In a recent post, I talked about some of the numbers regarding the IRS Form 1023-EZ application for tax-exempt status, which allows some organizations with annual receipts of $50,000 or less to apply on-line using a much simpler form and process than that required by Form 1023. Today I want to talk about some of the issues that have been raised by the new form.
The Taxpayer Advocate Service (TAS), an independent organization within the IRS that is charged with ensuring that taxpayers are treated fairly, had previously argued that Form 1023 was unfairly onerous to small organizations, and in 2011 the National Taxpayer Advocate Nina Olson suggested to the Exempt Organizations Division (EO) of the IRS that a simpler Form 1023-EZ be developed. At the time, EO declined to take that suggestion, but in 2013 did set about creating such a form.
When it was released, however, TAS felt that it had swung too far in the other direction. Their criticisms were:
1. The lack of a narrative statement of activities – organizations applying on Form 1023 are required to supply a detailed explanation of their organization’s mission and the activities it intends to undertake in support of that mission. There is no such requirement on Form 1023-EZ. Additionally, most organizations that receive their status through the EZ will file Form 990-N annually. This form also has no requirement to describe the activities of the organization. As a result, we are creating a new generation of charities whose activities are essentially unknown to the IRS and to the public.
2. The lack of supporting documentation – the Form 1023 requires that organizations attach copies of the articles of incorporation, by-laws and other organizational documents that allow the IRS to determine that the applying organization is legally organized. The Form 1023-EZ has checkboxes where the applicant attests that certain things are true, and that certain documents exist.
3. The lack of questions that might reveal issues and irregularities – during the 1023 application process, it is not unusual for there to be clarifying give-and-take exchanges between organizations and EO. This would very rarely happen in the 1023-EZ process.
4. The $200,000 annual receipts eligibility threshold for using 1023-EZ – this is the one area in which EO relented, reducing the threshold to $50,000.
One indication that the fears of TAS are legitimate is an audit that the IRS did after the new form was already in use. The IRS picked a sample of 521 Form 1023-EZ applicants and conducted a pre-determination review of those organizations, essentially putting them through the same scrutiny that a Form 1023 applicant would go through.
Of the 411 organizations for which EO had made a determination by the time TAS released its 2016 report to Congress, 301 received a positive ruling as 501(c)(3) public charities, a success rate of 73 percent, versus a success rate of 95 percent for 1023-EZ applicants that did not undergo this additional scrutiny. Statistically speaking, we must conclude that there are now more than 20,000 organizations with a positive IRS determination letter that would not have one had they undergone a more thorough process.
One question that is still up in the air is the extent to which a private foundation can depend on the determination letter of a 501(c)(3) charity that was granted that status based on a Form 1023-EZ application. IRS Revenue Procedure 2014-40 states:
“a determination letter issued to an organization that submitted a Form 1023-EZ in accordance with this revenue procedure may not be relied upon if it was based on any inaccurate material information submitted by the organization. Inaccurate material information includes an incorrect attestation as to the organization’s organizational documents, the organization’s exempt purposes, the organization’s conduct of prohibited and restricted activities, or the organization’s eligibility to file Form 1023-EZ.”
When an organization has a determination letter based on a Form 1023, the IRS allows donors to make contributions in good faith until such a time as the IRS informs the public that they may no longer depend on the determination letter. That is not what they are saying for Form 1023-EZ. There is at least the implication that the donor should be doing the same sort of due diligence that the IRS does for organizations that file Form 1023, a process for which most donors are ill-suited.
The 2016 TAS report to Congress says “…Form 1023-EZ and Form 990-N, even taken together, provide almost no transparency.” It certainly seems that there is room to gather more information from smaller organizations without causing these organizations unnecessary record keeping requirements, for example, requiring on Form 1023-EZ some statement about mission and activities, and requiring on Form 990-N the reporting of revenue and expenses. Hopefully, the IRS will continue to study these issues and tweak both of these forms until they become at least somewhat useful to the IRS and the public.
The preceding is a guest post by Chuck McLean, a founding employee of GuideStar. Chuck is responsible for conducting research for GuideStar and for customers interested in nonprofit sector data. He also works to identify new data sources and ways to present data effectively to GuideStar users. Chuck produces the annual GuideStar Compensation Report, which analyzes the salary and benefits of thousands of nonprofits throughout the country.