Form 1023-EZ Process Allows Unqualified Entities to Obtain Tax-Exempt Status

The IRS Form 1023-EZ based streamlined process for seeking 501(c)(3) status is designed exclusively for certain, small nonprofit organizations.Form 1023-EZ is the streamlined version of Form 1023, Application for Recognition of Exemption Under Section 501(c) (3) of the Internal Revenue Code. Any organization may file Form 1023 to apply for recognition of exemption from federal income tax under section 501(c)(3). Only certain organizations are eligible to file Form 1023-EZ

 

Form 1023-EZ IRS Backlog

Since July 2014, the IRS has addressed backlogs in its inventory of applications for tax-exempt status by allowing certain organizations to use Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3).  Form 1023-EZ adopts a “checkbox approach” that requires applicants merely to attest, rather than demonstrate, that they qualify for exempt status.

Filing Form 1023-EZ

In particular, Form 1023-EZ does not solicit any narrative regarding an organization’s planned activities, any organizing documents (such as articles of incorporation or bylaws), any financial data, or any explanatory material.  The IRS approves about 95 percent of applications submitted on Form 1023-EZ.  However, the IRS’s own data show it approves only about 77 percent of applications when it requests documentation.

 

What is Form 1023?

The 1023-EZ was designed to assist the IRS and charities in clearing up a backlog of applications for tax exemption that, by 2013, had reached 66,000. Charities were waiting months or years for determinations from the IRS, with “applications requiring review” taking 18 months or more to be assigned to a reviewer. (It’s noteworthy that an applicant for tax-exemption as a charity has the right to sue the IRS if their application hasn’t been acted on within 270 days.)

 

Who Files Form 1023-EZ?

Specifically, applicant organizations must satisfy the IRS definition of small.  That means they must:

  • Anticipate less than $50,000 in annual gross receipts each year for the first 3 years, and
  • Have already had less than $50,000 in annual gross receipts for all 3 prior years (if applicable), and
  • Have total assets valued at under $250,000

 

EZ eligibility is dependent upon purpose

Form 1023-EZ eligibility is dependent upon purpose.  The organizational types below are usually required to supply the IRS with more information regarding their activity than is required by the streamlined process.

These purpose exclusions include:

  • Organizations investing more than 5% of assets in non-publicly traded securities
  • Nonprofits exclusively purposed to test consumer products for public safety
  • Accountable Care Organizations
  • Health Maintenance Organizations
  • Credit counseling purposes (including budgeting, personal finance, financial literacy, mortgage foreclosure assistance, etc.)
  • Supporting organizations under section 509(a)(3) (formed to support another specific 501(c)(3))
  • Charitable risk pools
  • Cooperative service organizations
  • Cooperative hospital service organizations
  • Hospitals and medical research organizations
  • Schools, colleges, and universities
  • Churches and church associations
  • Organizations maintaining one or more donor advised funds

 

What is the organizational test for qualification as a Section 501(c)(3) organization?

Similarly, TAS conducted a research study, published in Volume 2 of the report, that examined a representative sample of organizations in 20 states that make articles of incorporation viewable online and whose Form 1023-EZ application had been approved by the IRS.  It found, among other things, that 37 percent do not meet the organizational test for qualification as a Section 501(c)(3) organization.  In other words, these organizations received favorable determination letters from the IRS even though they are not eligible for exempt status under the law.  The report recommends that the IRS revise Form 1023-EZ to require applicants to submit their organizing documents, a description of actual or planned activities, and past or projected financial information, and that the IRS review this information before deciding whether to approve exemption applications

 

Who cannot use Form 1023-EZ?

The applicant cannot use the Form 1023EZ if any of the following applies: (1) it received more than $50,000 in any of the prior three years, (2) it will receive more than $50,000 in any of its next three years, (3) it has more than $250,000 in assets, (4) it was formed outside the U.S., (5) it has a mailing address outside the U.S., (6) it is a limited liability company, (7) it is a successor to a for profit entity, (8) it is a church, (9) it is a school, college or university, (9) it is a hospital, or (10) it is a private operating foundation. For the complete list of disqualifications read the “IRS Form 1023-EZ Eligibility Test.”

 

501c3 and Form 1023-EZ

Most organizations seeking exemption from federal income tax under section 501(c)(3) are required to complete and submit an application. However, the following types of organizations may be considered tax exempt under section 501(c)(3) even if they do not file Form 1023 or Form 1023-EZ.

IRS Form 990 Tax Exempt Organizations

As you probably know, the Form 990 is the information return that most large tax exempt organizations file with the IRS each year. There are variations such as the Form 990-PF for private foundations; the short form, 990-EZ for mid-size organizations; and the Form 990-N e-Postcard for smaller organizations.

This article uses terms like Form 990-series return for the Forms 990, 990-EZ, 990-N e-Postcard, and the Form 990-PF. However, when we say Form 990, we’re talking specifically about the Form 990 that must be filed by charitable organizations to be entitled to certain exempt organization tax benefits.

 

What is Form 990?

Unlike most IRS forms, Form 990-series returns are not tax forms. Their primary purpose is not to report financial information. Instead, the forms provide the IRS and the public with information about an organization’s programs, activities, relationships, transactions and governance, in addition to revenues, expenses and assets.

 

How do exempt organizations use form 990?

The IRS uses Form 990 returns to administer the tax laws and to ensure that exempt organizations abide by those laws. And because Form 990 is a publicly disclosable document, it’s also the public’s window into an organization’s operations. A properly completed and filed Form 990-series return will meet the filing obligations of the organization and show the IRS and the public that the organization is organized and operated as a tax-exempt entity – that it is in compliance with applicable tax laws; that it’s well governed and managed; that it furthers its mission through its exempt activities; and that it provides valuable services to the public.

 

Who Must File Form 990?

As you already know, certain types of organizations don’t have to file a Form 990-series return. These include churches, associations of churches, and integrated auxiliaries of churches. I repeat churches do not have to file the Form 990, 990-EZ or 990-N. However, they must file 990-T to report unrelated business income if they have more than $1,000 of gross unrelated business income in any taxable year.

There are also a few other exceptions to filing Form 990, mostly for governmental entities and political organizations. If you’re interested, Publication 557, Tax-exempt Status of Your Organization and the Form 990 and 990-EZ instructions list all of the exceptions.

New Organizations and Form 990

Newly formed organizations that don’t meet any of these exceptions are required to file a Form 990-series return, even if they haven’t yet applied for or received recognition of exemption from the IRS. It’s not enough that the organization claims to be exempt from taxation. You may be required to file a Form 990-series return.

If an organization has filed, or plans to file a Form 1023, but is not yet recognized by the IRS as tax exempt, then it should check the “application pending” box on page one of the Form 990 or Form 990-EZ.

 

501(c)(3) and Form 990

The annual information return an organization is required to file is determined by either its public charity status or its financial activity. For example, if an organization is exempt under 501(c)(3) and classified as a private foundation, it will file the Form 990-PF.

If a 501(c)(3) meets a public support test over a five-year period, it will qualify as public charity rather than private foundation, so it will complete one of the other Form 990- series returns, not the PF. If a 501(c)(3) organization doesn’t know whether it meets the public support test, then it should fill out Form 990, Schedule A, before going any further. In general, it meets the test if it has many contributors and/or other sources of support.

 

Form 990-EZ and the Form 990-N

Form 990-EZ is the annual information return that most mid-sized taxexempt organizations may file instead of the Form 990. The Form 990-EZ is kind of like the little cousin of the Form 990.

Form 990-N, the e-Postcard, is the newest member of the Form 990-series and it comes to us courtesy of the Pension Protection Act of 2006.

You’ll save a lot of time and aggravation if you delegate preparation of sections of the Form 990 to those with specific knowledge about the organization’s operations that a particular part of the form is asking about.

 

Filing Form 990

Before you file your Form 990, if you’re doing this in paper, you’ll want to assemble the package of forms and schedules and attachments in the following order. You’ll put the core form with all parts completed, parts one through 12 that will go first. Then the schedules that you completed as applicable – and you’ll file those in alphabetical order. Then you’ll attach any attachments that you’ve completed.

Many have asked why these schedules are necessary. The IRS believes that there’s a close link between good governance and tax compliance. Organizations that adopt and implement sound risk management policies greatly improve their ability to be tax compliant. Conversely, most violations of tax-exempt law that we have seen in examinations have resulted, in part, from failure to exercise good governance.

 

Unrelated business income, or UBI for Non-Profits

Organizations may have to report and pay tax on UBI. If UBI activities become a substantial part of an organization’s activities, it might jeopardize the organization’s exempt status.

So what is UBI? Well, there’s a three-part test. It is income from a trade or business that is regularly carried on and not substantially related to the organization’s exempt purpose. The first part of the test is that the activity must be a trade or business. An activity does not lose its identity as a trade or business merely because it is carried on within a larger group of similar activities that may be related to the organization’s exempt purpose.

For example, the regular sale of pharmaceutical supplies to the general public by a hospital pharmacy is a trade or business. However, sales to the hospital and patients are related, and therefore, not UBI. Likewise, a hospital cafeteria operated for the convenience of the hospital’s employees, patients, and the patients’ visitors is a related activity and also not UBI.

 

Business Activity of an Exempt Organization

The second part of the test is that the trade or business must be regularly carried on. A business activity of an exempt organization is generally considered to be regularly carried on if it shows a frequency and continuity that is conducted in a way generally similar to comparable businesses of non-exempt organizations. For example, a hospital auxiliary’s operation of a sandwich stand for a week at a state fair would likely not be regular conduct of a trade or business; however, operation of the sandwich stand daily at the hospital and open to the public would be considered regular conduct of a trade or business.

 

What are IRS 501(c)(4) Organizations?

Nonprofit status is a state law concept. An organization usually becomes a nonprofit under state law by filing organizing documents with the state, such as Articles of Incorporation, which indicate the organization is formed under the state’s Nonprofit Corporation Act. Nonprofit status may make an organization eligible for certain benefits, such as exemption from property, income and state sales tax. This is on the State level and filing requirements and benefits vary state by state.

 

What are IRS 501(c)(4) Organizations?

Section 501(c)(4) organizations include civic leagues, social welfare organizations and local associations of employees. A social welfare organization, under 501(c)(4), must be organized exclusively for the promotion of social welfare. A 501(c)(4) organization operates primarily to further the common good and general welfare of people of the community, such as by bringing about civic betterment and social improvements. In this group — this includes groups formed to educate and inform the public about particular issues. Some more examples of section 501(c)(4)s include volunteer fire companies, civic leagues and community associations. And we also do want to point out that option 501(c)(4)s conduct activities that are very similar to those of 501(c)(3) organizations, however, 501(c)(4)s are not constrained by many of the restrictions and prohibitions placed on (c)(3)s

 

Applying for 501(c)(4) Status

Organizations applying for exemption under 501(c)(4) use Form 1024, called Application for Recognition of Exemption under section 501(a). Form 1024 is also used to apply for recognition of exemption under 501(c)(5), (c)(6), and the rest of the sections we discussed today.

 

More IRS Information on 501(c)(4) Organizations

The promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office. However, a section 501(c)(4) social welfare organization may engage in some political activities, so long as that is not its primary activity. However, any expenditure it makes for political activities may be subject to tax under section 527(f). For further information regarding political and lobbying activities of section 501(c) organizations, see Election Year IssuesPolitical Campaign and Lobbying Activities of IRC 501(c)(4), (c)(5), and (c)(6) Organizations, and Revenue Ruling 2004-6.

 

Examples of exempt as social welfare organizations

Homeowners associations and volunteer fire companies may be recognized as exempt as social welfare organizations if they meet the requirements for exemption. Organizations that engage in substantial lobbying activities sometimes also are classified as social welfare organizations.

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Ten Things Tax-Exempt Organizations Need to Know About the Oct. 15 Due Date

A crucial filing deadline of Oct. 15 is looming for many tax-exempt organizations that are required by law to file their Form 990 with the Internal Revenue Service or risk having their federal tax-exempt status revoked.  Nonprofit organizations that are at risk can preserve their status by filing returns by Oct. 15, 2010, under a one-time relief program.

The Pension Protection Act of 2006 mandates that most tax-exempt organizations must file an annual return or submit an electronic notice, with the IRS and it also requires that any tax-exempt organization that fails to file for three consecutive years automatically loses its federal tax-exempt status.

 

Here are 10 facts to help nonprofit organizations maintain their tax-exempt status.

  1. Small nonprofit organizations at risk of losing their tax-exempt status because they failed to file required returns for 2007, 2008 and 2009 can preserve their status by filing returns by Oct. 15, 2010.
  2. Among the organizations that could lose their tax-exempt status are local sports associations and community support groups, volunteer fire and ambulance associations and their auxiliaries, social clubs, educational societies, veterans groups, church-affiliated groups, groups designed to assist those with special needs and a variety of others.
  3. A list of the organizations that were at-risk as of the end of July is posted at IRS.gov along with instructions on how to comply with the new law.
  4. Two types of relief are available for small exempt organizations — a filing extension for the smallest organizations required to file Form 990-N, Electronic Notice and a voluntary compliance program for small organizations eligible to file Form 990-EZ, Short Form Return of Organization Exempt From Income Tax.
  5. Small tax-exempt organizations with annual receipts of $25,000 or less can file an electronic notice Form 990-N also known as the e-Postcard. To file the e-Postcard go to the IRS website and supply the eight information items called for on the form.
  6. Under the voluntary compliance program, tax-exempt organizations eligible to file Form 990-EZ must file their delinquent annual information returns by Oct. 15 and pay a compliance fee.
  7. The relief is not available to larger organizations required to file the Form 990 or to private foundations that file the Form 990-PF.
  8. Organizations that have not filed the required information return by the extended Oct. 15 due date will have their tax-exempt status revoked.
  9. If an organization loses its exemption, it will have to reapply with the IRS to regain its tax-exempt status and any income received between the revocation date and renewed exemption may be taxable.
  10. Donors who contribute to at-risk organizations are protected until the final revocation list is published by the IRS.