As many folks know, the IRS is VERY behind on processing applications for tax-exempt status. At the end of March, the IRS submitted a draft of a new “1023-EZ” to the Office and Management and Budget for a comment period – and in theory we will see a final version this summer. What does this mean? [**UPDATE: The form was released on July 1st, 2014. This post has been updated in light of the newly released form.]
First – just a reminder of how we got here: there is a massive backlog of applications (Forms 1023 and 1024) pending with the IRS. Approximately 80,000 applications come in annually (approximately 20,000 of those are coming in because they were automatically revoked for failure to file annual returns 3 years in a row). As of 6/5/14, the average date of pending applications is August 2013 – remember, this means that an equal number of applications were submitted before August of 2013 as were submitted after. So…long delays. Delays are due to budget issues, sequestration, automatic revocation, and “Tea Party Non-Gate” (which still continues).
The IRS probably had to do something – it has been clear for a while that they are not making progress in getting reasonably caught up on processing applications. It is estimated that approximately 17% of applicants will be eligible to file the 1023-EZ. Who is eligible? Well, the IRS (in all its difficult-ness) has instead defined eligibility by providing a long list of those ineligible to file. That list includes things like:
- Organizations with annual revenues exceeding $200k (or projected to exceed in the next 3 years), or assets in excess of $500k. [**UPDATE: As of July 1st, instructions for the new form now state that an organization is only eligible if it does not expect its gross assets to exceed $50,000 in the next three years (and has not in the previous three years) and assets not exceeding $250k. The new form and other relevant documents can be found here.]
- A successor to a for-profit entity
- A organization whose tax-exempt status was revoked (other than for failure to file a return) and *** certain organizations whose status was revoked for failure to file [**UPDATE: organizations applying for retroactive reinstatement under Sections 5 or 6 of 2014-11 cannot use the form].
- Organizations engaged in joint ventures
- Organizations managing donor advised funds
Should every organization that is eligible fill this out? I am not so sure…. There are definitely advantages. It should be cheaper (although we don’t know yet what the filing fee will be) [**UPDATE: Filing fee is $400]. It should be less intensive to fill out (and thus perhaps cheaper). In theory, review by the IRS should be faster. It can be e-filed (must be e-filed). However, there are also some significant disadvantages. The IRS has explicitly stated that there will be an increase in oversight over organizations filing the 1023-EZ (although we don’t yet know what that oversight will be). Organizations filling out the 1023-EZ really lose out on the educational opportunities on 501(c)(3) requirements that are provided (forced on them) by filling out the full Form 1023. Finally, there are many traps for the unwary – making it easy to fill out an inaccurate form.
The National Council of Nonprofits, in their comments on the Form 1023-EZ, said the following:
“[W]e are concerned that the proposed new Form 1023-EZ and related streamlined approval process for tax-exemption will (1) decrease, rather than improve, the quality of information the IRS needs to make informed decisions; (2) reduce public trust; and (3) inappropriately shift the IRS’ obligations onto others – foisting burdens on the public, existing charitable nonprofits, the funding community, and state charity regulators.”
The National Association of State Charity Officials was also critical of the Form 1023-EZ in their comments:
“We believe that the Form 1023-EZ will increase opportunity for fraud and heighten the burden on state regulators to compensate for the reduced standards that will be required of the organization to meet federal tax exemption requirements. While we appreciate that the IRS will be committing more resources to back-end compliance examinations to address the potential for malfeasance, our concern is that the current 17% of all applicants for which the Form 1023-EZ would apply could grow exponentially if the process for obtaining tax-exempt status was significantly simplified. Both IRS and state charities regulator enforcement capabilities are already stretched thin. While use of the Form 1023-EZ may result in somewhat of a short-term reduced burden in processing applications, the long-term effect certainly will be a greatly increased burden on already overburdened state and federal regulators.”
So should we ditch the form? Yes – but that isn’t going to happen. We either have to make the process of exemption easier/faster for a significant number of folks – or provide more funding for the IRS. Congress isn’t going to provide additional funding anytime soon….so…we have the 1023-EZ.
Organizations looking to fill out the form are going to perceive a significant advantage to filling out the shorter form – however these perceptions may not be accurate. I agree with the above comments – noncompliance is going to become more common as a result of the easier process. Organizations thinking about filling out the 1023-EZ should seek counsel and weight the advantages and disadvantages to the 1023-EZ for their organization – otherwise, they may find themselves penny-wise, but pound-foolish.