Apply for Tax Exempt Status with Form 1023

Starting non-profit organization and applying for tax exempt status can be a challenging adventure, but it is certainly worthwhile. It creates an opportunity to help those in need, rally around a cause, and give back to a community. It also gives its founder the chance to create a lasting legacy and source of pride. To be recognized as a tax-exempt organization, a non-profit must submit an Application for Recognition of Exemption Under Section 501(c)(3) to the IRS. This application (Form 1023) is quite comprehensive and can appear daunting to new and small non-profits.

To get around the detail required in the 1023, some organizations choose to submit the “Streamlined Application for Recognition of Exemption Under Section 501(c)(3)” (Form 1023 EZ). “ Streamlined ” ooooooo, doesn’t that sound grand? We should all be so lucky to use a streamlined tax form, right? Well, actually for most non-profits with goals of tax-exempt status, the more comprehensive and initially scarier looking form is actually the better choice. Here are four reasons why, with a little background first.

A Little Background

The complexity of designing a non-profit results from it needing to satisfy a wider audience than a for profit business. A for profit business has a healthy dose of happiness it must mete out to stick around. Among them are the founders, the board, those that have invested, state law, tax law, and of course, customers. On top of all of these stakeholders and compliance partners that a for profit business needs to keep happy, a tax-exempt non-profit must add a healthy dose of federal tax law to its list. State level entity laws govern the structure, rights, responsibilities, and liabilities of the organization’s internal stakeholders (directors, officers, agents). Federal tax law supplies another body of rules that when followed reward a non-profit with tax-exempt status.

While there are many types of tax-exempt entity, when we speak of these we generally tend to mean a 501(c)(3) organization. These are organizations organized exclusively for charitable, religious, educational, scientific, literary, prevention of cruelty to children and animals, public safety testing, and amateur sports competition purposes. In later entries we will go much more in depth on the topic of non-profits and tax-exempt status. The take away you need for now is this: all 501(c)(3)’s are non-profits, but not all non-profits are 501(c)(3)’s. Obtaining tax-exempt status is an extra step beyond simply forming a non-profit.

Reason #1: Sometimes Less Isn’t More; It’s Just Less

The most attractive aspect of the EZ is its simplicity. The EZ initially appears much easier to complete than the 1023 (EZ is only 3 pages long vs. 1023, which is over 20 pages). However, this initial impression is misleading. The EZ provides no opportunity for clarification or explanation, meaning that for activities and operations that are legitimate if done properly you are incentivized to just say no to them because a yes without explanation could lead to risk of denial. For example, the EZ asks whether an organization will participate in political lobbying. A quick web search will show the EZ user that public charities should not do any significant lobbying activities. Meanwhile, the 1023 asks the same question but gives an opportunity to describe these operations and how they will be in compliance with the law. Without an opportunity to explain an EZ applicant may feel it is safer to forgo all lobbying and just answer “No” on the application rather than risk a denial for saying yes.

Reason # 2: Only Certain Organization May Use the 1023 EZ

The EZ is for organizations with less than $50k revenue. If you receive a grant that’s larger than expected and you had reason to know this was possible there could be risk of being accused of making a material misstatement and losing exempt status. Also, the receipt of a large grant for an EZ filer may be an audit consideration.

Reason #3: ALL the Rules Apply, Even to EZ Filers

Once an organization applies for and receives tax-exempt status, even if it used an EZ to apply, the organization must still comply with every rule applicable to a public charity. Even though you might not know about a rule because the EZ didn’t make you aware of it, doesn’t give you a pass or exemption on compliance. In contrast, the 1023 gives you a chance to face those rules and plan for how to operate within them. By not giving you the opportunity to plan for the rules, the EZ creates the risk that if the IRS ever comes calling you’ll find yourself not in compliance with many aspects of required operations.

Reason #4: Planning is Fun

If success is great, and planning leads to success, then planning is great too. Disregarding the actual merits of that syllogism for a moment, the greatest advantage of the 1023 is the opportunity to plan. Some of you may think “But planning is SOOO boring”. Well, if you’ve ever laid out the rooms in your one day dream house, or picked options on your future car, Congratulations! You’re already a planner. Well-planned businesses and organizations tend to operate more efficiently and successfully than their seat of the pants counterparts. This is particularly important in the nonprofit world where a community or cause depends on an organization’s efforts, and where potential donors want to know their donations are being put to their highest good.

I like to embrace the 1023 and use it as an opportunity to map out the operations of an organization , its programs and activities, and its compliance with various laws. The EZ may get your foot in the door, but it may ultimately get you into a room you aren’t ready for.

Service Through Strategy SM

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© Christopher Way 2017

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