New nonprofits must apply to the IRS to be approved as a 501(c)(3) or tax-exempt organization. There are a few hurdles to clear.
First, nonprofits must be organized and operated exclusively for tax-exempt purposes — which means they aren't trying to make a profit. Also, none of their earnings can inure to the benefit of private shareholders or individuals. And they can't attempt to influence legislation as a substantial part of their activities or participate in political candidates' campaigns.
If your nonprofit meets all those conditions (and possibly others), congratulations! Now, what form should you use to apply? Traditionally, organizations only had the option to use Form 1023. But the IRS introduced Form 1023-EZ in 2014 and you may want to choose this streamlined version.
The Case for Form 1023
Many nonprofits still use the longer Form 1023 because there are virtually no restrictions on its use. It's available to every 501(c)(3) organization.
However, Form 1023 takes time and money to complete. Don't think you can crank out the form in a single short sitting. It's 40 pages long and accompanied by lengthy instructions. The instructions not only explain how to fill out the form but also indicate the documents you'll need. Do your homework before tackling Form 1023 and consider consulting an attorney to walk you through it.
Also consider the cost. You must pay the hefty sum of $600 to file Form 1023.
An Easier Way for Some
In comparison, Form 1023-EZ costs only $275 to submit. It must be filed online and it's only three pages long. This is considerably less "taxing" than filing the original Form 1023. For most applicants, completing it should require less than half the time it generally takes to fill out Form 1023.
However, eligibility for filing Form 1023-EZ isn't automatic. You must first make your way through a worksheet to verify your organization qualifies for this option. The worksheet contains 30 questions and it only takes one "yes" answer to eliminate Form 1023-EZ. For example, your organization can't:
- Expect to have annual gross receipts of more than $50,000 during the next three-year period. This includes receipts from all sources.
- Own assets valued at more than $250,000. This isn't limited to cash — it also includes the fair market value of bank accounts and loans receivable, inventories, bonds, stocks, equipment and buildings.
- Have been previously revoked or be a successor to a previously revoked organization.
- Be formed outside of the United States. But being formed in S. territories such as Puerto Rico or the Virgin Islands is acceptable.
- Be organized as any other entity besides a corporation, an association, a trust or an unincorporated operation. Thus, an entity registered as a limited liability company isn't eligible.
- Be currently recognized as tax-exempt under 503(c) or under another section of the tax code.
- Be a church, school, college, university, hospital, medical research association, agricultural research organization, health maintenance organization or an accountable care organization or be applying for tax-exempt status as one of these under other tax code provisions.
- Maintain a donor advised fund (DAF). DAFs provide donors with greater control over charitable distributions than they have with regular contributions.
- Be a successor to, or controlled by, an organization involved in any way with terrorist organizations, groups participating in terrorist activity or those that have had their tax-exempt status revoked or suspended.
- Be a private operating foundation. A private operating foundation generally is formed by an individual or family and operates by using investment income.
These represent major obstacles for nonprofits to use Form 1023-EZ, but you must go through the entire worksheet. As long as you answer "no" to every question, you can proceed to use the form. But if you have any questions about your organization's eligibility, consult tax and legal advisors.
Know the Risks
Form 1023-EZ is faster to complete and costs less than Form 1023, yet it's not for every organization seeking tax-exempt status. The first obstacle is meeting the eligibility requirements.
But there's also potentially some risk that using the shorter form will increase audit exposure. So, the most prudent move is to obtain professional guidance for your nonprofit's situation.