In mid-July, the National Taxpayer Advocate’s office released the Fiscal Year 2016 Objectives Report to Congress, in which the National Taxpayer Advocate, Nina Olson, continued to criticize the use of the Form 1023-EZ to obtain 501(c)(3) status. If you take nothing else from her report, you should read this statement summarizing her opinion of the current iteration of the 1023-EZ: “Because Form 1023-EZ does not require applicants to provide supporting documentation or substantiation, but only to attest they qualify for exempt status, the IRS has in effect relinquished its power to educate and regulate taxpayers before it confers exempt status.”
The Taxpayer Advocate’s report gives us a good summary of the impact of the 1023-EZ on the determinations process:
- From 2010-2014, the IRS was making less than 60,000 determinations a year on applications for 501(c)(3) status, with between 82% and 94% of those applications getting approved.
- At the beginning of 2014, the IRS approved streamlined procedures for processing applications that allowed applicants to “attest” to various requirements, rather than demonstrate their compliance with those same requirements.
- In July of 2014, the Form 1023-EZ was introduced.
- The IRS’ determinations on applications for 501(c)(3) status increased to 100,000 in 2014, with 94% of those being approvals.
- Since its release, 95% of Form 1023-EZs have been approved.
For those that were stuck in the unending wait for applications to get approved, or hesitant to put in an application that could have easily taken 1-2 years or more to get approved, this sounds like a welcome relief. However, where we gain faster processing, we lose in the compliance arena. More from the Taxpayer Advocate’s report:
- If they are properly filing a 1023-EZ (because they must have revenues <$50,000), then these same organizations that got exempt status through checking some boxes also don’t have to disclose information on their annual return because they are only required to file a 990-N (e-Postcard). Thus, we have little to no information about these organizations and whether they are actually operating in accordance with 501(c)(3).
- The IRS did its own random sample analysis of 1023-EZ filers and selected 521 applications for review. Out of 411 for which a determination had been made at the time the Taxpayer Advocate wrote her report, only 301 were recognized as 501(c)(3), producing a 73% approval rate. She notes that even if all the remaining applications selected are approved, that is still only a 79% approval rate, which is far less than the 95% of 1023-EZs that get approved. Because this was a representative sample, we can extend this to all 1023-EZs filed, which tells us that the difference between the number of applications approved and the number that should be approved (based on the 73%) calculates out to an error rate of 21%. In 2014, that was almost 6,700 1023-EZ filers.
- Of those that were rejected, 41% were ineligible to use the 1023-EZ because they did not meet the requirements of the eligibility worksheet (which you have to attest that you meet). Another 41% were rejected because they didn’t respond to requests for further information from the IRS. Both of these scenarios should be cause for concern in these organization’s abilities to properly manage a tax-exempt organization.
- The Taxpayer Advocate’s office did their own, non-representative sample of 1023-EZ filers. They picked 13 organizations whose 1023-EZs were approved, and come from states where the organization’s Articles of Incorporation are available online for free through the relevant state agency. Out of those 13, only three had the required elements in their organizing documents (thus, allowing them to meet one of the central tenants of 501(c)(3) status – the organizational test). Yet another scenario that should be cause for concern that those running the organization are not aware of the requirements on 501(c)(3) organizations.
The IRS has said that more organizations are going to be subject to audit in order to review whether or not they are compliant with the tax laws, and we are definitely seeing that playing out already. However, the Taxpayer Advocate states that she “…believes helping taxpayers meet the requirements for exempt status from inception, prior to granting recognition of exempt status, is the most effective approach for increasing cost effectiveness, reducing taxpayer burden, and enhancing consumer protection. “
Beyond the arguments that it is a better use of taxpayer dollars, better for potential donors, and just overall better for compliance (for those of us that care about such things) – it is also better for the organizations seeking exempt status to actually understand the requirements going into the process, rather than find out years later that they have been noncompliant. I am sure most founders of charitable organizations don’t want to find out years later, after audit, that they have a huge tax bill and/or have lost their tax-exempt status because they didn’t operate properly from day one.
For all these reasons and more – 1023-EZ users, beware, and let’s hope the Taxpayer Advocate is able to push for some improvements in this arena!