Form 1023-EZ: First-year results are in

In 2014, the IRS introduced a streamlined process to allow small organizations to more easily apply for tax-exempt status. A recent IRS survey of organizations that have been through the application process indicates that eligible organizations are more satisfied with the new process than those that are required to use the full process; the survey also showed that many ineligible organizations have attempted to use the process. The IRS is also contemplating changes to the form, based on its experience in the first year.

Normally, organizations must apply for tax-exempt status under Sec. 501(c)(3) using Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, and must provide the IRS a detailed statement of the organization’s proposed activities. Regs. Sec. 1.501(a)-1(b)(2) also allows the IRS to require additional information if it deems it necessary for determining whether the organization should be exempt.

Form 1023 is 26 pages long, including 11 parts of the main form and Schedules A through H. The IRS estimates taxpayers will need an average of almost 15½ hours to prepare the form and all schedules, plus another almost 185 hours of recordkeeping and learning about the law or form. And while one can question the accuracy of the IRS’s time estimates, the Service clearly anticipates that Form 1023 requires substantial effort to properly prepare.

Feeling that this effort was too much of a burden on small organizations, the IRS introduced in regulations and a revenue procedure a streamlined process using a new form, Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.

The streamlined process is available for U.S. organizations with assets of $250,000 or less and annual gross receipts of $50,000 or less.

Form 1023-EZ is 2½ pages. The IRS estimates that preparing the form will take, on average, 5½ hours, and recordkeeping and learning about the law or form will take another 12½ hours—a significant reduction from its estimates for Form 1023.

First-year results

During the first year of Form 1023-EZ’s availability, the IRS monitored use of the form and conducted a customer satisfaction survey of organizations that had been through the process during the six months ending March 31, 2015. In December 2015, it issued a “Form 1023-EZ First Year Report.”

One unsurprising result of the shorter form has been shorter IRS processing times. The average processing time for Form 1023-EZ is 13 days, compared with an average of 191 days for Form 1023. During the first year of Form 1023-EZ’s availability (July 1, 2014, through June 26, 2015), the IRS reports that 52% of applications for exemption were filed on Form 1023-EZ.

The IRS also reported that 77% of reviewed Form 1023-EZ applications were approved; rejections were primarily due to the organization’s ineligibility to use the shorter form. The IRS says it is looking at making changes to the form and instructions to clarify the application requirements so that fewer ineligible organizations will submit applications on Form 1023-EZ.

The two biggest reasons for rejection were failure to meet the retroactive reinstatement requirements (i.e., the Form 1023-EZ submission date was more than 15 months after the IRS posted the organization’s name on its EO Select Check list) and invalid employer identification numbers (EINs). The IRS says that it has changed its procedures when an applicant uses an invalid EIN. Originally, the form was just rejected, but now the IRS says it will perform additional research to locate a correct EIN for the applicant.

Less than 5% of applicants were rejected because their gross receipts (or projected gross receipts) exceeded $50,000 or because their total assets exceeded $250,000.

Customer satisfaction

The IRS’s customer satisfaction survey results show marked differences between Form 1023 and Form 1023-EZ applicants. Overall satisfaction was 87% for Form 1023-EZ applicants and 72% for Form 1023 applicants.

Only 41% of Form 1023 applicants were satisfied with the time it took to complete the application, and only 49% were satisfied with the ease of completing the application. The corresponding satisfaction levels for Form 1023-EZ applicants were 73% and 74%, respectively.

Only 55% of Form 1023 applicants were satisfied with the length of the application process, and only 53% were satisfied with the ease of understanding the application. For Form 1023-EZ applicants, the corresponding satisfaction ratings were 86% and 69%, respectively.

The IRS also provided some insight into the types of organizations that are using the new process (based on their National Taxonomy of Exempt Entities codes). Number one is youth development programs, followed by Christian groups, animal protection and welfare groups, human services organizations, and parent-teacher groups. One concern that has been raised about the streamlined process is that with such low asset and gross receipts limits, only the very smallest organizations are actually eligible (see “Tax Clinic: Only Smallest Charitable Trusts Benefit From Streamlined Application,” The Tax Adviser, December 2014, page 864).

Looking ahead

The IRS also says that starting in 2016 it will conduct correspondence audits of organizations that received determination letters after filing Form 1023-EZ, both to assess the level of compliance by the new organization but also to identify ways to improve the application process. Under this compliance program, the IRS will perform correspondence examinations of a random sampling of the Form 990 series information returns or notices filed by Form 1023-EZ applicants.

In addition to starting a post-determination compliance program for Form 1023-EZ filers in 2016, the IRS says it will continue to monitor filings and use of the form. The IRS also promises some changes to the form, including requiring the identification of a contact person for additional information requests, requiring the applicant to attest that gross receipts or expected gross receipts are less than $50,000, and requiring an independent attestation that the organization’s total assets are less than $250,000.

About the author

Alistair Nevius is the JofA’s editor-in-chief, tax. To comment on this article or to suggest an idea for another article, contact him at anevius@aicpa.org or 919-402-4052.