Applying for 501(c)(3) Tax-Exempt Status: The Gift and the Curse of the 1023-EZ

 

Form1023EZ_hp

 

Until recently, if a nonprofit organization wanted to apply for 501(c)(3) status it had to file the 26-page Form 1023. Considering that most nonprofit corporations apply for 501(c)(3) status at some point, this presented a problem. Form 1023 was notoriously difficult and stressful to fill out. The headaches didn’t stop once the nonprofit completed Form 1023, either. Just as Form 1023 is difficult to fill out, it is also difficult for the Internal Revenue Service to review and process. Applicants often had to wait 1 year or longer for their 1023’s to be processed by the Internal Revenue Service and to receive their letter of determination regarding the application.

 

To address this problem, the IRS gave those wishing to apply for 501(c)(3) status another option. In July of 2014, the IRS introduced Form 1023-EZ, a streamlined application for 501(c)(3) status. Form 1023-EZ is a far cry from the burdensome 1023. It is a mere 3-pages, can be completed online, does not require the submission of nonprofit bylaws or articles of incorporation, and only requires the application to attest that it meets the legal requirements for 501(c)(3) status by checking a few boxes. The user fee that must be submitted along with the form is $400, the form is usually processed in 2 weeks and the IRS approved 95% of all 1023-EZ applications submitted. Overall, the process of filling out and filing 1023-EZ is much less burdensome than the original 1023.

 

Not every nonprofit corporation is eligible to file the 1023-EZ. Nonprofit corporations should always consult the 1023-EZ worksheet before deciding to file. In general, only nonprofit corporations with $50,000 or less in annual gross receipts for its first 3 years and $250,000 or less in assets. Based on these restrictions, larger nonprofit corporations may be stuck filing Form 1023. However, smaller nonprofit corporations should be able to benefit from the streamlined 1023-EZ application.

 

Given the ease of completing 1023-EZ, there are some traps for the unwary that applicants should be aware of. While the up-front screening conducted by the IRS is greatly reduced the legal requirements for 501(c)(3) organizations remain the same. All 501(c)(3) organizations must still pass the organizational and operational test. The organizational test requires a 501(c)(3) nonprofit to be organized exclusively for charitable, educational, or scientific purposes. To satisfy this test, the nonprofit corporation must include specific language in its Articles of Incorporation. While a nonprofit corporation filling out Form 1023-EZ certifies that this language is in their Articles of Incorporation by checking boxes 5 through 7, many nonprofit corporations submit their 1023-EZ without having the required language in their Articles of Incorporation. As mentioned previously, the IRS does not require any organizational documents to be submitted with the 1023-EZ and therefore the IRS does not examine a nonprofit’s Articles of Incorporation when they submit their 1023-EZ. Therefore, while not having the required language in the Articles of Incorporation will not prevent a nonprofit from obtaining its 501(c)(3) status, it will mean that the nonprofit is in violation of IRS regulations which will cause the nonprofit to lose its tax-exempt status if it is ever audited by the IRS. There is also the issue of the operational test. The operational test requires all 501(c)(3) nonprofits to be operated primarily for a charitable, educational, or scientific purpose. Determining what the IRS considers to be “charitable”, “educational”, or “scientific” can be difficult. The long form 1023 requires the applicant to describe what type of activities the nonprofit is planning to engage in which allows the IRS to make an up-front determination as to whether the nonprofit will be operated primarily for a tax-exempt purpose. This is not the case with the 1023-EZ. Therefore, it’s important to make sure that your nonprofit is primarily operated for a tax-exempt purpose or the nonprofit’s 501(c)(3) status may be jeopardized if the IRS audits the organization. Lastly, there are IRS regulations regarding how a 501(c)(3) organization may engage in political lobbying, how it can generate revenue through a business activity, and how it uses its assets. Questions 4 through 11 of the 1023-EZ are largely meant to make applicants aware of these regulations and it may be helpful to talk with a lawyer about what those specific regulations are.

 

In short, the 1023-EZ application has greatly helped smaller nonprofit organizations as it streamlines the 501(c)(3) application process and makes it significantly less burdensome. However, in some ways it is too easy. Regulations governing 501(c)(3) organizations are extensive and restrict what types of activities and programming a nonprofit can engage in and how it can utilize its funds. It also requires the nonprofit to have specific language in its Articles of Incorporation. None of these requirements are changed when a nonprofit uses Form 1023-EZ. Therefore, it’s important that if your nonprofit decides to utilize Form 1023-EZ to apply for 501(c)(3) status that you are in full compliance with IRS regulations. Otherwise, your nonprofit’s tax-exempt status may be revoked by the IRS down the road.