – 5 p.m. (local time), at 877-829-5500 to check on the status. – IRS
Form 1023-EZ (sample) is an online form that is 3 pages long. It requires no narrative responses and consists of mostly check box attestations. By checking just one box, the applicant is attesting that it will do all of the following:
- Refrain from supporting or opposing candidates in political campaigns in any way. ￼￼￼
- Ensure that its net earnings do not inure in whole or in part to the benefit of private shareholders or individuals (that is, board members, officers, key management employees, or other insiders).
- Not further non-exempt purposes (such as purposes that benefit private interests) more than insubstantially.
- Not be organized or operated for the primary purpose of conducting a trade or business that is not related to its exempt purpose(s).
- Not devote more than an insubstantial part of its activities attempting to influence legislation or, if the organization made a section 501(h) election, not normally make expenditures in excess of expenditure limitations outlined in section 501(h).
- Not provide commercial-type insurance as a substantial part of your activities.
If you submitted a Form 1023-EZ application, you can expect to be contacted within 90 days from the date you submitted the application. After 90 days, if you haven’t been contacted, you can call the toll-free Customer Account Services number, Monday through Friday, 8 a.m. – 5 p.m. (local time), at 877-829-5500 to check on the status. – IRS
Filing the Form 1023-EZ
- It’s much easier to prepare; and
- It’s typically processed in less than half the time it takes to process Form 1023 (the IRS has reportedly processed the Form 1023-EZ in as few as two weeks).
- It doesn’t provide sufficient guidance to the organization or the IRS about whether the organization is actually organized to meet the requirements of 501(c)(3). According to the National Taxpayer Advocate, in a blistering criticism of Form 1023-EZ, 37 percent of a representative sample of Form 1023-EZ applicants whose applications were approved by the IRS were not, as a matter of law, 501(c)(3) organizations (i.e., they didn’t qualify and could run into major problems if they ever get audited). We’ve even seen a for-profit corporation granted 501(c)(3) status because the IRS never reviewed its articles of incorporation (it’s not required with a 1023-EZ application) and the applicant checked the wrong box.
- It doesn’t require the organization to develop a business plan consistent with 501(c)(3) before obtaining 501(c)(3) status, which is very likely to cause greater compliance problems. While the Instructions to Form 1023-EZ provide some information about what is necessary to operate consistent with 501(c)(3), the organization is never required to identify specifics about its operations (apart from checking a few boxes) to be vetted by the IRS. It’s become so easy for a startup to receive 501(c)(3) status (95% approval rate) that an IRS determination letter is becoming almost meaningless with respect to evidencing that an organization is actually operating consistent with 501(c)(3).
- It will produce an IRS determination letter, assuming it’s not rejected, that will reveal to knowledgeable funders that Form 1023-EZ was used to obtain tax-exemption. This may make the organization a less attractive grantee because its governance structures, insider compensation and transactions, and planned activities were never vetted by the IRS unlike with organizations that received tax-exempt status by filing Form 1023. [2017 UPDATE: The IRS has expressed that it has changed this practice of issuing a different determination letter for applicants using the Form 1023-EZ.]
Criticisms of Form 1023-EZ
We were among the many critics of the Form 1023-EZ when it was first proposed (Proposed Form 1023-EZ). Nevertheless, a revised version was released by the IRS on July 1, 2014, lowering the annual gross receipts threshold from $200,000 to $50,000 (Form 1023-EZ Streamlined 501(c)(3) Exemption Application). The criticisms have continued and may eventually cause the IRS to implement some changes.
The Tax Exempt and Government Entities Exempt Organizations function approved Form 1023-EZ applications much less frequently — 77 percent of the time, compared to 95 percent of the time — when it requested documents or basic information from the applicants, rather than relying on the attestations contained in the form. – National Taxpayer Advocate
National Taxpayer Advocate’s Recommended Changes to the Form 1023-EZ
- Revise Form 1023-EZ to require applicants, other than corporations in states that make articles of incorporation publicly available online at no cost, to submit their organizing documents.
- Revise Form 1023-EZ to require applicants to provide a description of their actual or planned activities and submit summary financial information such as past and projected revenues and expenses.
- Make a determination only after reviewing the Form 1023-EZ application, the applicant’s organiz- ing documents, its description of actual or planned activities, and its financial information.
- Where there is a deficiency in an organizing document, require an applicant to submit a copy of an amendment to its organizing document that corrects the deficiency and has been approved by the state, even where the documents are available online at no cost, before conferring exempt status.