Every year tens of thousands of charities and non-profit organizations apply to the IRS for tax-exempt status. Charities with less than $250,000 in total assets and less than $50,000 in donations in each of the past three years are eligible to file the "streamlined application", known as Form 1023-EZ. Although the IRS approves 94 percent of these applications, many of these charities may not be fully compliant with IRS requirements.
The National Taxpayer Advocate (NTA) is a federal agency that identifies and reports on issues faced by taxpayers. In its 2016 report, the NTA claims that the IRS is wrongfully approving one-quarter of Form 1023-EZ applications. The NTA reached this conclusion after reviewing a sample of Form 1023-EZ applications from 20 states.
How Are Charities Failing to Qualify for Tax-Exempt Status?
In short, many charities are not providing adequate documentation, but the IRS is approving their applications anyway. In order to maintain tax-exempt status under Section 501(c)(3) of the federal tax code, charities must pass what is known as an "organizational test." In order to pass this test, a charity must state its purpose and also discuss its procedures in the event of dissolution.
Per the NTA, 26 percent of the Form 1023-EZ applications it reviewed in 2016 failed the organizational test. Moreover, the IRS even approved Form 1023-EZ applications for churches, schools and LLCs, even though these organizations are not eligible to file this form.
What Can Be Done to Ensure Greater Compliance?
Form 1023-EZ balances two competing factors. First, the charities applying for tax-exempt status through Form 1023-EZ often have limited resources. It can be challenging for these organizations to provide full documentation to the IRS. Furthermore, the IRS has limited resources to fully vet each application. On the other hand, the federal government has a strong interest in making sure that charities are serving the public interest.
The NTA recommends the IRS require charities that file Form 1023-EZ to also provide financial information and organizational documents. The IRS is not following this recommendation. Rather, the IRS is relying on charities to provide additional information through the returns for tax exempt organizations (Form 990 and Form 990-EZ).
Charities and nonprofits of all sizes face unique and sometimes challenging tax issues. A skilled tax lawyer can make all the difference. The tax attorneys of Goldburd McCone LLP provide the highest caliber of counsel and advocacy to nonprofits throughout New York City and beyond.
Sources: Many tax-exempt charities don't meet IRS requirements, Tax Pro Today, February 6, 2017, by Michael Cohn, 2016 Annual Report to Congress, National Taxpayer Advocate