Filing the IRS Form 1023-EZ?

The Internal Revenue Service (IRS) introduced a new, short-form application for tax-exempt status: IRS Form 1023-EZ. The file form is significantly shorter than the IRS 1023 application and takes substantially less time to fill out.

This will especially help smaller nonprofits, but organizations may be surprised to learn that the IRS’ acceptance of the 1023-EZ does not assure compliance with the Internal Revenue Code and regulations.

Who Can File the 1023-EZ?

To be eligible to file for tax exemption with the 1023-EZ, organizations must have:

• Annual gross income of less than $50,000 for each of the three previous tax years;
• Projected annual income of less than $50,000 for each of the three subsequent years; and
• Total assets of $250,000 or less.

According to Gene Takagi, a nonprofit attorney in California, “The EZ form was designed in part to help eliminate the backlog of applications that the IRS had. At one point, the IRS had 60,000 to 70,000 applications in backlog. Some applications were taking well over a year to get a determination.”

Takagi further notes that the time it takes to receive a determination with the EZ form has reduced waits to four to five weeks, while the wait for a determination on the long form is about five to six months. He estimates that approximately 50 percent of tax-exemption applicants now file with the form 1023-EZ eligibility worksheet.

Besides the financial limitations, there are several other requirements (contained in Form 1023-EZ instructions) that applicants must meet to qualify to file. The IRS does not allow some types of organizations to file using the 1023-EZ, including foreign organizations, limited liability companies (LLCs), churches, schools, hospitals, and successors to a for-profit entity.

What Are the Risks for Nonprofit Organizations Filing the 1023-EZ?

“It’s a very simple form,” says Takagi, “but it’s super controversial because it doesn’t provide very much information to the IRS. Someone can easily check a few boxes, promising they will operate consistently with [section] 501(c)(3) and not disclose very much else.

“If you get audited, you might fail,” he continues. “This is why we would still suggest that whether you are actually operated for a 501(c)(3) purpose or not is really important to try to figure out at the start. If you get audited, you could get hit with penalties—including personal penalties if you’ve done it wrong.”

Based on Takagi’s experience, the IRS hasn’t been particularly strong at detecting whether an organization’s business plan is consistent with the tax-exempt purpose. He notes that part of that has to do with the new form.

Experienced Legal Advice Is Important in the Application Process

Organizations shouldn’t lulled into thinking they are meeting the IRS’s compliance expectations simply by filing the EZ form. Takagi suggests nonprofits do the opposite and weigh their compliance efforts against the requirements contained in the 1023 long form. “You might not have to present your business plan [with the EZ], but it would be wise to do so—just in case you encounter a follow-up examination inquiry from the IRS agent reviewing that application.”

Determining whether an organization’s activities and business plan are consistent with its exempt purpose is a complex issue. “It goes beyond what a book or paralegal service could provide—check the right boxes, and you’ll get your determination letter, which is true,” says Takagi. “It might work and minimally get you there, but it doesn’t necessarily assist you on compliance issues—especially if you are in that gray zone.”

Tax-exempt organizations should not take compliance issues for granted. Whether filing the 1023-EZ form or the long form, an organization should consult with an experienced nonprofit attorney before filing to ensure there are no surprises down the road, such as revocation and the need for reinstatement.