By: Zachary S. Kester, J.D., LL.M, CFRM and Laura Fucio, Charitable Allies
IRS recognition of a nonprofit’s tax-exempt status is crucial for any nonprofit hoping to receive grants. Most grantors or donors need advanced assurance of the IRS determination of tax-exemption or deductibility to satisfy tax obligations upon them.
In 2014, the IRS introduced the Form 1023-EZ, designed to streamline the process for smaller nonprofits. However, some concerns arose regarding the ability of grantors to rely on EZ determination letters. The IRS has assuaged some of these concerns, but others remain.
A determination letter is a document issued by the IRS confirming that the IRS has recognized an organization as tax-exempt, and often detailing under what section of the Internal Revenue Code the nonprofit qualifies.
Traditionally, nonprofits obtained such a letter by filing the full-length Form 1023 – a time-consuming and confusing process. The form itself is 12 pages long, requires detailed narrative answers and multiple attachments, and can include any of up to eight schedules. The IRS estimates completion of the form itself will take 15½ hours, while record keeping, learning and associated tasks can take up an additional 185 hours of working time. That’s more than a month of full-time effort.
By contrast, the 2½-page, mostly check-the-box Form 1023-EZ should only take up a total of 18 hours to learn about, collect needed data and complete. It also produces results in about 10 percent of the time it takes the IRS to issue a determination letter than for an organization filing Form 1023. The filing fee is greatly reduced as well ($275, compared to $850). Small wonder, then, that it is highly popular with qualifying nonprofits.
To qualify for Form 1023-EZ, an organization must complete a worksheet (part of the 1023-EZ instructions) and attest that it meets the requirements described, which include:
• having less than $50,000 in annual gross receipts
• owning less than $250,000 in assets
• not belonging to one of several specialty categories of tax-exempt organizations.
However, it does not need to provide proof of its attestations or finances, nor submit its organizing documents, unless requested.
This has raised serious concerns about whether nonprofits submitting the 1023-EZ in fact qualify for IRS exempt status.
A representative sample of 1023-EZ applicants in 2015 found that 37 percent did not qualify and risked serious consequences if they ever faced an audit, according to the National Taxpayer Advocate.
This can be off-putting to potential grantors, who can see from the determination letter (available publicly, as a matter of law) whether an organization filed a full Form 1023 or the 1023-EZ.
The IRS issued guidance in 2016, stating that grantors could rely on an EZ-based determination letter to the same extent as one issued from a full Form 1023 filing. IRS Division Chief Jeffrey I. Cooper issued a memo last November stating that the determination letters in the future would be revised to be identical.
However, concerns still remain over potential fraud or oversight by nonprofits using the 1023-EZ.
With its lower filing fee and shorter time, nonprofits will no doubt continue to utilize the 1023-EZ despite its risks. However, funders must proceed carefully and do their due diligence on potential grant recipients, in order to avoid funding ineligible organizations and causing valuable time and expenses to be wasted.
Attorney Zac Kester provides generalist and strategic nonprofit legal and consulting services. He holds a Master of Laws, a post-law school advanced degree, in which he studied the unique needs of tax-exempt nonprofit organizations. His legal and consulting career has focused on nonprofit organizations.
With highly experienced legal and training personnel, Charitable Allies provides all manner of legal and educational services for boards, officers, management and staff of myriad charities throughout the sector. From basic one-time questions about a single matter to training for boards and officers to complex reorganization or merger of activities, Charitable Allies is your go-to cost-effective provider of legal services to nonprofit organizations.