IRS Form 1023-EZ: Nonprofits Rejoice – but is the Potential for Fraud Real?

On July 1, 2014, the Internal Revenue Service (IRS) released Form 1023-EZ, a streamlined alternative to the venerable IRS standard-bearer in the world of nonprofits – Form 1023 Application for Recognition of Exemption Under Section 501(c)(3). The original Form 1023, weighing in at a robust 26 pages (including 7 schedules), can be burdensome, especially for small, volunteer based charities. For such nonprofits, the potential benefits were, quite simply, trumped by the significant commitment of time, money and organizational resources necessary to file the original Form 1023.

Yet, due to the administrative oversight needed to process the lengthy Form 1023 applications, the IRS Determinations Unit built up a backlog of more than 65,000 pending applications. Therein laid the catch-22 for the IRS – many worthy organizations precluded from applying for tax exempt status, and yet, even the applications that were being submitted were creating an almost insurmountable backlog (approval times routinely exceeding nine months).

The introduction of 1023-EZ is intended to tackle both issues head-on. Organizations with gross annual receipts of $50,000 or less and total assets of $250,000 or less are eligible to file the new 3-page form, which is filed online. Organizations are simply required to complete an eligibility checklist before submitting Form 1023-EZ. The application has taken the form of a certification by the organization that certain required formalities and policies exist, rather than requiring organizations to provide actual copies along with lengthy financial disclosures and addendums.

According to IRS Commissioner John Koskinen, “[Form 1023-EZ] is a common-sense approach that will help reduce lengthy processing delays for small tax-exempt groups and ultimately larger organizations as well.” Koskinen further noted, “previously, all of these groups went through the same lengthy application process – regardless of size; it didn’t matter if [an organization] was a small soccer or gardening club or a major research organization.”

Now, four months in, 1023-EZ appears to be accomplishing these goals. Applications have been receiving positive determinations within two to three weeks. With most small nonprofits, including as many as 70 percent of all total applicants (according to the IRS) qualifying to use the streamlined form, it will be an extraordinary improvement if this lightening-speed turnaround can be sustained.

Small charities are the obvious winners here, as the streamlined process will allow legal and tax practitioners to develop a more concise, fixed-fee, consumer-friendly spectrum of services to assist with the initial non-stock incorporation and subsequent 1023-EZ application. Small organizations will be able to afford quality professional services that were previously out-of-reach.

Savvy local businesses are also learning to leverage the opportunities presented by Form 1023-EZ. Local businesses in Northeast Wisconsin are used to supporting a growing number of local charities, from sports booster clubs, education foundations, church organizations and conservation groups, many of which are not tax exempt. Local business owners and executives, many of whom serve as directors for these organizations, are now sensing the opportunity and encouraging these groups to pursue tax exemption by filing Form 1023-EZ, thus expanding the fundraising opportunities for the organizations, while creating a tax-deductible benefit for the businesses that support these groups.

Yet, despite its initial success, 1023-EZ has not been without its share of criticism. According to an article written by Michael Wyland for Non Profit Quarterly, Tim Delaney, President and CEO of the National Council of Nonprofits, has voiced his objection to 1023-EZ, citing concerns that the streamlined form will impair the IRS’ ability to conduct proper due diligence on applicant organizations. Delaney views 1023-EZ as an invitation for abuse and stated that it will increase opportunities for fraud and heighten the burden on state governments.

IRS Commissioner Koskinen counters that “rather than using large amounts of IRS resources up front reviewing complex applications during a lengthy process, [the IRS] believes the streamlined form will allow [the IRS] to devote more compliance activity on the back end to ensure groups are actually doing the charitable work they apply to do.”

Therefore, practitioners anticipate that some entities may be randomly selected for audits. As such, nonprofits submitting 1023-EZ should pay careful attention to the organizational and ongoing corporate formalities of their entities.

As for whether Delaney’s concerns for fraud and abuse will be realized, time will tell. For now, though, signs point to a business-friendly, reasonable regulatory environment allowing charities and nonprofits to maximize fundraising potential while providing an immediate tax benefit to businesses and individual donors.

So far, a welcome change.

This article was published in the December 2014 edition of The Business News.