2015 Lane Reports

Streamlined Application for Tax Exemption Presents a New Opportunity for Charities

The Lane Report, January 2015
Friday, January 2, 2015 10:00 am
by Joshua S. Kreitzer

Most nonprofit organizations which seek to be classified as tax-exempt charities (under Section 501(c)(3) of the Internal Revenue Code) are required to apply for recognition of their tax-exempt status from the Internal Revenue Service. (Some nonprofit organizations can claim tax-exempt status without having to apply: these include churches and other religious congregations, their integrated auxiliaries, associations or conventions of such religious congregations, and organizations whose gross receipts normally do not exceed $5,000.)

Until recently, all organizations required to apply for recognition did so using IRS Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code). Form 1023 consists of a 12-page main form followed by 14 pages of schedules. Although Form 1023 may not be as tough to complete as that makes it sound – for example, Schedule B would be completed only by schools, and Schedule C would be completed only by hospitals and medical research organizations, with all other applicants being allowed to ignore those schedules – it still represents a significant amount of work for an applicant organization.

Since last summer, however, the IRS has made it easier for some charitable organizations to apply for recognition of tax-exempt status by issuing Form 1023-EZ (Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code). Unlike the full Form 1023, Form 1023-EZ is only three pages long. Furthermore, it must be submitted online, unlike Form 1023 which is submitted on paper.

What Organizations Are Eligible to File Form 1023-EZ?

The reduction in length of the streamlined form can be attributed in part to the fact that organizations wishing to use it are required to complete a 26-question checklist found in the form’s instructions – and they must answer every question “No” in order to use Form 1023-EZ rather than Form 1023. The first two criteria that an organization must satisfy to use Form 1023-EZ is that it must not project that its annual gross receipts will exceed $50,000 in any of the next three years, nor may it have had annual gross receipts exceeding $50,000 in any of the previous three years. These criteria may not eliminate many smaller charitable organizations, but they will exclude many private foundations. Often a private foundation is initially funded by a single gift from its founder(s) that far exceeds $50,000 – and any such private foundation will be required to file the full Form 1023. Nor may an applicant using Form 1023-EZ have total assets exceeding $250,000.

To use Form 1023-EZ, the organization must not have been formed under the laws of a foreign country, nor have its mailing address in a foreign country. Nor may it be a successor to, or controlled by, an organization whose tax exemption has been suspended for supporting terrorism. An organization using Form 1023-EZ may not be a limited liability company, nor can it be a successor to a for-profit entity.

The organization’s tax-exempt status may not have been previously revoked, nor may it be a successor to another organization whose tax-exempt status was revoked, unless the revocation (in either case) was an automatic revocation for failure to file a Form 990-series annual report for three consecutive years. Organizations whose tax-exempt status was automatically revoked for failure to file Form 990-series reports may use Form 1023-EZ if (a) they are small organizations which had been eligible to file Form 990-EZ or Form 990-N for the three consecutive years, by virtue of having gross receipts under $200,000 and assets under $500,000, and are filing within 15 months of revocation, or (b) they are requesting reinstatement of tax-exempt status only prospectively, not retroactive to their revocation date. Larger organizations seeking retroactive reinstatement of tax-exempt status, and any organization seeking retroactive reinstatement more than 15 months after its revocation date, must file the full Form 1023.

Certain categories of organizations are excluded by the checklist from using Form 1023-EZ and must use the full Form 1023 instead. These include churches (including synagogues, temples, and mosques) and conventions or associations of churches. (Although, as stated above, churches and conventions or associations of churches are not required to file Form 1023 to secure tax exemption, many do file in order to assure donors of their tax-exempt status.) Schools (including colleges and universities), hospitals, hospital organizations, and medical research organizations must also use the full Form 1023. The same holds true for cooperative hospital service organizations, cooperative service organizations of educational organizations, and qualified charitable risk pools. Organizations which are considered supporting organizations for publicly supported organizations – those which would themselves be considered private foundations, if not for their relationship with the public charities they support – must file the Form 1023. So must organizations with a substantial purpose of providing assistance to individuals through credit counseling activities such as budgeting, personal finance, financial literacy, mortgage foreclosure assistance, or other consumer credit areas.

Organizations which intend to invest more than 5% of their total assets in non-publicly traded securities or assets must file the full Form 1023, as must organizations which intend to participate in partnerships with partners other than 501(c)(3) organizations and those which intend to sell carbon credits or carbon offsets. Also excluded from filing Form 1023-EZ are health maintenance organizations (HMOs) and accountable care organizations (ACOs), as well as organizations which intend to maintain any donor-advised funds and organizations organized and operated exclusively for testing for public safety seeking to be classified as public charities. Finally, organizations seeking classification as a private operating foundation – an organization funded primarily by only a small number of donors rather than the public, but which conducts charitable activities directly rather than by making grants to other organizations – must use the full Form 1023.

What Does Form 1023-EZ Require?

If an organization has run the gauntlet of completing the questionnaire with all answers being “No,” it may proceed to complete the Form 1023-EZ. Many of the questions on the form are self-explanatory, such as the organization’s name, address, taxpayer identification number, and the names and addresses of all of the officers, directors, and/or trustees. The organization must check a box to certify that it has an appropriate organizing document (articles of incorporation for a corporation, articles of organization for an unincorporated association, or a trust agreement or declaration of trust for a trust), and check boxes to attest that the organizing document limits the organization’s purposes to those allowed under Section 501(c)(3); does not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities that in themselves are not in furtherance of one or more exempt purposes; and provides that if the organization is dissolved, its assets must be distributed for an exempt purpose, or to the federal, state, or local government for a public purpose. Unlike with the full Form 1023, an organization filing Form 1023-EZ does not actually have to submit a copy of its organizing document, nor does it have to submit its bylaws.

The full Form 1023 requires an applicant organization to provide a “thorough and accurate” narrative description of its “past, present, and planned activities.” The Form 1023-EZ is quite different in this regard – rather than describing its activities in detail, the organization must provide only a three-character code (as taken from a table in the instructions to the form) which describes the organization’s activities. For example, “A52” represents children’s museums, “C27” represents recycling programs, and “L41” represents temporary shelters for homeless people.

Another important distinction between the full Form 1023 and Form 1023-EZ is the financial data section. Depending on how long the organization has been in existence, an organization filing Form 1023 must provide a breakdown of income and expenses for a period ranging from three to five years – and if the organization has not been in existence that long, the statement of revenues and expenses must include projections for future years. The organization must also provide a balance sheet. However, if the organization is filing Form 1023-EZ, no such financial data is required.

If an organization files Form 1023-EZ, the user fee is $400. This is advantageous because the user fee for the full Form 1023 is $400 for organizations whose gross receipts do not exceed $10,000 or less annually over a 4-year period, or $850 for organizations with higher gross receipts. Hence, organizations whose gross receipts are between $10,000 and $50,000 per year can save money by filing the Form 1023-EZ.

Repercussions of Form 1023-EZ

The introduction of the Form 1023-EZ received criticism from the National Association of State Charity Officials (NASCO), an organization representing government officials engaged in regulating charities at the state level. NASCO raised concerns that the simpler form would make it easier for “scam” charities to receive tax-exempt status and would increase the burden on state regulators to ensure that charitable assets are used for the purposes they are supposed to be used for.

Not only did the regulators object to the Form 1023-EZ, but so did the National Council of Nonprofits, an organization representing over 25,000 charitable organizations. The National Council of Nonprofits raised concerns that the streamlined form would not give the IRS enough quality information to determine eligibility for federal tax exemption. Furthermore, since an organization’s application for tax exemption and supporting documents become public records, having the Form 1023-EZ become a simple check-off form significantly decreases the amount of information about a charity which is subject to public scrutiny.

Nevertheless, the Form 1023-EZ is here, and it is in the best interests of a charity which is eligible to file it to use the Form 1023-EZ rather than the long Form 1023. The IRS’s own estimates say that the estimated average time to complete the Form 1023 is over 104 hours (without even considering the schedules), while the estimated average time to complete the Form 1023-EZ is less than 19 hours. If a charitable organization has the opportunity to devote its efforts to carrying out its charitable mission rather than preparing its application for tax exemption, it would be a good idea to take that opportunity.

The Law Offices of Marc J. Lane has experience in organizing nonprofit organizations, and securing and maintaining their tax exemption. If you or the leaders of a nonprofit organization with which you are associated would like to learn about our services for tax-exempt entities, please contact Marc J. Lane in confidence via email at [email protected] or via telephone at (312) 372-1040/ (800) 372-1040.

Peterborough's problem was daunting: Sixty percent of prisoners serving short-term sentences historically had gone on to re-offend within a year after their release. But policymakers were confident that a solution was within their reach. They attracted private investment to pay experienced social service agencies to provide intensive, multidisciplinary support to short-term prisoners, preparing them to re-enter society and succeed outside the penal system. - See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf

The world's first social impact bond, or SIB, was introduced in 2010 to fund innovative social programs that realistically might reduce recidivism by ex-offenders in Peterborough, England, and, with it, the public costs of housing and feeding repeat offenders. Prudently building on the strengths of that initiative, Illinois Gov. Pat Quinn is rolling out SIBs to help solve some of the state's most vexing social problems.

A SIB isn't a traditional bond where investors are guaranteed a fixed return but a contract among a government agency that agrees to pay for improved social outcomes, a private financing intermediary and private investors. SIBs shift the risk of experimenting with promising but untested intervention strategies from government to private capital markets, with public funds expended only after targeted social benefits have been achieved.

Peterborough's problem was daunting: Sixty percent of prisoners serving short-term sentences historically had gone on to re-offend within a year after their release. But policymakers were confident that a solution was within their reach. They attracted private investment to pay experienced social service agencies to provide intensive, multidisciplinary support to short-term prisoners, preparing them to re-enter society and succeed outside the penal system.

The government decided which goals would be supported, but exactly how those goals would be achieved was left to the private sector. It was the investors, through a bond-issuing organization, who ultimately endorsed the allocation of investment proceeds — how much would be invested in job training, drug rehabilitation and other interventions.

If the Peterborough plan eventually shrinks recidivism rates by 7.5 percent or more, the government will repay the investors' capital and share the taxpayers' savings with them, delivering up to a 13 percent return. If the target isn't hit, the investment will have failed and the government will owe the investors nothing.

Illinois' SIB effort was spearheaded by the state's Task Force on Social Innovation, Entrepreneurship and Enterprise — the governor's think tank on social issues, which I am privileged to chair — with support from Harvard University's John F. Kennedy School of Government, the Rockefeller Foundation and the Aurora-based Dunham Fund. A request for information issued by the Office of Management and Budget on May 13 yielded responses from service providers eager not only to reduce recidivism here but also to create jobs, revitalize communities, improve public health outcomes, curb youth violence, cut high school dropout rates and alleviate poverty.

Now the governor has issued a request for proposals intended to spur better outcomes for Illinois' most at-risk youth — by increasing placement stability and reducing re-arrests for youth in the state's Department of Children and Family Services, and by improving educational achievement and living-wage employment opportunities justice-involved youth most likely to re-offend upon returning to their communities.

Kudos to Mr. Quinn for bringing SIBs to Illinois. May they soon start delivering on their promise.

- See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf
The world's first social impact bond, or SIB, was introduced in 2010 to fund innovative social programs that realistically might reduce recidivism by ex-offenders in Peterborough, England, and, with it, the public costs of housing and feeding repeat offenders. Prudently building on the strengths of that initiative, Illinois Gov. Pat Quinn is rolling out SIBs to help solve some of the state's most vexing social problems. - See more at: http://www.chicagobusiness.com/article/20131007/OPINION/131009850/a-new-kind-of-futures-contract-for-illinois#sthash.ThgxeiFt.dpuf

Joshua S. Kreitzer is a Senior Associate Attorney with The Law Offices of Marc J. Lane, a Professional Corporation. Mr. Kreitzer is a graduate of Northwestern University (J.D.), the University of South Florida (M.A.), and Harvard University (B.A.)


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