The IRS has just made it faster, easier and less expensive for small charities to apply for tax-exempt status.
In the past, it could be a fairly daunting process for small nonprofits to apply and be recognized as a tax-exempt 501(c)(3) organization by the Internal Revenue Service.
Charities had to fill out IRS Form 1023, a 26-page document that required detailed descriptions of activities and purpose, qualifications of officers and directors, financial statements and copies of articles, bylaws, a conflict of interest policy and other organizational documents. Whether you were a small arts organization or a community service club, the process was time consuming and the paperwork intensive.
The benefits to becoming a 501(c)(3), though, are certainly worth it. Securing federal tax-exempt status allows an organization’s donors to make tax-deductible contributions of goods and services. Tax-exempt organizations don’t have to pay taxes in many circumstances and are eligible for reduced postage rates. They can apply for foundation and government grants that are restricted to tax-exempt organizations.
So, many small and start-up nonprofits breathed a collective sigh of relief when the IRS introduced Form 1023-EZ last month. The new form is a mere three pages that the IRS is calling a “common sense approach” designed to eliminate paperwork, reduce processing delays and ultimately make it easier for nonprofits to “focus on their important work.”
Small charities should apply
The IRS estimates as many as 70 percent of all applicants will qualify to use the new streamlined approach “without creating compliance risks.” Interested organizations must:
- Complete an eligibility worksheet with 26 “check-the-box” questions related to activities. Organizations must, in good faith, be able to answer “no” to each one. These include questions ranging from the type of entity and amount of gross receipts to more arcane queries about selling carbon credits and charitable risk pools. Most will be fairly easy for newly formed, standard nonprofits.
- Meet the revenue requirements by having gross receipts under $50,000 in each of the first three years of operation and assets totaling less than $250,000.
- Meet the structural requirements. Churches, schools, hospitals, foreign organizations, limited liability companies, successors to for-profit entities and other types of organizations aren’t eligible to use the EZ form — although just because an organization is faith-based or geared toward education, it may not necessarily be classified as a church or school.
- File online and pay the $400 user fee. This is a reduction from the $850 user fee typically required by most applicants for the traditional 1023 EZ.
Why the changes?
While the IRS hasn’t come right out and said so, many suspect the streamlined approach begins a shift in philosophy to less initial scrutiny when the organization is just being formed and has yet to embark on many of its planned activities, saving greater scrutiny for when the organization has begun performing services and collecting funds. The IRS has said it plans to “devote more compliance activity on the back end to ensure groups are actually doing the charitable work they apply to do.”
There’s no doubt Form 1023-EZ is perfect for small and start-up charities that don't necessarily anticipate fast or steep growth. Some tax practitioners, however, have noted this new approach is too simple and the IRS isn’t asking the right questions about a nonprofit’s organizational structure, operations or financing.
With that in mind, nonprofits would be well advised to approach the process carefully — and with the support of legal counsel. Since the IRS has already indicated it plans to dedicate more resources to reviewing the Form 990s filed by nonprofit organizations post-exemption, don’t rush.
A nonprofit that quickly files the 1023-EZ without proper organization and structural planning could still face issues down the road when it comes time to provide its annual reporting. While daunting, the traditional 26-page application still offers tremendous value as a resource. A nonprofit would be wise to still think through the various issues set forth in the traditional application and related instructions, using it as an educational tool and planning device.
Christin Petroski is an attorney at Warner Norcross & Judd LLP who has extensive experience helping with formation and tax issues of nonprofits. She can be reached at firstname.lastname@example.org.