Which Form Should Be Used to Apply for 501(c)(3) Status – Form 1023 or 1023-EZ?

New charitable organizations must apply to the IRS to be approved as a 501(c)(3) tax-exempt organization. There are a few hurdles to clear. First, 501(c)(3) organizations must be organized and operated exclusively for charitable purposes. Also, none of their earnings can inure to the benefit of private shareholders or individuals. And they can’t attempt to influence legislation as a substantial part of their activities or participate in political candidates’ campaigns.

If your organization meets all those conditions (and possibly others), congratulations! Now, what form should you use to apply form 1023 or 1023EZ? Traditionally, organizations only had the option to use Form 1023. However, the IRS introduced Form 1023-EZ in 2014, and you may want to choose this streamlined version.

The Case for Form 1023

Many nonprofits still use the longer Form 1023 because there are virtually no restrictions on its use. It’s available to every 501(c)(3) organization.

However, Form 1023 takes time and money to complete. Don’t think you can crank out the form in a single short sitting. It’s 40 pages long; accompanied by lengthy instructions and must be filed online. The instructions not only explain how to fill out the form but also indicate the documents you’ll need to attach. Do your homework before tackling Form 1023 and consider consulting with your tax advisor or attorney to walk you through it. Also, you may want to consider the cost. You must pay $600 to file Form 1023.

An Easier Way for Some

In comparison, Form 1023-EZ costs only $275 to submit. It must also be filed online and it’s only three pages long. This is considerably less “taxing” than filing the original Form 1023. For most applicants, completing it should require less than 10% of the time it generally takes to complete Form 1023.

However, eligibility for filing Form 1023-EZ isn’t automatic. You must first make your way through a worksheet to verify your organization qualifies for this option. The worksheet contains 30 questions, and it only takes one “yes” answer to eliminate Form 1023-EZ. For example, your organization cannot:

• Expect to have annual gross receipts of more than $50,000 during the next three-year period. This includes receipts from all sources.
• Own assets valued at more than $250,000. This isn’t limited to cash — it also includes the fair market value of bank accounts and loans receivable, inventories, bonds, stocks, equipment and buildings.
• Have been previously revoked or be a successor to a previously revoked organization.
• Be formed outside of the United States. But being formed in U.S. territories such as Puerto Rico or the Virgin Islands is acceptable.
• Be organized as any other entity besides a corporation, an association, a trust or an unincorporated operation. Thus, an entity registered as a limited liability company isn’t eligible.
• Be currently recognized as tax-exempt under another section of the tax code.
• Be a church, school, college, university, hospital, medical research association, agricultural research organization, health maintenance organization or an accountable care organization or be applying for tax-exempt status as one of these under other tax code provisions.
• Maintain a donor advised fund (DAF). DAFs provide donors with greater control over charitable distributions than they have with regular contributions.
• Be a successor to, or controlled by, an organization involved in any way with terrorist organizations, groups participating in terrorist activity or those that have had their tax-exempt status revoked or suspended.
• Be a private operating foundation. A private operating foundation generally is formed by an individual or family and operates by using investment income.

These represent major obstacles for nonprofits to use Form 1023-EZ, but you must go through the entire worksheet. As long as you answer “no” to every question, you can proceed to use the form. If you have any questions about your organization’s eligibility, consult your tax or legal advisors.

Understand the Risks

Form 1023-EZ is faster to complete and costs less than Form 1023, yet it’s not for every organization seeking tax-exempt status. The first obstacle is meeting the eligibility requirements. Another downside is that both the Form 1023 and Form 1023-EZ are subject to public inspection.

First, the Form 1023-EZ provides less assurance than the traditional Form 1023. The Form 1023 is an in-depth application process that requires detailed explanations of the organization’s mission and planned activities, disclosure of the organization’s governing documents, financial projections, and numerous questions designed to highlight key compliance concerns. While this process entails significantly more front-end work, organizations who receive approval of their 501(c)(3) status using the Form 1023 are generally entitled to rely on this determination that their mission, activities, and governance structure are consistent with section 501(c)(3).

By contrast, the Form 1023-EZ does not provide sufficient guidance to the nonprofit that its operations are organized to meet the IRS requirements for 501(c)(3) organizations. An organization whose Form 1023-EZ application is approved is entitled to treat itself as a 501(c)(3) organization, but there is greater risk of the IRS revoking the organization’s 501(c)(3) status in the event of an audit – a risk that may not be worth it.

Second, it is possible that major donors, foundations, and other grantmaking organizations will be more hesitant to fund new organizations that received their 501(c)(3) status by filing the Form 1023-EZ. Filing the Form 1023-EZ can give the perception that the organization is small and expects to remain small – a perception nonprofits may not want potential grantors and donors to have.

Most importantly, organizations that use the Form 1023-EZ miss an important opportunity for learning the rules governing 501(c)(3) organizations. The Form 1023 requires new organizations to give serious thought to difficult concepts like the exempt purpose test, public charity status, and the private benefit, excess benefit, and inurement rules.

If you are contemplating applying for tax-exempt status under 501(c)(3), please contact VonLehman’s Nonprofit tax specialists Bryan Pautsch (bpautsch@vlcpa.com) or Alex Bramer (abramer@vlcpa.com) by email or phone at 800.887.0437. They can assist you in choosing the correct form to file and advise your organization on how to comply with the various IRS requirements.