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​Tax Exempt Application Changes: Good or Bad? Only Time Will Tell

By Kay Vollans, Tax Manager at Raffa, P.C.

The 1023-EZ, much like the 990-EZ, is a fraction of the size of its full form version and significantly reduces the amount of questions and preparation needed by aspiring tax-exempt organizations choosing to file it. The IRS has said it will regulate these organizations with compliance checks and field audits post filing. Many practitioners think that this deferred compliance is a short-sighted move by the IRS. While the IRS appears to be cleaning up the application process for tax exemption by rolling out the interactive 1023 form, and more recently releasing the new Form 1023-EZ, some practitioners and advisors in the field are less than impressed with the recent changes.

According to their website, the IRS receives "more than 70,000 applications for tax-exempt status each year,"[1] and currently, the average age of the pending application inventory is ten months old. However, the goal of the IRS is to be fully processing applications in 270 days or less by fall of this year. They appear to be making headway towards this goal. As of August 19 of this year, most exemption applications more than a year old have been closed.

Development of Form 1023-EZ

The development of a fully electronically filed form was hoped to result in more accurate applications, as well as shortening the approval process which were both noted problems for years in the EO division. This idea was long in the making with recommendations to the IRS from the Exempt Organizations Subcommittee of the ACT dating back to May of 2003b to streamline the determinations process and develop a fully electronically filed form. Originally, IRS Cyber Assistant was to be on-line help for 501(c)(3) applicants that also offered reduced fees, but it failed to launch after many years of postponements. Recommendations for updating the Form 1023 included items to reflect the 2006 Pension Protection Act changes, as well as the 2008 Form 990 redesign consistencies, both of which are now on hold. All efforts have been focused on the interactive Form which provides relevant links, instruction excerpts and helpful pop-up windows as you complete the application. We're not quite there, however, as applicants will still need to print and mail their forms (and sorry, no price reduction for using the tool!).

Application Process Changes

Changes to the application process have been urged for many years by various professionals and authorities in the field, and are now more vital than ever. In ACT's June 2012 Report of Recommendations,[2]  the Advisory Committee pushed for the IRS to develop an interactive web-based form for the 1023 application. They followed those comments by confidently recommending against a 1023-EZ form. Their rationale was not that the Form 1023 be laid out as a barrier to organizations with its complexities and requirements, but that organizations would be "entering into a (probably unfamiliar) comprehensive regulatory regime" and by completing the full application organizations were able to work through and consider very important questions about their activities, finances, and management practices.

Interestingly, National Taxpayer Advocate, Nina E. Olson, has been recommending a Form 1023-EZ for years, but in her mid-year report to Congress,[3]  just released weeks ago, she states:
"I and many others have grave concerns about the IRS's new approach. The IRS's new Form 1023-EZ eliminates all sections of the tax-exemption application in which the organization must describe its mission and activities, and it does not require the organization to send in its formation documents for review. Instead, the IRS adopts a "check-the-box" approach in which the organization merely "attests" that it meets the requirements of § 501(c)(3) and that its articles of incorporation or other formative documents contain the necessary language against self-inurement and the appropriate dissolution clause."
With comments such as this from Tim Delaney, President and CEO of the Council of Nonprofits: "It's easier to get tax-exempt status under 1023-EZ than it is to get a library card," and headlines reading "IRS Stops Screening 80% of Nonprofit Applications,"[4]  it's somewhat concerning, for those of us in this arena, how these changes at the IRS will affect our sector.
The IRS noted that most small organizations, including as many as 70 percent of all applicants, qualify to use the new streamlined form. That means that roughly 49,000 applicants a year will be eligible to file minimal paperwork in order to achieve tax exempt status – while making no mention of what they will actually be doing. Unfortunately, many professionals in the field are concerned that this truly "EZ" process will open the door for more fraudulent activity and charity scams that could reduce contributor confidence, general public giving, and possibly taint the nonprofit sector as a whole. IRS Commissioner John Koskinen stated that "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."[5]   While the IRS may believe that these changes will ease the burden and wait time for exempt organization status – they may have set the wheels in motion for bigger problems later. Only time will tell. 
This article was contributed by Kay Vollans, a Manager in Raffa's Tax Practice.  If you have any questions about tax exempt application changes, Kay can be reached at 202.955.6757 or kvollans@raffa.com.
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[2] http://www.irs.gov/pub/irs-tege/tege_act_rpt11.pdf Advisory Committee on Tax Exempt and Government Entities (ACT) Report of Recommendations, June 6, 2012, Publication 4344 (Rev. 06-2012) Catalog Number 38578D, Department of the Treasury
[3] http://www.taxpayeradvocate.irs.gov/userfiles/file/FY15-Full-Report/Volume-1.pdf National Taxpayer Advocate, Fiscal Year 2015 Objectives, Report to Congress, Volume 1, June 30, 2014