CARL WATTS & ASSOCIATES

September 22, 2014

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Tax Exempt Status
Form 1023-EZ
Before you get too excited about the topic of this newsletter, let us clarify that this refers to certain types of organizations that are granted tax exempt status by the IRS.

Generally speaking, the Internal Revenue Code requires that people who live and work in the United States file a federal income tax return and pay tax on their income every year.

Some people whose income falls below certain thresholds aren't required to pay federal income tax and/or file a tax return. These thresholds change every year and are outlined in IRS Publication 17, which is updated annually.

Things are different, though, when it comes to certain organizations. Since 1959, the IRS added a special section called Section 501(c)(3), enabling applicable organizations to obtain exemption through the tax code.

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization (i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates).

Organizations described in section 501(c)(3) are commonly referred to as charitable organizations. Organizations described in section 501(c)(3), other than testing for public safety organizations, are eligible to receive tax-deductible contributions in accordance with Code section 170.

The organization must not be organized or operated for the benefit of private interests, and no part of a section 501(c)(3) organization's net earnings may inure to the benefit of any private shareholder or individual. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any organization managers agreeing to the transaction.

Section 501(c)(3) organizations are restricted in how much political and legislative (lobbying) activities they may conduct.
An organization may qualify for exemption from federal income tax if it is organized and operated exclusively for one or more of the following purposes.

  • Religious.
  • Charitable.
  • Scientific.
  • Testing for public safety.
  • Literary.
  • Educational.
  • Fostering national or international amateur sports competition (but only if none of its activities involve providing athletic facilities or equipment).
  • The prevention of cruelty to children or animals.
To qualify, the organization must be a corporation, community chest, fund, articles of association, or foundation. A trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify.

Qualifying organizations include:

  • Nonprofit old-age homes,

  • Parent-teacher associations,

  • Charitable hospitals or other charitable organizations,

  • Alumni associations,

  • Schools,

  • Chapters of the Red Cross,

  • Boys' or Girls' Clubs, and

  • Churches.

As you can easily assume, it takes a long and complicated process to obtain the tax exempt status. Organizations that want to apply for 501(c)(3) status should be aware of the forms required, the user fee, the filing deadline, and the processing procedures.

Up until this year, the only form available to apply for a tax exempt status was Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.

As of this year, there is a new Form 1023-EZ, which 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.

The change allows 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.

"We believe that many small organizations will be able to complete this form without creating major compliance risks," said IRS Commissioner John Koskinen. "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.

Most organizations must file this application by the end of the 27th month after they were legally formed.

The Form 1023-EZ must be filed using pay.gov, and a $400 user fee is due at the time the form is submitted.

If you happen to have an organization that is not a private foundation, then you are not required to file an application unless the organization’s annual gross receipts are normally more than $5,000. The organization must file an application within 90 days of the end of the tax year in which it exceeds this threshold.

As always, when taxes are involved, and even more so when there’s a tax exemption status, it is your best option to enroll help from tax professionals to make sure you comply with all the existing rules and regulations.
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