Form 1023-EZ Is Too Easy
Fifty-five percent of organizations applying for Internal Revenue Code Section 501(c)(3) status in fiscal year 2015 applied using the new Form 1023-EZ. But the National Taxpayer Advocate, part of the Taxpayer Advocate Service (TAS), recently released a report to Congress indicating that the new Form appears to have significant problems and that the Internal Revenue Service (IRS) went too far in reducing the amount of information required from an organization seeking tax-exempt status. The statistics are even more daunting when one compares the number of Section 501(c)(3) applications in FY 2014 (100,032) to the number in FY 2013 (45,289).
The TAS is an independent
organization within the IRS that helps taxpayers and protects taxpayer rights. The Taxpayer Advocate is appointed by and reports to the Commissioner of Internal Revenue and is responsible for identifying problems and proposing changes in the administrative practices of the IRS.
The new Form 1023-EZ was introduced in July 2014 to provide a simplified method for small organizations to apply for tax-exempt status as a Section 501(c)(3) organization. While the National Taxpayer Advocate had initially recommended a simplified Form for small organizations, she ultimately expressed concern that the new Form lacks the information that would prove whether an organization is eligible for tax exemption (essentially public funds).
The Taxpayer Advocate may have recommended the simplified form because of the severe backlog the IRS and the public were experiencing: At the time, thousands of organizations were reapplying for tax-exempt status after they failed to file Form 990 for three consecutive years and had their status revoked.
Passing (or Failing) the Organizational Test
Organizations seeking tax exemption under Section 501(c)(3) must pass organizational and operational tests. The organizational test requires that certain provisions be in the organizing documents (articles of incorporation and bylaws) that show the entity is organized for exclusively Section 501(c)(3) purposes (purposes clause) and that assets are dedicated in perpetuity to charitable purposes (the dissolution clause).
The Taxpayer Advocate’s study examined 408 organizations that had applied for Section 501(c)(3) status using the shortened Form and found that 37 percent failed the organizational test because their articles of incorporation did not have an appropriate purposes clause or dissolution clause or both. The study was based on a review of organizations from states where the articles of incorporation could be found online. The report states, “It took the reviewers about three minutes on average to review an organization’s articles and determine whether there were acceptable purpose and dissolution clauses.”
Key Differences between the Forms
The organizational test is just one example of where the new Form has gone too far in the direction of efficiency. While the usual form with additional schedules and attachments is 12 pages long, the new form is only a two-pager. Aside from the length, the short form differs from the full Form 1023 in three significant ways:
- Articles of Incorporation and Bylaws are not required to be submitted.
- The applicant does not have to provide a narrative description of its activities.
- Only an attestation is required regarding private inurement or private benefit – not information such as financial details.
Not every organization is eligible to use the two-page form. The organization cannot have more than $250,000 in assets, nor can it have more than $50,000 of income for the past three years. Many organizations that qualify to file the Form 1023-EZ would also qualify to file the Form 990-N postcard, whereby an organization must attest that it normally has no more than $50,000 in gross receipts.
Doubts Remain about Organizations’ Charitable Activities
In addition to deficient articles of incorporation, the study found that only about half of the organizations surveyed had websites that would allow the IRS to easily find information about the activities of the organizations. The study found eight organizations in the sample that had previously filed tax returns as taxable corporations and questioned whether those organizations had changed their operations to be charitable.
Because Section 501(c)(3) organizations can receive tax deductible contributions, these organizations are, in essence, subsidized by public funds. Therefore, it is imperative that only organizations that deserve Section 501(c)(3) status are granted such status.
The Taxpayer Advocate has provided the IRS Exempt Organizations Division with the names of the organizations that failed the tests. The Taxpayer Advocate recommended that the Form 1023-EZ be modified to require applicants to submit organizing documents, a narrative description of activities and financial information.
Tax exemption is a privilege and not a right. Especially in the case of Section 501(c)(3) organizations where taxpayers can make deductible contributions, a lack of close monitoring leaves opportunities for abuse. IRS’s first bite at the apple of compliance is to test the organization before it grants the organization exemption. The quick form may very well be appropriate in situations in which the IRS had already vetted the organization with the full Form 1023 but revoked exempt status because Form 990 was not filed for three years. In that case, the IRS would already have important information and documents about the organization. However, in other situations, it appears that more information is needed so that the exempt organization community and the public are protected.