On July 1, 2014, organizations seeking 501(c) (3) tax-exempt status were provided with a new streamlined application process in the form of Form 1023-EZ. The traditional Form 1023 is a 26-page form that can take applicants over 9 hours to complete. Furthermore, at the time Form 1023-EZ was released, more than 75,000 Form 1023 applications were in the IRS queue, some of which had been awaiting review for more than a year.
Form 1023-EZ, at a mere three pages, requires eligible applicants to attest that the entity meets exempt status requirements, does not require the submission of corporate formation documents, and is submitted entirely electronically. Eligible entities are generally not-for-profit corporations with $50,000 or less in annual gross receipts and $250,000 or less in assets (always consult the Form 1023-EZ instructions before determining filing eligibility). Form 1023-EZ is intended to provide a quicker, more convenient exemption approval process for smaller organizations with routine operations and bases for tax-exempt status, thereby expediting the long wait times for the review of larger and more complex entities submitting the traditional Form 1023.
Now that Form 1023-EZ has been in use for more than one year, the IRS has released its First Year Report, summarizing the impact of Form 1023-EZ. The streamlined application process was used by 52% of all exemption applicants during its first year and the process has, in fact, resulted in faster processing times for the IRS—13 days on average. Additionally, the IRS approved 95% of all EZ applications submitted and closed during the first year. During Form 1023-EZ’s first year, its filers were primarily made up of youth development programs, Christian organizations, animal protection and welfare groups, human service organizations, and parent-teacher groups. The rollout of Form 1023-EZ also correlated with increased satisfaction when compared to filers of the traditional Form 1023 during the same time period, as well as significantly greater overall satisfaction with the IRS tax-exemption application process for filers of Form 1023-EZ and the traditional Form 1023 alike.
However, the results of first-year filings show that, in some cases, Form 1023- EZ may create more complications for applicants and the IRS after exempt status has been expeditiously granted. Roughly 3% of 1023-EZ applications were selected for predetermination review. In a predetermination review, the reviewing agent would review the application and conduct follow-up research in order to make a determination to either approve or reject the application. About 77% of predetermination review applications were approved, with rejections primarily resulting from invalid EIN numbers or ineligibility to file the application. The 18% discrepancy in approval rates between the predetermination review applications and all EZ applications suggests that applicants not selected for predetermination review may not, in reality, all be eligible for federal tax exemption. In anticipation of this problem, the IRS has stated that it will conduct retrospective audits on EZ-filing tax-exempt organizations.
The IRS admits that the first year of Form 1023-EZ implementation has been a learning year and that adjustments to the Form1023-EZ process are ongoing. For example, to reduce the number of applications rejected, the IRS has begun researching incorrect EIN numbers rather than automatically rejecting applications and also following-up by phone when applicants fail to respond to the IRS’s written requests for additional information.
The IRS acknowledges that the simplified application comes with some inherent risks, including insufficient information to make an accurate determination and increased likelihood of fraud. To address these issues, the IRS has implemented new procedures, including providing educational materials to potential applicants and using predetermination reviews to screen applications. In the coming year, the IRS plans to further reduce risk and refine the Form 1023-EZ process by implementing a post-determination compliance program for Form 1023-EZ filers that have been operating for at least one year. It will also implement changes to Form 1023-EZ and its instructions to clarify what information is being requested, require additional attestations, and secure additional contact information for follow-up.
It is important to understand that Form 1023- EZ does not loosen the requirements for becoming a tax-exempt organization; rather, it simply streamlines the application process. Whether filing with Form 1023-EZ or traditional Form 1023, it is critical that organizations seeking tax-exempt status understand the organizational and operational requirements that come with 501(c)(3) status.