Great news for new small nonprofits – the IRS recently streamlined the process of applying for 501(c)(3) status by introducing Form 1023-EZ. The new form applies to certain small organizations seeking federal tax exemption under Internal Revenue Code (“IRC”) § 501(c)(3), and reduces the application down to three pages instead of the full 31-page Form 1023.
What is 501(c)(3) Status?
When you start a nonprofit organization, regardless of whether you formally incorporate with your state, you are creating a legal entity that is subject to federal tax regulations.
The IRS has determined that certain nonprofit organizations should be exempt from some federal income taxes. Specifically, IRC § 501(c) lists 26 types of exempt organizations. The third category on the list, 501(c)(3), is for nonprofit organizations that are organized and operated exclusively for charitable, scientific, literary, religious, or educational purposes.
These types of organizations are able to accept contributions and donations that are tax-deductible to the donor, and apply for grants and other public or private financial allocations available only to IRS-recognized 501(c)(3) organizations. However, an organization generally must apply for recognition under 501(c)(3). This is where Form 1023 and 1023-EZ come in.
Up until the summer of 2014, most nonprofit organizations seeking tax exemption under 501(c)(3) had to file Form 1023, which requires a substantial amount of input from the applicant, including a written narrative, financial data, and specific organizational documents. On top of that, applicants typically had to wait six months or more to have the application processed by the IRS.
Form 1023-EZ, however, provides a faster and easier method of obtaining 501(c)(3) status. The form is significantly shorter and does not require a narrative description or other documents, and the cost and approval time are reduced as well.
As of this article, Form 1023-EZ has a filing fee of $400.00 and can be approved in as fast as one month. Compare that to the full Form 1023, which costs up to $850.00 and can take six or more months to be approved.
Only certain nonprofit organizations are able to obtain 501(c)(3) recognition through Form 1023-EZ. Before completing Form 1023-EZ, applicants are required to complete an eligibility worksheet that asks 26 “yes or no” questions about the applying organization. Applicants must be able to answer “no” to all questions in order to qualify. Fortunately, the questions are favorable for many small nonprofits.
The first few questions are the most relevant to small nonprofits since they ask about the financial size of the organization. The questions ask whether the organization anticipates its annual gross receipts to be more than $50,000 in any of the next 3 years, had annual gross receipts over $50,000 in any of the past 3 years, or has assets exceeding a fair market value of $250,000. If you can answer “no”, then Form 1023-EZ might be for you.
While Form 1023-EZ greatly reduces the burden of seeking 501(c)(3) status, there are some possible shortcomings:
First, nonprofit organizations can and should actually attempt to make a profit in order to better fulfill their missions. Consequently, an organization that originally qualified as tax exempt under 501(c)(3) by filing Form 1023-EZ may find itself grossing more than $50,000 in a year. This creates the possibility of being audited by the IRS. While good record keeping should avoid any issues, organizations can preemptively avoid the $50,000 threshold by using the full Form 1023.
Second, Form 1023-EZ’s lack of a requirement for documents may not always be beneficial since some nonprofit organizations have complicated structures and programs that need to be explained to the IRS. Form 1023-EZ does not allow for these explanations but Form 1023 gives an organization space to explain its operations.
Form 1023-EZ provides an excellent opportunity for small nonprofits to gain the benefits of tax exemption under IRC § 501(c)(3). With a reduced time and financial burden, many nonprofit organizations will find this form a welcomed addition.
Notice: This post is for informational purposes only and is not a substitute for professional advice based on a review of individual circumstances. Please contact an attorney regarding your particular legal issues.