Nonprofit Accounting Basics

The Form 1023-EZ (Part 1 of 2): Overview and Controversy

Author: 

Benjamin Takis

Tax-Exempt Solutions, PLLC

On July 1, 2014, the IRS revolutionized the nonprofit world by finalizing and launching the Form 1023-EZ, a new streamlined method of applying for 501(c)(3) status. The Form 1023-EZ is now live on www.pay.gov, along with final instructions, and the accompanying Revenue Procedure 2014-40. This article, the first in a two-part series, provides a brief overview of the differences between the Form 1023-EZ and the Form 1023, and a discussion of the controversy provoked by the new form. Part Two will discuss who should (and should not) utilize the Form 1023-EZ.

The Form 1023-EZ essentially makes it possible for certain new organizations to self-certify their own 501(c)(3) status. While other types of tax-exempt organizations, such as those exempt under Code sections 501(c)(4), 501(c)(5), or 501(c)(6), have long been allowed to “self-declare” their tax-exempt statuses without filing for IRS approval, 501(c)(3) organizations historically have been required to endure a rigorous application process comprising a detailed 26-page Form 1023, a written narrative, financial data, and specific governing documents such as the Articles of Incorporation, Bylaws, Conflict of Interest Policy, and copies of contracts with officers, directors, and service providers.

In contrast, the Form 1023-EZ is only two and a half pages long, requires no documents, and basically requires only that applicants check various boxes attesting that they will comply with the rules governing 501(c)(3) status.

Similarly, while the Form 1023 includes many probing questions designed to bring to light any instances of impermissible private benefit (i.e. any benefit to a private party that is more than incidental to the organization’s public benefit), and private inurement (i.e. any transaction that results in outsized benefits to directors, officers, and other insiders of the organization), the Form 1023-EZ simply prompts the applicant to attest that “net earnings do not inure in whole or in part” to the benefit of insiders, and its activities do “not further non-exempt purposes (such as purposes that benefit private interests) more than insubstantially.”

There are other incentives to use the Form 1023-EZ besides its simplicity. Most applicants will pay a reduced filing fee for the Form 1023-EZ, which costs only $400, compared to the $850 for most applicants filing the standard Form 1023. And applicants filing the Form 1023-EZ will surely have their applications processed much faster (the turnaround on Form 1023-EZ applications is expected to be only a month or two, rather than the one to two-year waiting periods many Form 1023 filers are experiencing).

The Form 1023-EZ has been widely criticized for making it too easy to obtain 501(c)(3) status. As one commentator has remarked, “It’s easier to get tax-exempt status under 1023-EZ than it is to get a library card.” Some commentators have accused the IRS of inappropriately shifting the burden of enforcement onto private foundations, state tax departments, and state charity regulators, which have traditionally relied on the rigorous federal process for approval of 501(c)(3) status.

More fundamentally, critics also worry the Form 1023-EZ abandons the crucial educational role the application process has traditionally served. The standard Form 1023 requires new organizations to give serious thought to difficult concepts like the exempt purpose test, the commerciality doctrine, and the private benefit and inurement rules. In the absence of this forced training period, many organizations will be tempted to commence operations without knowledge of the rules.

Continue to Part 2 of this article >