By all accounts, public response to the new streamlined 1023-EZ has been enthusiastic. The form is relatively simple and is processed in a matter of weeks at a reduced filing fee of only $400. Meanwhile, the logjam of traditional long-form 1023s seems to be making headway. If the ease of the 1023-EZ application process seems too good to be true, that is probably because it is.
For self-filers who opt to file the Form 1023-EZ there are several traps for the unwary that could come back to haunt your organization. First, filers must self-certify that they have complied with several requirements for 501(c)(3) status. Specifically, the applicant must certify that its governing documents contain the following:
- A purpose clause that restricts the organization’s activities to those that qualify for tax-exempt status under Code Section 501(c)(3);
- A dissolution clause that ensures the nonprofit’s assets are permanently dedicated to public purposes; and
- Private foundation prohibitions.
While these items seem straight forward, we have seen both lay people and lawyers fail to include these crucial tax provisions in governing documents. This is an easy mistake to make because state nonprofit incorporation forms do not include the provisions required by the IRS to obtain tax-exemption.
Second, there is list of twenty-six circumstances that disqualify an organization from 1023-EZ eligibility and several are not obvious. For example, organizations organized as LLCs or successors to for-profits do not qualify. This fact excludes organizations either testing their ideas in a for-profit entity or those who make the mistake of forming their organization as an LLC, not realizing an LLC with private members can never qualify for exemption. Those seeking classification as a church, school, hospital, or supporting organization or that plan to offer donor advised funds are among the groups precluded from filing Form 1023-EZ.
Third, there is also some judgment involved in determining whether the organization’s budget meets the revenue and asset limits. To be eligible for the 1023-EZ, the organization must have had less than $50,000 in annual revenue for each of the past three (3) years, anticipate less than $50,000 in annual revenue for each of the first three (3) operational years, and have less than $250,000 in total assets. Budgets are typically little more than a hope and a prayer so it is easy enough to temper one’s projections in order to qualify; however, where the activities contemplated clearly call for more money in the first three years than the limit allows, where grant applications being submitted reflect budgets exceeding the limits, or where a source of funds have been identified making it likely the organization will exceed the $50,000 threshold, the filer should think twice before relying on Form 1023-EZ. Material misstatements on an Application for Exemption, including Form 1023-EZ, can lead to retroactive revocation of the organization’s tax-exempt status down the road.
Finally, the IRS has not been shy about letting people know they plan to boost examinations of exempt-organizations in operation. Specifically, the IRS is relying more heavily on its Review of Operations Unit (“ROO”) which began in 2005. A ROO specialist will often review a new organization’s first few years of annual returns (Form 990, 990-EZ, 990-PF, or 990-N) and other publicly available information regarding the organization. The ROO specialist will then compare that information to the application for recognition of exempt status and follow-up on inconsistencies or other areas that raise compliance issues. In such cases, the ROO specialist may refer the case for a more in depth examination.
The 1023-EZ will work for many clients and is a great tool for the IRS to catch up on the backlog of long-form 1023s; however, applicants must fully read and understand the instructions to make sure they do not make representations they cannot keep once in operation. The cost could be your tax-exempt status.
Ellis Carter is a nonprofit attorney licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide.