Posted: January 28th, 2016
To be recognized by the IRS as a charity under 501(c)(3) of the Internal Revenue Code once required all organizations to undertake the lengthy and somewhat arduous process of filing the IRS Form 1023. According to the IRS, it could take a novice more than 100 hours to complete the form. After submission, applicants can expect to wait four to six months or, in some circumstances, even longer for a determination as to their organization’s tax-exempt status.
In an effort to reduce the backlog that had been frustrating charitable organizations and their donors, the IRS introduced a new, streamlined version of the application in July of 2014—the IRS Form 1023-EZ. “Previously, all of these groups went through the same lengthy application process — regardless of size,” said IRS Commissioner John Koskinen. “It didn’t matter if you were a small soccer or gardening club or a major research organization. This process created needlessly long delays for groups, which didn’t help the groups, the taxpaying public or the IRS.” The IRS hopes that the change will speed up the application process for smaller charitable organizations, and free up resources for the review of applications of larger, more complex organizations. In theory, the effect should be a reduction in backlog and turnaround time for organizations of all sizes. The form can only be completed online and currently costs $400.
Organizations Eligible for the Form 1023-EZ
Not all charitable organizations are eligible to apply for exemption under section 501(c)(3) using Form 1023-EZ. To determine eligibility, an organization must complete the Form 1023-EZ Eligibility Worksheet. The worksheet lists 26 questions for perspective organizations. If the answer to any of those questions is “yes”, the organization is ineligible and must file the full Form 1023. For starters, organizations must be small in the eyes of the IRS. This mean that the organizations must: (1) anticipate less than $50,000 in annual gross receipts each year for the first 3 years, and (2) have already had less than $50,000 in annual gross receipts for all 3 prior years (if applicable), and (3) have total assets valued at under $250,000.
In addition, an organization’s ties with a foreign country, its business structure and history of any predecessor organizations, and its purpose and activities can render the organization ineligible for the 1023-EZ. For example, organizations investing more than 5% of assets in non-publicly traded securities, charitable risk pools, schools, colleges, and universities, and churches and church associations are unable to take advantage of the streamlined application. Your organization should carefully examine the Eligibility Worksheet available on the IRS website. Some organizations that are eligible should consider filing the long-form 1023 instead, especially those nonprofits that expect grant funding and/or corporate giving to be an essential part of their income stream.
Be Sure to Closely Examine These Parts of Your Application, Because the IRS Will
There are many factors that can disqualify your organizations for tax-exempt status, and many are less-than-obvious. Two of the most important and easily overlooked concern the organization’s governing documents.
First, the articles of organization or articles of incorporation must contain a purpose clause that restricts the organization’s activities to those that qualify for tax-exempt status under IRC 501(c)(3). Those purposes are charitable, educational, religious, literary, scientific, testing for public safety, fostering national or international amateur sports competition, and prevention of cruelty to children or animals. The regulations then include, within charitable, the following purposes: Relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of Government; and promotion of social welfare. Merely referencing section 501(c)(3) will not ensure that your purposes are limited to those described in that section. In fact, all of the language in your organizing document will be considered. According to the IRS, the following is a satisfactory example of a limitation of purpose clause:
The organization is organized exclusively for charitable, religious, educational, and scientific purposes under section 501(c)(3) of the Internal Revenue Code, or corresponding section of any future federal tax code.
In addition, your articles must contain a dissolution clause that will permanently dedicate the organization’s assets for a section 501(c)(3) purpose. According to the IRS, naming a specific organization to receive your assets upon dissolution will only be acceptable if your articles state that the organization must be exempt under 501(c)(3) at the time the dissolution takes place and the articles provide for an acceptable alternative if the specific organization is not exempt. Remember that state law concerning dissolution may not be sufficient to satisfy the 1023 and 1023-EZ requirements regarding dissolution.
The 1023-EZ provides a helpful alternative for smaller non-profits hoping to avoid the expense and delay of the traditional Form 1023. However, organizations should be mindful of its eligibility requirements and the common deficiencies of organizational documents that can delay or even prevent non-profit recognition by the IRS.
Written by Taylor Barnett (’16), Wake Forest School of Law Student Practitioner