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Update: The IRS Has Made It Too 'E-Z' to Start Charities

   Mar 08, 2016

Less than a year ago CharityWatch warned donors to get ready for a stampede of solicitations thanks to the IRS’s July 2014 introduction of a new “streamlined” application process for certain eligible organizations to apply for 501(c)(3) public charity tax-exempt status by submitting IRS “Form 1023-EZ.” Sure enough, the EZ Form has been very popular with charity applicants in just its first year of use. Unfortunately, by making the application process so “E-Z,” it turns out that the IRS has been erroneously granting public charity tax-exempt status to many organizations.

As part of its 2015 Annual Report to Congress, the Taxpayer Advocate Service (TAS), an independent organization within the Internal Revenue Service, conducted a study that covered 408 organizations that gained 501(c)(3) approval using Form 1023-EZ. The purpose of the study was to determine the extent to which approved organizations actually satisfied the “organizational test,” which is a legal requirement for qualification as a 501(c)(3), and the extent to which approved organizations (whether or not they met the organizational test) were eligible to apply for tax exempt status using the EZ Form. The TAS found that an alarming 37% of the 408 organizations studied failed to meet the organizational test to qualify as a 501(c)(3), and 4% of the 408 were actually ineligible to use the 1023-EZ application yet received approval anyway.

The Taxpayer Advocate Service concluded that its “study showed that a significant number of Form 1023-EZ applicants were recognized as IRC [Internal Revenue Code] §501(c)(3) organizations despite failing to meet the legal requirements for such status.” Moreover, the TAS found that over half of the 408 organizations studied didn’t even have a public website (Facebook pages excluded), thereby limiting the public’s opportunity to find additional information about the charity beyond the basic information provided on the 1023-EZ application and the organization’s annual IRS reporting form. (Generally 1023-EZ-eligible organizations will meet IRS annual reporting requirements by submitting Form 990-N, or an “e-Postcard,” which contains just eight pieces of information: taxpayer ID number; tax year; legal name & mailing address; other names used; name & address of the principal officer; website address (if applicable); confirmation that annual gross receipts are $50,000 or less; and a termination statement (if applicable).) According to the TAS report, “… the skeletal Form 1023-EZ, the brevity of the [IRS] annual report required of these organizations, and the probability that the organizations will not have a website result in a disturbing lack of information about them, undermining the public’s and the IRS’s ability to effectively monitor this segment of the exempt organization population.”

The IRS’s own analysis also shows that it is approving a significant number of 501(c)(3) applications via the 1023-EZ that it would have rejected had the applicants been subjected to a slight amount of scrutiny. According to the IRS’s Form 1023-EZ First Year Report, approval rates were only 77% in cases where the IRS requested documents and more detailed descriptions of basic information (based on 965 closed cases of EZ applicants that were selected by the IRS for “pre-determination review”), compared to an overall 95% approval rate when the IRS used only the applicant attestations submitted via the EZ Form. The most common reasons the IRS rejected applicants under pre-determination review were ineligibility to use the 1023-EZ or failure to respond to the IRS’s request for additional information.

Unfortunately for the donating public, the early returns on the use of IRS Form 1023-EZ for organizations to apply for charitable tax-exempt status are just as CharityWatch feared they would be: the EZ Form is being used by a majority of applicants, and the IRS is erroneously approving 501(c)(3) charities at an alarming rate. The Taxpayer Advocate Service has expressed serious concern that the IRS has run with the idea of the 1023-EZ “to the point of absurdity” and stated that “[w]ith the adoption of Form 1023-EZ, the IRS effectively abdicated its responsibility to determine whether an organization is organized and operated for an exempt purpose.” Therefore, as we urged last year, donors need to be more cautious than ever in choosing charities to support, and certainly don’t equate a charity’s 501(c)(3) status with any kind of assurance that the charity is operating legitimately.