Forming a nonprofit corporation is not the same as being tax-exempt. To obtain 501(c)(3) status, newly formed entities must apply to the IRS for a formal determination of exemption. Entities seeking 501(c)(3) status apply by filing Form 1023. (Entities seeking exemption under other sections of 501(c) file Form 1024.)
Newly formed organizations applying for exemption face a chicken and egg dilemma. Form 1023 requests considerable detail regarding the charity’s planned programs and activities. The attitude of the IRS is that requiring applicants to articulate detailed plans is a small price to pay for the significant tax benefits associated with 501(c)(3) status.
1. Narrative Statement. Newly formed organizations often struggle to articulate their plans with the level of specificity the IRS demands. We generally try to provide at least a paragraph describing the who, what, when, where and how of each of the entity’s separately identifiable programs. Narratives statements that are very brief tend to elicit additional questions from the IRS. Narrative statements that go on for pages create an impression of trying too hard. We generally try to provide a 1-2 page narrative description.
2. Language Matters. Many applicants unknowingly use language that has a specific meaning in tax-exempt organizations parlance. This can confuse the IRS and generate long lists of questions that may not apply, but nevertheless must be responded to. For example, there are strict rules that govern whether scientific research is “in the public interest” or “commercial.” Statements that the organization conducts “research” are likely to trigger a list of questions pertaining to scientific research. The terms “advocacy,” “partnership,” “political,” and “publishing” can cause similar confusion.
3. Ancillary Documents. Often, the IRS will ask applicants to provide various contracts, grant applications and agreements, scholarship applications and guidelines, cost sharing agreements, and other evidence supporting the applicant’s plans. We have found that preparing and submitting drafts of the documents the planned activities call for can streamline the process significantly.
4. Timing. The IRS has a process to screen applications. Applications the screener finds raise no issues are processed within a few weeks to a few months. If the IRS screener has any issues or concerns, the application is assigned to a specialist for review. It typically takes 4 to 5 months for the file to be assigned to a specialist. Once a file has been assigned, we usually receive follow-up questions within a few weeks. The time required to resolve follow-up questions depends upon the complexity of the issues and the experience and training of the specialist.
5. Expedited Processing. It is possible to request expedited processing of the application in cases where the applicant has been offered a grant that will lapse unless the entity provide the funder with a favorable determination letter by a specific date.
NOTE (1/10/14): As of January 2, 2014, the IRS will no longer accept requests to expedite determination letters (including 1023 and 1024 applications). See Rev. Proc. 2014-4.
6. Interim Fundraising. Until the new charity receives its determination letter, it should disclose to potential donors that an application for 501(c)(3) status is pending. If the application is filed within 27 months of the date of incorporation and is ultimately approved, the entity’s 501(c)(3) status will be retroactive to the date of incorporation. Donors who claim a charitable deduction before IRS issues its determination letter assume the risk that application will not be approved. Many non-profits work with a fiscal sponsor during its start-up period to ensure their donors that their contributions will be deductible.
7. Cyber Assistant. The IRS has announced its plan to unveil a new Form 1023 preparation program called “Cyber Assistant” some time during 2010. This new tool will guide applicants through the Form 1023, providing cover sheets for attachments, continuation sheets for lengthy responses, and relevant taxpayer education.
8. User Fees. The IRS charges user fees to file an application for exemption. These fees are scheduled to increase on January 3, 2010. Organizations whose gross receipts average less than $10,000 per year currently pay $350. This fee will increase to $400. All others pay $850. This fee will increase to $850. When the Cyber Assistant becomes available later in 2010, applicants who use it will be eligible for a reduced user fee of only $200.