Earlier this year the IRS updated Form 1023, the application through which over 1.5 million entities have gained recognition of tax exempt status.  As discussed below, I consider the changes incorporated to be reasonable and largely welcome.

The most noteworthy changes included 1) a lowering of application fees (invariably a welcome development for applicants), 2) an increase in the information required on the EZ form, and 3) some updating to the full form, reflecting ten years of changes, and elimination of some obsolete items.

The change in fee structure is noteworthy because it is unusual for a government agency to actually lower a fee for a service.

Form 1023.  The full Form 1023 application fee was reduced from $850 to $600.  The previous option of paying $400 for an organization with $10,000 or less in annual revenue was rightly eliminated.  Three years ago when the EZ form was introduced for organizations with revenues under $50,000 a year at a cost of only $275, the $400 option was rendered meaningless except in the less common case of an organization not qualified to file the EZ form, such as a church.

Form 1023-EZ.  The application fee for Form 1023-EZ has remained the same at $275, despite the fact that the IRS has increased the amount of information required on the application, likely resulting in greater IRS review time.  Paradoxically this increase in information required is actually a welcome change to the short form.  The qualifications worksheet for the earlier EZ form was simply incorporated by reference, rather than incorporating the relevant, deciding qualifications into the body of the form.  It was too easy for unknowing applicants to simply check a box that they were qualified to use the EZ form, that they were properly formed, had proper purposes, etc.  The new format requires an applicant to expressly verify that the organization is not a church, school, or hospital (for which the EZ form is inappropriate) before making application.  It also requires an applicant to iterate in words the main purpose for which the nonprofit organization was created.  Not all legal purposes qualify an entity for tax exemption.

Frankly, I believe that the IRS could have beneficially gone even further by incorporating the complete qualification worksheet in the form.  If excluding the qualification checklist from the body of the form was intended to make it easier to complete – a mere 2-page document compared to the intimidating stack of pages in the full Form 1023 – in essence the qualification restrictions appear meaningless.  Potentially (and what has been happening) as a result of the appearance of simplicity, unrepresented fledgling nonprofits will be lured into filing the form themselves without so much as a glance at the instructions or qualification worksheets.  This has resulted in some undesirable consequences for entities that were not formed properly, or were not qualified to use the EZ form in the first place.  Since the IRS does not require provision of the founding documents, these are sometimes improperly prepared.  At least some of the common mistakes could be prevented if the yes/no checklist for EZ qualification was in the body of the Form.

Group Exemption.  The Group Exemption application fee dropped from $3,000 to $2,000 in the latest revision of the 1023 family.  In years past there was the expectation among nonprofit professionals that the Group Exemption might be phased out eventually; this lowering of the fee would seem to indicate that such elimination is not on the IRS’ near-term agenda.

This reduction of the fee is reasonable in light of the fact that the application itself is one of the simplest in the 1023 family to complete.  In fact, there is not an official form for this process; a mere letter is required.  The requisite information to be enclosed in such letter is clearly prescribed in IRS materials.  Most entities seeking a Group Ruling have been in existence for some period, have already obtained an individual exemption, and are now seeking to restructure as a central organization in the hub of other mini-versions of itself.  In this scenario, there is less cause for concern on the part of the IRS since it has had a full opportunity to scrutinize the entity previously.  In consequence a lower price tag on the application is thought appropriate.

In fact, the IRS achieves its own purposes by granting Group Exemption rulings.  The central organization takes on the role of the IRS in that it evaluates its subordinates in the Group for proper tax exempt formation and operation on an annual basis.  Each year the central organization requires financials and updates from its subordinates and merely reports to the IRS as to which organizations should still be included.  Because most entities holding Group Exemption ruling are/have been advised by counsel, there will usually be a higher understanding of the exemption requirements with these central organizations; this will often, in turn, help the subordinates gain an understanding of exemption rules.  Because the subordinates are often smaller associations, this level of scrutiny achieves a greater compliance with requirements than if each filed the Form 1023-EZ on their own.

In the last five years there has been an ebb and flow in the IRS’ efficiency, which has resulted in widely varying wait times for exemption determinations.  Anecdotally, it was observed that in the heyday of recent IRS efficiency, around 2010 or 2011, some full applications flew through the examination process in as little as 5 weeks.  On the other hand, 2013 was observed to be the worst year – with wait times up to a year and a half for simple applications needing no interaction with the IRS; the applications were simply stuck in the ostensibly unmovable backlog and remained unassigned for months on end.  Due to this backlog the IRS created the Form 1023-EZ option for smaller organizations to get through the mire more quickly, allowing exemption specialists to focus on more complicated applications.

It remains to be seen, but I suspect that the IRS desires to encourage the pursuit of Group Exemption Rulings through this more accessible fee structure, thereby, as discussed, lessening its overall workload.

Overdue Updating.  In addition to removing the obsolete option for small organizations under $10,000 in annual revenue (mentioned above), the new Form 1023 also finally removed the messy red add-on guidance that graced the form for the last five years, directing applicants to override portions of the existing instructions.  Examples included the outdated mailing address instructions, as well as the nearly 2/3 page of confusing language that referred to the “advanced ruling” protocol, which has been obsolete since 2008.  The Form 1023 now appears much cleaner with the 2018 upgrade.

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