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Pros and Cons of Using Form 1023-EZ for Starting a Nonprofit

Pros And Cons Of Using Form 1023-EZ For Starting A Nonprofit

Nonprofits seeking federal tax-exemption under Section 501(c)(3) of the Internal Revenue Code have for decades applied by filing Form 1023 with the IRS.  In 2011, the National Taxpayer Advocate recommended that the IRS develop a simplified method, particularly for small nonprofits.  The IRS ultimately followed that recommendation, but far more extensively than anyone anticipated.

March 2014…The IRS posted a surprise announcement in the Federal Register.  They were soliciting comments on their intent to introduce a new, streamlined process for smaller nonprofits seeking 501(c)(3) status.  The proposed process included a new application, Form 1023-EZ, that would be online only, and would be accompanied by a lower filing fee.

The Federal Register posting also indicated that “small nonprofit” was going to be defined by anticipated gross revenue of up to $200,000 per year.  The proposal overall was roundly criticized in the nonprofit community (more on that below), especially the part about $200,000 in annual revenue being the upper threshold.  By that standard, over 90% of applicant organizations would have qualified as “small”.

The IRS relented on the issue of income, but nothing else.  On July 1, 2014, the IRS released Form 1023-EZ, fileable by applicant nonprofits expecting under $50,000 in gross receipts each of its first three years.  It was a significant concession, but it did little to quell the concerns, as more than 70% of new nonprofits could still qualify.  That has proven true…approximately that percentage of new nonprofits used Form 1023-EZ in 2018 rather than the traditional full Form 1023.

Annual income isn’t the only qualifying limitation.  There are other purpose, structure, and asset-based limitations on qualifying for this process.  For example, neither schools nor churches can use Form 1023-EZ.  Organizations with more than $250,000 in total assets can’t either.

Form 1023-EZ has been a mixed bag, to say the least.  The rest of this article will take a look at the pros and cons of this streamlined process.

The Pros

It is easier.  The standard Form 1023 is 26 pages, including sub-schedules.  And while not every nonprofit has to complete every sub-schedule, the final filing package for most applicants ranges from 50 to 100 pages once you include all the required documentation. Form 1023 is chock-full of very complex, technical questions that require an in-depth understanding of tax compliance issues.

Form 1023 applicants must also include a 3 year budget, a written narrative description of their proposed programs, and copies of their Articles of Incorporation and bylaws.  In addition, they may have to include copies of leases, contracts, board meeting minutes, resumes of officers and directors, and more.  It’s a lot of stuff.

Form 1023-EZ is made up of 3 online-only pages of mainly “yes/no” attestations…no budget, no narrative (beyond a purpose statement), and no attachments.  The IRS calls this process streamlined, and they aren’t kidding about that.

It is less expensive.  When Form 1023-EZ was first released, the filing fee was $400.  In 2017, the fee was reduced to $275.  That is considerably less expensive than the $600 filing fee associated with the standard Form 1023.

It can be helpful to true micro-charities.  We don’t subscribe to the idea that most small nonprofits should use Form 1023-EZ.  But for some groups, it has been beneficial.  Good candidates include micro-charities that have very simple programs, those that tend to be very local in nature, and/or those that never intend to seek grants or corporate donations.  Kids’ sports clubs, booster clubs, and similar groups can benefit from this easier process.

The Cons

It encourages DIY.  You might be surprised to find this point listed as a con instead of as a pro.  But we feel strongly about this point.  Most trade groups representing nonprofits, along with virtually every state Attorney General’s office opposed Form 1023-EZ’s release, and continue to speak out against it now.

Starting a successful nonprofit is NOT a do-it-yourself project.  It starts with a good business plan, but it has to be one that is compliant with state and federal law.  Very few would-be social entrepreneurs are experts in the complexity of nonprofit tax law.  I’ve made a career of this for over 25 years, and there is scarcely a week that goes by that I’m not having to research a complicated issue for a client that even I can’t answer off the top of my head.  With the introduction of Form 1023-EZ, tens of thousands of new nonprofits have gotten started with virtually no understanding of the issues they face, or the significant liability and risk associated with non-compliance.

It encourages fraud.  Ever since there has been a federal tax code, con artists and hucksters have looked for ways to manipulate it for their benefit.  Many have attempted over the years to set up sham charities to take advantage of good-hearted people, only to pocket the money for themselves.  The complete Form 1023 process at least provides a formidable barrier to fraud.  It doesn’t completely prevent it, but it makes it harder.

Not so much with Form 1023-EZ.  Most applications are computer-approved.  If someone knows which answers to check “yes” or “no”, and if they can come up with a reasonably plausible charitable purpose sentence, their application will likely be approved with no supporting documentation required.  That is not a good thing.

We mentioned the Taxpayer Advocates office at the beginning of this article.  The idea of a simpler process originated with them, but they never intended for the process to become a rubber-stamp.  In 2016, their office examined 1,000 random nonprofits who had their 501(c)(3) status approved using Form 1023-EZ and found that nearly half weren’t even legally incorporated!

It encourages unscrupulous companies.  When Foundation Group opened its doors almost 24 years ago, we were the first specialty tax firm in the US to provide nonprofit formation services to new nonprofits nationwide.  Since that time, there have been others to come along, some good, and many not-so-good.  Sadly, most of our biggest competitors have decided to leverage Form 1023-EZ as a profit-center, encouraging most prospective customers to use the process, even when they don’t qualify or would be better served by the standard process.  We know because we regularly shop them.  It amounts to malpractice and it takes advantage of the lack of understanding that many startup founders have regarding tax compliance.

States have had to step into the gap.  Along with state AGs, the Taxpayer Advocate has continued to ask the IRS to significantly strengthen the Form 1023-EZ process.  The IRS defends the current system by pointing out that they randomly select up to 5% of applicants for stringent examination.  But given that over 50,000 nonprofits successfully used Form 1023-EZ in 2018, that means that 47,500 were not thoroughly evaluated.  As a result, the states have aggressively ramped up examinations and audits of small nonprofits out of concern that the IRS is not fulfilling its duty to oversee the nonprofit community.

It is negatively impacting grant funding opportunities for small nonprofits.  Since Form 1023-EZ was released, many grant-making foundations have adopted policies against accepting grant applications from nonprofits that received 501(c)(3) status using the streamlined process.  They understand that these charities have not been sufficiently vetted at the federal level and will not fund them.  We advise all of our clients that qualify to file Form 1023-EZ to use the standard full process if they even think they might seek grant funding at some point.

Starting a Nonprofit Should Be Somewhat Difficult

The full Form 1023 process has been described as a gauntlet, but it serves a great purpose.  As someone who generally despises red tape, I struggle a little bit saying that.  But having worked with many thousands of clients over the years, the extended process and documentation necessitates a more deliberate approach.  It allows time for nonprofit founders to evaluate their business plan against the realities of tax compliance, and to tweak, trim, and adjust it to make it work most successfully.  And since it requires a real IRS review, the applicant, donors, and grant-makers alike can have confidence that this organization is a legitimate 501(c)(3) charity.

We’re not opposed to a simpler process for the smallest nonprofits.  In fact, we use Form 1023-EZ with our clients that are well-suited for it.  But even with those clients, we take the time to work with them to ensure their organization is established according to compliant, best-practice.

Form 1023-EZ isn’t going anywhere…it’s here to stay.  Understanding the extent of the problems associated with the streamlined process, however, will hopefully result in more small charities opting to invest in their future by taking the longer road.

Greg McRay, EA

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

This Post Has 18 Comments
  1. My family just started a foundation for men who are victims of domestic violence. We are mainly educational, informational, and will offer aid such as a place to stay and possibly help with an attorney. I filled out the long form because I wasn’t aware of the EZ form…I haven’t sent the long form in yet, what do you think I should do?

    1. There’s no right or wrong answer here, really. If you will receive under $50k per year in total income for at least the first 3 years, and you do not intend to ever seek grant funding, it is certainly a simpler road. However, if you have already completed the long form, you may wish to follow through in the event you may want to seek grant funding down the road. If you read the entire article, you know our opinion of DIY…it’s usually a mistake, regardless of which form you choose. Best of luck with it. Don’t forget about state compliance as you get this established.

  2. This article and the Q & A were very helpful. My new organization has just recently been granted 501(c)(3) status using the 1023-EZ form. The gentleman who filed the application, and did the State registration, set it up as “unincorporated.” It appears that is not the best for our charitable organization, and it has been strongly suggested that we should be incorporated. Changing the status with the State is not complicated. How do we change that with the IRS?

    1. When you file your Form 990 annually, you can indicate on the first page what your entity structure is. And yes, you should incorporate. You received very bad advice on that one. Shameless plug 🙂 – use professionals who know this stuff. DIY and amateurs get charities into trouble quickly. It’s worth what it costs. Good luck!

  3. A small group of us is in the process of starting a non-profit animal rescue in the state of Iowa. I filed our Articles of Incorporation with the state and obtained an EIN. I included the necessary 501(c)(3) provisions on the Articles of Incorporation. This will be 100% funded by donors and operated entirely by volunteers. We don’t have an actual building yet, so all animals we take into our care will be kept in foster homes.
    We would like to be able to qualify for grants in the future. Would we be considered a public charity (instead of a private foundation) and would we qualify to complete the 1023 EZ? We live in a small rural county and don’t anticipate having a large amount of rescue animals, so I’m not sure what dollar amount we can expect in donations. Thanks so much for your help!

    1. You would almost assuredly be a public charity and, yes, you should qualify to use Form 1023-EZ from what you described. You may find seeking grants in the future is more difficult for the reasons stated in the article. That’s up to you and your team to decide how much of a factor that is for you. There’s no right or wrong answer. Good luck with it.

  4. My children attend a very small, very new charter school in Texas. We are starting our very first booster club. I have filed our Certificate of Formation as a Nonprofit Corporation in Texas. It looks like 1023 EZ would be ideal for our situation. Any advice or thoughts before I begin?

    1. Booster clubs are part of small, subset of charities that Form 1023-EZ may be ideal for. They are usually low-budget, very limited in focus, and don’t usually seek grants. If you expect to stay under $50 in annual gross revenue (and I suspect you will), it probably makes sense for you.

  5. My wife “recently” filed a 1023-EZ and was happy to receive our IRS designation letter so soon! BUT, after investigating Amazon Smile opportunities, my wife discovered that she applied incorrectly as a Private Foundation, rather than the Public Charity that we are (or should be). Is there any way to “fix” this problem without having to go through the 60-month period I have read about?!
    Thank you in advance for any and all advice!

    1. Hi, Jeff. I wish I could tell you there is an easy fix, but there isn’t. Converting from a private foundation to a public charity takes 5 years, no exceptions. The only real option you have is waiting it out, or starting a new public charity and phasing out the private foundation.

      If you decide the latter, call us. Yours is a textbook example of why starting a nonprofit is NOT a do-it-yourself project for anyone. Nonprofit tax compliance is complicated. No matter how “easy” a form may seem, you don’t know what you don’t know. I say that with sincere sympathy for your dilemma. Professional expertise is worth the price.

  6. We’re starting a small nonprofit organization to help an animal control shelter in a rural Florida county reduce the surrender rate of dogs/cats and lower the euthanasia rate.

    To wrap our arms around this problem we seek to educate and get support from the public in various ways, such as: importance of getting your pet fixed, good pet ownership, going after grants for reduced or free spay/neuter, dog training, etc.

    Inside the shelter, we want to reduce the time an animal stays by providing medical care for serious issues that would prevent adoption, training programs to help dogs make better pets, making dogs/cats comfortable during their stay, and sponsoring adoption events, etc.
    Question is: if we apply on 1023 EZ and later in a year or two have more revenue and need to apply under the full 1023, is that doable?

    1. No, you won’t have to do that. See my full answer to a similar question from another reader. Success to you!

  7. Super helpful piece. Does anyone know it is possible to file initially with the 1023 EZ, and then to refile with the full 1023, or even if it is required for smaller non-profits to re-file if they cross the $50k threshold?

    1. It is not necessary to refile if you end up going over $50k in any of the first three years. That said, anticipated gross income is the first filter for qualifying for Form 1023-EZ. You file that application with the attestation of your income expectations under penalty of perjury, so it is important to file with honest intent. If you happen to go over that in any early year, congratulations for being more successful than you budgeted for.

      Do not, however, think you can sandbag the IRS and file 1023-EZ knowing your budget is really higher than the threshold allowed. Your actual income will be reported to the IRS, so you don’t want to be caught banking $100k when you told them it would be half that. That’s called an audit target!

  8. I am aware that starting a successful nonprofit begins with a good business plan. As mentioned, it must be compliant with state and federal law.

    Would it be possible to either obtain a copy of a successful business plan which was prepared by a current nonprofit and who has consented for its use by other budding nonprofits? If this information is not available, do you have a successful format (or table of contents) for use in developing a viable nonprofit business plan?

    1. Hi, Rodney…A good business plan for a nonprofit is going to look very different from organization to organization. A private school’s business plan is not going to read much like one for a church or a food pantry. What they do have in common, however, is similar structure. In other words, the skeleton is similar, but the meat on the bones will not look the same. There are many great books and resources out there that can teach you the elements of a good business plan, whether that’s for a nonprofit or a commercial business. Amazon is full of them. SCORE’s is available here: https://www.score.org/resource/business-plan-template-startup-business . You would have to tailor it for nonprofit revenue and activity, but it’s doable.

      Putting together a workable business plan for any business is challenging. The tricky part for nonprofits is not just the feasibility of the plan itself. It’s the issue of whether every element is compliant with state and federal tax law. There is no template for that, and it’s why we have worked with nearly 20,000 startups…none of which have faced the same issues the exact same way. All the more reason to approach Form 1023-EZ with caution.

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