Nonprofit Accounting Basics

The Form 1023-EZ (Part 2 of 2): Who Should (and Should Not) File?

Author: 

Benjamin Takis

Tax-Exempt Solutions, PLLC

In the first part of this two-part series, we provided a brief overview of the differences between the Form 1023-EZ and the Form 1023 and discussed the criticisms of the new form. In this second part, we will examine which organizations should file the Form 1023-EZ and which organizations should stick with the standard Form 1023.

The first consideration is whether the organization is eligible to use the Form 1023-EZ. The instructions spell out with precision the types of organizations ineligible to use the Form 1023-EZ, and applicants must attest they have completed an eligibility worksheet provided in the instructions (though the worksheet itself need not be submitted). The following types of organizations may not use the Form 1023-EZ and must use the standard Form 1023 instead:

  • Organizations with projected annual gross receipts of more than $50,000 in either the current taxable year or the next two years.
  • Organizations with annual gross receipts that have exceeded $50,000 in any of the past three years.
  • Organizations with total assets the fair market value of which is in excess of $250,000. For purposes of this eligibility requirement, a good faith estimate of the fair market value of the organization’s assets is sufficient.
  • Organizations formed under the laws of a foreign country.
  • Organizations that do not have a mailing address in the United States.
  • Organizations that are successors to, or controlled by, an entity suspended under Code section 501(p) (suspension of tax-exempt status of terrorist organizations).
  • Organizations that are not corporations, unincorporated associations, or trusts.
  • Organizations that are successors to a for-profit entity.
  • Organizations that were previously revoked or that are successors to a previously revoked organization (other than an organization the tax-exempt status of which was automatically revoked for failure to file a Form 990 series return or notice for three consecutive years).
  • Churches or conventions or associations of churches.
  • Schools, colleges, or universities.
  • Hospitals or medical research organizations.
  • Cooperative hospital service organizations described in Code section 501(e).
  • Cooperative service organizations of operating educational organizations described in Code section 501(f).
  • Qualified charitable risk pools described in Code section 501(n).
  • Supporting organizations described in Code section 509(a)(3).
  • Organizations that have as a substantial purpose providing assistance to individuals through credit counseling activities such as budgeting, personal finance, financial literacy, mortgage foreclosure assistance, or other consumer credit areas.
  • Organizations that invest, or intend to invest, five percent or more of their total assets in securities or funds that are not publicly traded.
  • Organizations that participate, or intend to participate, in partnerships (including entities or arrangements treated as partnerships for federal tax purposes) in which they share profits and losses with partners other than 501(c)(3) organizations.
  • Organizations that sell, or intend to sell, carbon credits or carbon offsets.
  • Health Maintenance Organizations (HMOs).
  • Accountable Care Organizations (ACOs), or organizations that engage in, or intend to engage in, ACO activities.
  • Organizations that maintain, or intend to maintain, one or more donor advised funds.
  • Organizations that are organized and operated exclusively for testing for public safety and that are requesting a foundation classification under Code section 509(a)(4).
  • Private operating foundations.
  • Organizations that are applying for retroactive reinstatement of exemption under sections 5 or 6 of Revenue Procedure 2014-11, after being automatically revoked for failure to file Form 990, 990-EZ, or 990-N for three consecutive years (in other words, organizations applying for reinstatement within 15 months of the revocation notification date that did not qualify to submit the Form 990-EZ or 990-N for each of the three years, or organizations applying for reinstatement more than 15 months after the revocation notification date).

 

Some organizations that satisfy these eligibility requirements may nonetheless prefer to file the standard Form 1023, despite the incentives to use the shorter, faster Form 1023-EZ. 

First, an organization projecting less than $50,000 of revenue for its first few years may end up receiving a larger grant than expected. While it does not appear there is any penalty for underestimating revenue if the projections were reasonable at the time and made in good faith, it is possible an organization that receives more than $50,000 per year could be flagged for audit by the IRS. Some organizations may prefer to file the Form 1023 rather than risk triggering an audit a few years later. 

Second, the Form 1023-EZ provides no opportunity for clarification or explanation, which may work to the disadvantage of certain organizations. For instance, the Form 1023-EZ includes the following “yes or no” questions:

  • Do you or will you attempt to influence legislation?
  • Do you or will you pay compensation to any of your officers, directors, or trustees?
  • Do you or will you donate funds to or pay expenses for individual(s)? 
  • Do you or will you conduct activities or provide grants or other assistance to individual(s) or organization(s) outside the United States?
  • Do you or will you engage in financial transactions (for example, loans, payments, rents, etc.) with any of your officers, directors, or trustees, or any entities they own or control? 

These activities trigger IRS concerns, and an applicant has a strong incentive to click “no,” but all of these activities are allowed for 501(c)(3) organizations if conducted properly and in accordance with applicable rules and limits. Organizations answering “yes” to any of these questions may prefer to have the chance to offer more explanation under the standard Form 1023. 

Similarly, some applicants may be unwilling to attest (under penalties of perjury) they will comply with complex rules such as the private benefit and private inurement rules and prohibitions of political activity. It can often be difficult to determine whether an activity crosses the line, and the Form 1023-EZ can expose an organization or its advisors to risk of perjury charges for making the wrong call. Under the standard Form 1023, on the other hand, an applicant merely describes its activities and leaves the burden of legal determination to the IRS. 

Lastly, and perhaps most importantly, there is a risk that private foundations, governments, and other donors will be less willing to provide funding to organizations that got their 501(c)(3) statuses by filing the Form 1023-EZ. The Form 1023-EZ is likely to unleash large numbers of ill-prepared and poorly conceived nonprofits that never would have followed through with the filing of the standard Form 1023. In the ultra-competitive world of grants and donations, it is possible that grantmakers and donors may screen out Form 1023-EZ filers to ensure only the most serious and most prepared organizations receive funding.