New Streamlined Application Process for 501(c)(3) Recognition

New 1023-EZ Issued

New 1023-EZ Issued

Most charitable organizations must seek recognition of their exemption under Section 501(c)(3) (exceptions include churches, associations of churches, integrated auxiliaries of churches, and very small charities with gross receipts normally $5000 or less per year). Application has historically been made on Form 1023 and over the past few years the processing time has become more and more lengthy.  I discussed that in this post.

Earlier this year the IRS issued a draft 1023-EZ proposing to streamline the process. Today the IRS has issued new guidance (in the form of final and temporary regulations under Section 501(c)(3)) as well as a working Form 1023-EZ.  Not all organizations will qualify.  Notably for my practice, churches that choose to file a 1023 must use the full form, schools, supporting organizations and private operating foundations must also use the full form. Finally, organizations with more than $250,000 of assets or that anticipate more than $50,000 per year over the first three years must use the full form.  The 1023-EZ Instructions contain a worksheet that identifies organizations that qualify/fail to qualify for the streamlined treatment.  Here’s to hoping this speeds the process up for everyone.

The IRS Press Release is set out below:

Issue Number: IR-2014-77

Inside This Issue

________________________________________

New 1023-EZ Form Makes Applying for 501(c)(3) Tax-Exempt Status Easier; Most Charities Qualify

WASHINGTON — The Internal Revenue Service today introduced a new, shorter application form to help small charities apply for 501(c)(3) tax-exempt status more easily.

“This is a common-sense approach that will help reduce lengthy processing delays for small tax-exempt groups and ultimately larger organizations as well,” said IRS Commissioner John Koskinen. “The change cuts paperwork for these charitable groups and speeds application processing so they can focus on their important work.”

The new Form 1023-EZ, available today on IRS.gov, is three pages long, compared with the standard 26-page Form 1023. Most small organizations, including as many as 70 percent of all applicants, qualify to use the new streamlined form. Most organizations with gross receipts of $50,000 or less and assets of $250,000 or less are eligible.

“Previously, all of these groups went through the same lengthy application process — regardless of size,” Koskinen said. “It didn’t matter if you were a small soccer or gardening club or a major research organization. This process created needlessly long delays for groups, which didn’t help the groups, the taxpaying public or the IRS.”

The change will allow the IRS to speed the approval process for smaller groups and free up resources to review applications from larger, more complex organizations while reducing the application backlog. Currently, the IRS has more than 60,000 501(c)(3) applications in its backlog, with many of them pending for nine months.

Following feedback this spring from the tax community and those working with charitable groups, the IRS refined the 1023-EZ proposal for today’s announcement, including revising the $50,000 gross receipts threshold down from an earlier figure of $200,000.

“We believe that many small organizations will be able to complete this form without creating major compliance risks,” Koskinen said. “Rather than using large amounts of IRS resources up front reviewing complex applications during a lengthy process, we believe the streamlined form will allow us to devote more compliance activity on the back end to ensure groups are actually doing the charitable work they apply to do.”

The new EZ form must be filed online. The instructions include an eligibility checklist that organizations must complete before filing the form.

The Form 1023-EZ must be filed using pay.gov, and a $400 user fee is due at the time the form is submitted. Further details on the new Form 1023-EZ application process can be found in Revenue Procedure 2014-40, posted today on IRS.gov.

There are more than a million 501(c)(3) organizations recognized by the IRS.

 

The IRS, Tax Exemption and Patience

Sign in front of IRS

Backlog at the IRS

Where is my exemption application and when will the IRS rule on it? I get those questions a lot from clients. This post will examine the current backlog problems at the IRS and offer a few planning options.

With very limited exceptions for churches, church-related organizations, and very small organizations (those with gross receipts normally not more than $5,000 per year), to be entitled to tax-exempt status under Section 501(c)(3) of the Internal Revenue Code an organization must obtain recognition of that status by filing Form 1023 (Application for Recognition of Exemption) with the IRS and receiving a determination letter. I receive many calls from individuals wishing to create a new 501(c)(3) organization and expecting that the process will be relatively quick. In fact, that is typically not the case.

Form 1023 is filed with the Determinations Office of the IRS. According to the IRS website, upon receipt applications that are accompanied by the required user fee are initially separated into four categories including those that can be approved immediately, those that may need minor additional information to be resolved, those that are incomplete, and those that require further development. Again, according to the IRS website, the first three categories result in the organization receiving a determination letter or a request for additional information within approximately 90 days of the date the application was submitted. The fourth category—those requiring further developments—must be assigned to an Exempt Organizations agent. While the IRS reports that approximately 30% of the applications submitted fall into this fourth category, my experience shows a much higher percentage. Given, this may be because the applications that I handle are typically not very basic or plain vanilla applications. Likewise, it may be because an inordinate percentage falls into the third category (incomplete applications) and once that issue has been resolved, the application falls into the fourth category. The IRS does not provide what percentage of applications are resolved within the initial 90 to 120 days. What is clear though is that the backlog is growing.

According to a Bloomberg BNA Daily Tax Report, National Taxpayer Advocate Nina Olson has said that the inventory of open applications increased from 15,570 in fiscal year 2010 to 33,505 in fiscal year 2012. If the IRS receives (as is reported) approximately 60,000 new applications a year and at least 30% of those require further development, the problem of the backlog is clear.

The issue with the backlog is that the applications are essentially in limbo during this wait. The applications have not been assigned to an Exempt Organizations agent and thus the organization has no contact person at the IRS. According to its website, the IRS is currently assigning the applications received in April 2012—17 months prior to this post being authored. The backlog increases month by month.

In light of this concern I am often asked what options exist. First, it should be noted that so long as the organization has filed its Form 1023 within 27 months from the time it was created (for nonprofit corporations, the time period when it filed its governing document with the Secretary of State), once exemption is granted (whenever that may be) it is retroactive back to the date of filing its initial governing document. While the organization cannot hold itself out as a Section 501(c)(3) tax-exempt organization during this interim time period, it can raise funds (though it cannot tell donors that those funds will be deductible) and it can operate. Oftentimes, this is not feasible as donors want the determination letter as evidence of the exemption. While the IRS does have procedures in place for expediting an exemption application, those procedures are narrowly drawn and require exceptional circumstances. If an organization believes they qualify for expedited handling, it is advisable to seek professional assistance in making that request.

The second option for organizations during this interim period is the use of a fiscal sponsor. A fiscal sponsorship arrangement is created between the organization with the pending application and an organization that has already been determined by the IRS to be a 501(c)(3) organization. The sponsor receives the funds with full discretion and control over the funds and uses the funds to support the pending organization’s project(s) in a way that furthers the sponsor’s tax-exempt purposes. There are various models of fiscal sponsorship and an organization considering entering into such a relationship needs to seek professional guidance to protect its assets, as well as its tax status and that of the sponsor organization. More information about fiscal sponsorship can be found from the National Network of Fiscal Sponsors.

Finally, an organization that has had its application pending for more than 270 days is authorized by Section 7428 of the Internal Revenue Code to seek a declaratory judgment that it is qualified under Section 501(c)(3). This requires a petition for declaratory relief to be filed in the United States Tax Court, the United States District Court for the District of Columbia, or the United States Court of Federal Claims (all of concurrent jurisdiction in such cases). This action requires a determination on the part of the board of directors that the expenditure of additional funds for the handling of this litigation is justified, in order to push through an exemption application.

It is well-known that the IRS is currently under fire and that the focus is specifically on Exempt Organizations. There has been significant turnover in management as a result of the inquiries and investigation concerning the handling of conservative groups’ 501(c)(4) applications. This has only served to exacerbate the backlog. That backlog is likely to continue to grow and thus an organization should understand its options for handling this interim period.

 

 

 

How to Set Up a Disaster Relief Charity

West

When tragedy strikes as it did in different ways last week in Boston and West one thing is a constant, the desire of Americans to help their neighbors. That help comes in many forms as people seek to meet the physical, emotional, spiritual and even financial needs of those affected. Sometimes to meet those needs individuals and businesses decide to set up new charitable organizations. This post will teach you how to set up a new charity (one that follows the IRS rules) to provide aid following a disaster.

There are many ways to help our neighbors in need. We give blood, give to established charities like the Red Cross and Salvation Army, donate clothes, food, and blankets, and join together to pray and show support. After the most immediate needs have been met in the aftermath of tragedy, the focus turns to what we can do longer term. Sometimes a decision is made to establish a fund to help those affected. While not mandated, often the decision is made to seek tax exempt status. Trying to meet the needs we see while also navigating the various rules that regulate this type of good is an admirable goal but not one without challenges.

The key to establishing a tax-compliant charity to provide for disaster assistance is defining the persons eligible for aid. This requires two answering two questions: (1) what class of persons is eligible for assistance, and (2) which of the persons in that class are needy or distressed.

To qualify for tax exempt status under Section 501(c)(3) an organization must serve public purposes, not private purposes. In the context of disaster relief this means defining the class broadly so as to benefit a “charitable class” as opposed to a narrower subset of individuals. Stated differently, the class must be sufficiently large or indefinite as opposed to closed and definite. For example, an organization established to provide assistance to families of the first responders who lost their lives in West, Texas would fail to qualify as a Section 501(c)(3) organization the class is closed and defined (i.e. a specific group that would qualify and no one else). However, an organization established to provide assistance to families of West, Texas first responders who lose their lives in the line of duty, both those from last week’s fertilizer plant explosion and those who may lose their lives in the future, would qualify the class is open and indefinite (the criteria may apply to any number of people in the future). As a side note, there is no bright line on what class is “sufficiently large” so as to qualify as a charitable class. While a class like the first responders killed during the event would be too small, a class of families of those killed or injured (more than 170) could arguably be large enough.  For example, One Fund Boston, according to news reports, has been established specifically to assist families of those killed or injured in the Boston bombing. It will be interesting to see if that class is sufficiently large so as to be charitable.

After ensuring the assistance is available for a charitable class, the organization providing disaster relief must also ensure the specific persons receiving aid are proper recipients of charity. The IRS has acknowledged that both individuals and businesses may be appropriate recipients of charity. Further, charitable aid may be provided on an emergency basis, a short-term basis (e.g. 3-6 months) or a long-term basis. With respect to emergency aid (such as blankets, hot meals, clothing), it is sufficient that the persons receiving aid were victims of the disaster no showing of financial need is required. However, for assistance beyond immediate emergency assistance, the organization must conduct an assessment to ensure the recipient of aid meets the test of being in need and qualifying for charitable aid, namely lacking the resources to obtain basic necessities.

At that point, the type of aid that is appropriate depends on the recipient’s needs and resources. For example, while all victims in the immediate area of the Boston Marathon bombing may qualify for immediate crisis counseling, whether long(er) term counseling may be given by a charitable organization depends on the needs and resources of the individual.

It is critical for the organization dispensing aid to document the assessment it performs so that it will have records to show that its funds were spent for charitable purposes. More information on documentation and reporting can be found in the IRS’s helpful publication on disaster relief, Publication 3833.

Aside from the issues in this post specific to disaster relief, to create a disaster relief charity, the founders must follow state law to create the organization and file Form 1023 to obtain recognition of tax exempt status from the IRS. Here is a link to a paper that I wrote in 2004 and updated in 2011 regarding the basic set-up of a 501(c)(3) organization discussing these concepts: Setting Up Your 501(c)(3) Nonprofit Organization.