Form 1023-EZ – Traps for the Unwary

Managing Restricted GiftsBy 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.

27 Responses to Form 1023-EZ – Traps for the Unwary

  1. Great overview of the pitfalls to think about when making the decision on which form to file! This is going to be an interesting topic to watch as it develops over the next several years.

  2. I am not clear as to whether or not a Friends organization qualifies for the EZ form. The library Friends organization exists entirely to raise funds for the library, especially for children’s programming. Where can I find out if this would be a good fit for the EZ form? Can you help me with this? Thank you in advance!

  3. More than six months after Form 1023-EZ was officially released, there are still no “Frequently Asked Questions” about the form on irs.gov, so I took it upon myself to post some of my own 1023-EZ FAQs at http://501c3book.org/Streamlined.html.

    Those who visit these FAQs will also find a free download. Originally written to help purchasers of my “long form” ebook who might need to complete Form 1023-EZ, this ebooklet could be useful to almost anyone completing Form 1023-EZ, so I have made it available as a free download.

    Sandy Deja

  4. we have a small lake that is worth about $100,000. We have six shareholders. The lake has been formed into a C Corp for six years. Our total income per year is about $3,500 and our expenses are about $2,500. We would like to become tax exempt to avoid income and property tax.

    we generate money by selling permits for fishing or by leasing the lake to fishermen on an annual basis.

    is becoming a tax exempt corporation worth the trouble? We do not currently have written by laws or written minutes of our meetings. Please advise at your earliest convenience.

    Thank you,
    Bill

  5. Thanks for a great post.

    Concerning the revenue limit, you say, “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.”

    Isn’t there a process whereby when this happens, you simply notify the IRS and file the more thorough paperwork? Why would this become grounds for revocation. This means your idea has taken hold and has interest.

    Best,
    Rezwan

  6. At this time there is no such process that I am aware of. Under representing revenue in order to qualify is grounds for revocation when it amounts to a material misrepresentation.

  7. My biggest concern is the income limitations. Assuming no other issues, if one truly “anticipate(s) less than $50,000 in annual revenue for each of the first three (3) operational years” it seems the 1023-EZ, but this only during the approval process. It says three (3) and hopefully approval comes within a year.

    So, if after approval, the charity gets a windfall (donation) that would cause them to exceed $50,000, will they have to turn down the money until the three (3) pass? No charity turns down money.

    It seems a lot of charities could retroactive lose the status if they later become too successful too soon.

    No one wants to lose their status. Has there been any charities where this has happened?

  8. I haven’t filed a 1023 for a non-profit organization for 20 years. Now I belong to the above group and they want 501c3 status to use concerts to raise money to buy ukuleles for the local Boys and Girls Club and to teach these youngsters how to play the ukulele. (obviously we want to insure the survival of the orchestra by training up and coming players as well as keeping as many kids as possible off the streets and out of gangs) The problem is I noticed the EZ 1023 form and thought it was a great idea until the director told me he had filed for an LLC four years ago. Sooooo I know I can’t file the EZ 1023 form but you state in your fourth or fifth paragraph….”not realizing an LLC with private members can never qualify for exemption.” Maybe I’m comfused about “private members” because I think this organization should be exempt. Do we need to reorganize and file for a new EIN to qualify for exemption? Or can we go ahead and file the 1023? Thank you in advance for any information you can give us. Marlyn Cairns, MNM

  9. An LLC whose member is another exempt entity could qualify if it has the right tax language in its documents so if that is your situation you can apply. If, however, an individual is the member it won’t qualify. Better to form a nonprofit corporation and apply for it.

  10. Ellis, after the three-year revenue restriction rule ends, can the nonprofit operate like a traditional nonprofit?

  11. I am looking to start an animal rescue. I plan to look for grants, etc. I “may” exceed the $50,000 limit in the first year. What alternative do I have besides the 1023EZ? Please email me if possible with this information.

  12. There is no revenue restriction. Only a risk that if you materially misrepresent your anticipated revenues the organization’s exemption can be retroactively revoked. If you legitimately anticipate no more than 50k a year for the first three years and have an unexpected windfall, you should be okay. If your reasonably likely budget is flirting with 50k however, I would go ahead and file the full Form 1023.

  13. So, what if an org plans to apply for a 100,000 grant, but doesn’t expect to get it? Would that count as materially misrepresentation?

    Our current, normal operations produce way less than 50k per year, but once we become a tax exempt non profit, the hope is to find and receive larger grants. I’m guessing thats ok, since I really have no idea what grants we will actually be awarded.

  14. I’ve just formed a community-based Social Skills (Training)Club & Family Support Group for children, teens & young adults with Autism Spectrum Disorder and related conditions in my county. After reading the IRS Publication 557 I do believe it most likely can qualify as a non-profit corporation under 501 (c) 3 tax-exempt status category-educational organization. We are forming in a small county that seems to be underserved (no other public, community-based organization providing training or family support exist here, that I’m aware of.) We may also qualify for community service grants under HHAgrants.gov. I want to exist as a non-profit corp w/tax-exempt status as some grants require it. I do not believe these grants would give us revenues or assets over the expressed limits of the 1023 EZ as most award $5,000 a year or less. However is there a IRS template that I can use to show that our expressed purpose is education, training, therapy, information referral, support, public awareness & advocacy and that we will not exceed that purpose. Also would we still be required to reserve & register our organization(corp.) name for the 1023-EZ application?

  15. You do not have to justify your status on 1023-EZ – you just declare it. You do need to be incorporated and you do need to ensure your Articles of Incorporation include required provisions for 501(c)(3)s.

  16. Is the income limit for three years from the date of approval, or three years from the date of starting operations? My organization is 20 months old and trying to decide if 1023EZ is for us.

  17. Hello, I am in the process of submitting the 1023EZ. I am starting a community health center. I do not know if I will be awarded grants moneys exceeding 50k or not. If I am awarded the exempt status and funded over the 50K annually, will the IRS revoke my status even though there is no way to know if you will receive the funding or not?

  18. We formed as an LLC (unfortunately, apparently). If we file form 8832 to be taxed as a corporation, are we still ineligible to use the 1023 EZ form? I

  19. I guess maybe I didn’t understand the whole LLC concept from the beginning. Our “members” are not other organizations. My (minor) S on, my husband , and I started his “business” which entails providing gifts and monetary support to a Children’s Hospital. Thought we needed LLC for strictly liability purposes, but thinking not now. We filed for the business name (and included LLC in it). Is there a way to change that designation?