United States: IRS Attempts To Simplify The Application Process For Certain 501(C)(3) Organizations, But Is "EZ" Better?

On July 1, 2014, the Internal Revenue Service ("IRS") released Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code ("Code").

Form 1023-EZ is an abbreviated version of the twelve page Form 1023 (which can be supplemented by as many as seven schedules) and is intended to streamline the application for recognition of exemption under Code §501(c)(3) for certain organizations.  Such organizations are those with gross receipts of $50,000 or less and assets of $250,000 or less and are otherwise eligible to file the Form by being a public charity described in Code §§170(b)(1)(A)(vi) or 509(a)(2), a private foundation, or an organization seeking reinstatement of exempt status pursuant to section 4 or 7 of Revenue Procedure 2014-11 following automatic revocation of such status for failure to file required annual returns or notices for three consecutive years.

In order to use Form 1023-EZ, an organization must complete (and retain) a seven page Form 1023-EZ Eligibility Worksheet.  The Worksheet asks various questions to "screen" for eligibility to use Form 1023-EZ by identifying if an applicant is one of 25 types of organizations that the IRS has determined are ineligible to file Form 1023-EZ.  Such organizations include, but are not limited to, those formed under the laws of a foreign country or having a foreign mailing address, successors to for-profit entities, limited liability companies, churches, educational institutions, hospitals, supporting organizations, private operating foundations, and health maintenance organizations.

Form 1023-EZ is three pages and has five parts.  Part I provides general information about an organization.  Part II includes various "check the box" items in which an applicant attests that its organizing document has an appropriate purpose clause, does not permit an impermissible amount of activities not in furtherance of exempt purposes and a dissolution clause that permanently dedicates assets to Code §501(c)(3) purposes.  Part III asks questions regarding activities and includes a "check the box" item indicating the organization has not and will not conduct activities that violate the political campaign prohibition and limitations related to private inurement, private benefit, and lobbying.  Part IV has questions related to classifying an organization as a public charity described in Code §§170(b)(1)(A)(vi) or 509(a)(2) or as a private foundation.  Part V is completed by an organization seeking reinstatement of exempt status pursuant to section 4 or 7 of Revenue Procedure 2014-11.

Form 1023-EZ is filed with the IRS electronically at www.irs.gov/form1023 or www.pay.gov.  A $400 fee is required to process a Form 1023-EZ.  Payment of the fee is made electronically using a bank account or a credit or debit card.  No supporting documentation or financial data is submitted with a Form 1023-EZ.

Approval of a Form 1023-EZ application is not guaranteed.  In most cases, however, it is anticipated the IRS will approve an application in two to three weeks without the questions or additional information that can follow the submission of a "full" Form 1023.

Two to three week processing time is "light speed" in an era of Form 1023 processing times of up to a year or more.  While faster processing is a beneficial byproduct of Form 1023-EZ, use of the Form is not without concerns.  For example, the questions on the Form 1023-EZ are complicated.  Moreover, the Form requires an officer or director of an applicant to attest under penalties of perjury to various items that effectively require legal conclusions regarding the organization and operation of the applicant.  By contrast, a "full" Form 1023 is an opportunity to present the IRS with a fulsome description of the organization and operation of an applicant with the goal of providing sufficient information so the IRS will issue a determination letter "blessing" such organization and operation.

Form 1023-EZ also shifts the compliance role of the IRS from the front-end to the back-end.  That is, prior to Form 1023-EZ, the IRS served as an informed gatekeeper for purposes of Code §501(c)(3).  With Form 1023-EZ, however, the IRS only asks for limited information and if documentation exists and is in place, but it does not require supporting documentation or financial data.  The IRS then relies on such information and various attestations in granting Code §501(c)(3) status.  The pitfall for an organization is the anticipated scrutiny the IRS will give to the annual information returns of organizations using Form 1023-EZ to ensure compliance with the requirements of Code §501(c)(3).  As a result, the IRS will no longer have the role of informed gatekeeper of tax-exempt status under of Code §501(c)(3).  Instead, the "gate" to Code §501(c)(3) status will be left open, with resulting opportunities for fraud and abuse, leaving the IRS the role of policing organizations on the back-end rather than on the front-end application stage.

"EZ" may not be better than the prior system of utilizing the "full" Form 1023 in determining qualification for tax-exempt status under Code §501(c)(3).  Indeed, it remains to be seen whether Form 1023-EZ will result in a more efficient and better regulated charitable sector.  At a minimum, Form 1023-EZ is likely to lead to changes in enforcement patterns by the IRS.  More importantly, Form 1023-EZ is a reminder for directors, trustees, officers, and all who advise charitable organizations, large or modest in size, that while the path to tax-exempt status under of Code §501(c)(3) may be easier for organizations eligible to use Form 1023-EZ, each Code §501(c)(3) organization must have appropriate governing documents, policies, procedures, and guidelines to make sure it is organized and operated in accordance with the requirements of Code §501(c)(3).

Further information about Form 1023-EZ can be viewed at www.irs.gov/uac/About-Form-1023EZ.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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