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Get Ready for a Stampede of Solicitations: The IRS Has Made It Too 'E-Z' to Start Charities

   Jun 04, 2015

New charities are sprouting faster than weeds in a garden. More than 94,300 charities received 501(c)(3) tax-exempt status approval from the Internal Revenue Service (IRS) in its fiscal year (FY) 2014, almost 150% more charities than in 2013. By comparison, the number of 501(c)(3) approvals in FY 2013 was down by about 16% from 2012, falling from just over 45,000 to approximately 37,900 between FY 2012 and 2013. What drove the 150% surge in the number of 501(c)(3) approvals from 2013 to 2014? The answer lies with just two letters: E-Z.

Before we explain the E-Z factor behind the IRS’s surge in 501(c)(3) tax-exempt status approvals in 2014, let’s revisit what being a 501(c)(3) charity means and why charities apply for 501(c)(3) status. Subsection (3) of section 501 of the IRS Code is the most commonly used 501(c) subsection, and most of the charities rated by CharityWatch have 501(c)(3) status. While section 501 of the IRS Code exempts certain types of organizations from taxation, section 501(c) describes the different types of eligibility for tax-exemption status and the requirements necessary to obtain that status. Groups that are organized exclusively for charitable, educational, and/or religious purposes comprise the majority of the subsection (3) eligibility types under section 501(c). (Other eligible exempt purposes under 501(c)(3) are: scientific, literary, fostering amateur sports competition, child or animal cruelty prevention, and testing for public safety.) Every 501(c)(3) organization is further classified as either a public charity or a private foundation. In addition to gaining exemption from federal income tax and eligibility for other types of tax exemptions, 501(c)(3) organizations benefit by being eligible to receive tax-deductible charitable contributions, which makes individual and corporate donors more likely to give their support. There are over one million 501(c)(3) organizations recognized by the IRS.

Any organization seeking 501(c)(3) tax-exempt status from the IRS prior to July 2014 was required to apply by submitting Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. The IRS, however, has now made it much “E-Zier” to apply since July 2014 with the introduction of Form 1023-EZ, which is a “streamlined” application for 501(c)(3) tax-exempt status that cuts the 26-page full-length Form 1023 down to a mere three pages. Most of the short Form 1023-EZ consists of only check-box questions for the applicant. Compared to the full form, required information missing from the EZ application includes: a narrative description of the organization’s activities; the compensation and other financial arrangements with officers, directors, trustees, employees and independent contractors; and financial data related to revenues, expenses, assets and liabilities. Also unlike the full form, EZ applicants do not need to provide supporting documentation such as articles of organization, adopted bylaws, conflicts of interest policy, fundraising contracts, or agreements with interested parties. Although some may consider such parts of the full Form 1023 application to be too complex or time-consuming, it is those parts that can aid the most in educating applicants regarding the requirements for and issues concerning the operations of a 501(c)(3) organization. The demands of the full form also help weed-out potential applicants that may be ill-prepared or have dishonest intentions. On the other hand, the EZ Form is so “E-Z” to complete that it doesn’t even ask for information as basic as an organizational mission or purpose statement.

The Form 1023-EZ was estimated to be appropriate for use by “[m]ost small organizations, including as many as 70 percent of all applicants,” according to the IRS at the time of the EZ’s release. Organizations do have to complete the Form 1023-EZ Eligibility Worksheet consisting of 26 yes/no questions to confirm their eligibility, which includes having/expecting annual gross receipts of $50,000 or less for the past/next three years and having total assets of $250,000 or less. Regardless of financial position, churches, schools, hospitals, medical research organizations, and organizations that maintain donor advised funds are among those that are ineligible for the EZ Form. All Form 1023-EZ applications are filed online with the IRS, and a $275 fee must be paid when the form is submitted. [Note: The IRS decreased the fee from $400 to $275 effective July 1, 2016.]

The IRS is much more rapidly approving charitable status due to the introduction of its streamlined application process and the implementation of the Form 1023-EZ in FY 2014. Thanks to the EZ Form, from April to September 2014 the IRS was able to reduce by 91% the backlog of 55,000 tax-exempt status applications pending at least 270 days, as cited in a March 2015 article in The Chronicle of Philanthropy. This is no surprise as it has taken the IRS an average of only 16 days to process Form 1023-EZ applications, compared to an average of 110 days for the full-length form, according to an April 2015 The New York Times article. But is there a price to pay for streamlining the 501(c)(3) application process?

With such a drastic cut in the information required relative to the full-length Form 1023, the Form 1023-EZ is drawing fervent criticism from many who believe that the EZ Form invites abuse and fraudsters, heightens the burden of already strained state regulators, and ultimately will end up harming public trust in charities. The president of the National Council of Nonprofits, Tim Delaney, spoke out against the EZ Form before its launch in a May 2014 The Chronicle of Philanthropy article by warning that it would “undercut the credibility of the entire nonprofit sector,” and he later claimed that “[i]n many communities, it takes more to get a library card than it takes to get this new exempt status,” according to an April 2015 article in The New York Times. Even the National Taxpayer Advocate Nina Olson, who had supported the adoption of an EZ version, wrote in a 2014 memorandum to the IRS that the Form 1023-EZ “goes too far in the opposite direction, effectively making a mockery of the I.R.S.’s significant oversight function,” as reported by The New York Times.

The IRS defends the Form 1023-EZ, asserting that the detailed vetting provided by the full-length form was premature for the small, newly-started groups that generally make up about two-thirds of the 501(c)(3) applications, and that it is a better use of the IRS’s resources to devote more compliance activity on examining groups based on what they’re actually doing after receiving 501(c)(3) status versus examining them upfront during the application process. To check for Form 1023-EZ abuses, the IRS also noted in an April 2015 The New York Times article that it had selected about 1,000 applications for more in-depth review and questioning and did not find “any indications that the EZ has been intentionally misused.” One thousand applications, however, represented less than 4% of the estimated 28,000 Form 1023-EZ applications that had been submitted to the IRS since the EZ Form’s introduction, according to the IRS as cited in The New York Times article. Further, only 67 disapprovals occurred out of the 100,032 total 501(c)(3) applications submitted to the IRS in its FY 2014, according to the 2014 IRS Data Book. Therefore, not only has the rate of approved 501(c)(3) applications surged since the introduction of the Form 1023-EZ, but the rate of disapproved 501(c)(3) applications has declined significantly, dropping from an already extremely low 0.174% of total applications to an even lower 0.067% between FY 2013 and 2014.

Count CharityWatch among the critics of the new Form 1023-EZ. The EZ Form has clearly benefited the overburdened, budget-constrained IRS by helping to eliminate its backlog of tax-exempt applications and through faster processing times for new applications. However, by requiring so little information and no supporting documentation from Form 1023-EZ applicants, the public now has considerably less assurance that newly-formed 501(c)(3) charities will operate legitimately and in the public’s best interests. Also, for those seeking out additional information on the background of newly-formed, or even longer-running charities, the bare-boned EZ Form won’t provide much substance at all.

The IRS and some new charities may be singing the praises of the new Form 1023-EZ, but don’t be fooled. With so many more charities easily and quickly gaining 501(c)(3) approval from the IRS thanks to the streamlined EZ Form, donors now have to be even more cautious in choosing charities to support. Certainly don’t equate a charity’s 501(c)(3) status with any kind of assurance that the charity is operating legitimately.