Form 1023-EZ or Regular 10236 Application?
On July 1, 2014, amidst much criticism, the IRS radically changed the nonprofit world by launching the Form 1023-EZ, a new streamlined method of applying for 501(c)(3) status. The Form 1023-EZ is now live on www.pay.gov, along with final instructions, and the accompanying Revenue Procedure 2014-40.
The Form 1023-EZ essentially makes it possible for certain new organizations to self-certify their own 501(c)(3) status. While other types of tax-exempt organizations, such as those exempt under Code sections 501(c)(4), 501(c)(5) or 501(c)(6), have long been allowed to “self-declare” their tax-exempt status without filing for IRS approval, 501(c)(3) organizations historically have been required to endure a rigorous application process comprising a detailed 26-page Form 1023, a written narrative, financial data, and specific governing documents such as the Articles of Incorporation, Bylaws, Conflict of Interest Policy, and copies of contracts with officers, directors, and service providers. In contrast, the Form 1023-EZ is only 2 and a half pages long, requires no documents, and basically requires only that the applicant check various boxes attesting that they will comply with the rules governing 501(c)(3) status.
There are other incentives to use the Form 1023-EZ besides its simplicity. Most applicants will pay a reduced filing fee for the Form 1023-EZ, which only costs $400, compared to the $850 for most applicants filing the standard Form 1023. And applicants filing the Form 1023-EZ will surely have their applications processed much faster (the turnaround on Form 1023-EZ applications is expected to be only a month or two, rather than the 1-2 year waiting periods many Form 1023 filers are experiencing).
Nonetheless, the Form 1023-EZ is here to stay for the foreseeable future. The immediate question for new organizations and practitioners is: Who should file the Form 1023-EZ and who should stick with the standard Form 1023? A few considerations are relevant to this question.
First, there are the qualification requirements. The instructions spell out with precision the types of organizations that are ineligible to use the Form 1023-EZ, and applicants must attest that they have completed an eligibility worksheet provided in the instructions (though the worksheet itself need not be submitted, and there is little safeguard against applicants dishonestly attesting that they qualify). The following types of organizations may not use the Form 1023-EZ and must use the standard Form 1023 instead:
(1) Organizations with projected annual gross receipts of more than $50,000 in either the current taxable year or the next 2 years.
(2) Organizations with annual gross receipts that have exceeded $50,000 in any of the past 3 years.
(3) Organizations with total assets the fair market value of which is in excess of $250,000. For purposes of this eligibility requirement, a good faith estimate of the fair market value of the organization’s assets is sufficient.
(4) Organizations formed under the laws of a foreign country.
(5) Organizations that do not have a mailing address in the United States.
(6) Organizations that are successors to, or controlled by, an entity suspended under Code section 501(p) (suspension of tax-exempt status of terrorist organizations).
(7) Organizations that are not corporations, unincorporated associations, or trusts.
(8) Organizations that are successors to a for-profit entity.
(9) Organizations that were previously revoked or that are successors to a previously revoked organization (other than an organization the tax-exempt status of which was automatically revoked for failure to file a Form 990 series return or notice for three consecutive years).
(10) Churches or conventions or associations of churches.
(11) Schools, colleges, or universities.
(12) Hospitals or medical research organizations.
(13) Cooperative hospital service organizations described in Code section 501(e).
(14) Cooperative service organizations of operating educational organizations described in Code section 501(f).
(15) Qualified charitable risk pools described in Code section 501(n).
(16) Supporting organizations described in Code section 509(a)(3).
(17) Organizations that have as a substantial purpose providing assistance to individuals through credit counseling activities such as budgeting, personal finance, financial literacy, mortgage foreclosure assistance, or other consumer credit areas.
(18) Organizations that invest, or intend to invest, 5 percent or more of their total assets in securities or funds that are not publicly traded.
(19) Organizations that participate, or intend to participate, in partnerships (including entities or arrangements treated as partnerships for Federal tax purposes) in which they share profits and losses with partners other than 501(c)(3) organizations.
(20) Organizations that sell, or intend to sell, carbon credits or carbon offsets.
(21) Health Maintenance Organizations (HMOs).
(22) Accountable Care Organizations (ACOs), or organizations that engage in, or intend to engage in, ACO activities
(23) Organizations that maintain, or intend to maintain, one or more donor advised funds.
(24) Organizations that are organized and operated exclusively for testing for public safety and that are requesting a foundation classification under Code section 509(a)(4).
(25) Private operating foundations.
(26) Organizations that are applying for retroactive reinstatement of exemption under sections 5 or 6 of Revenue Procedure 2014-11, after being automatically revoked for failure to file Form 990, 990-EZ, or 990-N for three consecutive years (in other words, organizations applying for reinstatement within 15 months of the revocation notification date that did not qualify to submit the Form 990-EZ or 990-N for each of the three years, or organizations applying for reinstatement more than 15 months after the revocation notification date).
Despite the incentives to use the Form 1023-EZ, there a few reasons organizations qualifying to file the Form 1023-EZ might consider opting for the standard Form 1023.
First, an organization projecting less than $50,000 of revenue for its first few years may end up receiving a larger grant than expected. While it does not appear that there is any penalty for underestimating revenue if the projections were reasonable at the time and made in good faith, it is possible that an organization that receives more than $50,000 per year could be flagged for audit by the IRS. Some organizations may prefer to file the Form 1023 rather than live with the possibility of an audit a few years later.
Second, the Form 1023-EZ provides no opportunity for clarification or explanation, which may work to the disadvantage of certain organizations. For instance, the Form 1023-EZ includes the following “yes or no” questions:
Do you or will you attempt to influence legislation? Do you or will you pay compensation to any of your officers, directors, or trustees? Do you or will you donate funds to or pay expenses for individual(s)? Do you or will you conduct activities or provide grants or other assistance to individual(s) or organization(s) outside the United States? Do you or will you engage in financial transactions (for example, loans, payments, rents, etc.) with any of your officers, directors, or trustees, or any entities they own or control?
These activities trigger IRS concerns, and an applicant has a strong incentive to click “no,” but all of these activities are allowed for 501(c)(3) organizations if conducted properly and in accordance with applicable rules and limits. Organizations answering “yes” to any of these questions may prefer to have the chance to offer more explanation under the standard Form 1023.
Lastly, there is the risk that private foundations, governments, and other donors will be hesitant to fund organizations that got their 501(c)(3) status by filing the Form 1023-EZ. The Form 1023-EZ is likely to unleash large numbers of ill-prepared and poorly conceived nonprofits that never would have followed through with the filing of the standard Form 1023. In the ultra-competitive world of grants and donations, it is possible that grantmakers and donors may screen out Form 1023-EZ filers to ensure that only the most serious and most prepared organizations receive funding.
Additionally, questions have been raised about the extent to which private foundations and other donors are legally entitled to rely on the 501(c)(3) status of an organization that applied using the Form 1023-EZ, particularly where the donor has knowledge of facts that cast doubt on the organization’s eligibility to use the Form 1023-EZ or qualify for 501(c)(3) status. Until these questions are fully resolved, private foundations and other donors may prefer to fund organizations that have filed the standard Form 1023.