1023-EZ Problems - and How to Avoid Them!

There is a lot to like about IRS form 1023-EZ! It is only three pages long, it asks for minimal information, and it can be filed online. What’s more, the filing fee is only $275, and the application is usually approved within a month or so. This quick and easy process is a boon for small organizations who want to get up and running quickly with minimal expense.

So, what’s the problem? Well, nonprofit and tax-exempt law is complicated and many people believe that their new nonprofit is organized and operating like a public charity, when in fact it is not. Studies by the IRS bear this out. In 2018 the IRS reported that a review of randomly selected applications showed that only 49% were fully compliant! The rest, 51%, had received tax exemption when they were not eligible.

These are some of the common problems that the IRS has uncovered – and that we see in our law practice:

  • Articles of Incorporation are not compliant. In the State of Michigan, the preprinted Articles of Incorporation form and online form do not contain all the articles required by the IRS for tax-exemption.
  • No Bylaws(!)
  • Having a mission that is not in fact charitable. Sometimes the organization could receive tax exemption – but not as a 501(c)(3) charity.
  • A board of directors that is too small. (You need at least 3 people in the State of Michigan).
  • Not, understanding the need to have arms-length financial transactions between the charity and any of its founders or directors.
  • Not understanding the need to continually meet the public support test for revenues.
  • Not being aware of all annual filing obligations.

Sometimes problems come to light when an organization applies for a grant and discovers that it is not eligible. Sometimes they come to light when the organization is completing a 990 or 990-EZ. A few of these problems are easy fixes. Others, especially if they have been going on for a while, need more serious work – and can even lead to loss of tax exemption.

So how to avoid these common problems? First, read the instructions to the forms very carefully and make sure that you understand all the questions. Second, run your application by a lawyer who is familiar with nonprofit law. Attorneys who regularly work with tax exempt organizations will be able to identify issues and advise you on what you can do to get into compliance before you file.

If you received tax exemption using the 1023 EZ, consider getting an attorney to do a review of your documents and operations.

The 1023 EZ may still be a good choice for many small organizations: with good legal advice, you can save time and money in your application for tax exemption.

Practice Area(s): Non Profit and Tax Exempt