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MSP #3: FORM 1023-EZ

Recognition as a Tax-Exempt Organization is Now Virtually Automatic for Most Applicants, Which Invites Noncompliance, Diverts Tax Dollars and Taxpayer Donations, and Harms Organizations Later Determined to be Taxable

TAS Recommendations and IRS Responses

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1.

TAS RECOMMENDATION #3-1

Revise Form 1023-EZ to require applicants, other than corporations in states that make articles of incorporation publicly available online at no cost, to submit their organizing documents.

IRS RESPONSE TO RECOMMENDATION: NTA Recommendation Not Adopted as Written, but IRS Actions Taken to Address Issues Raised by NTA. TAS recommends that some – but not all – Form 1023-EZ applicants submit copies of their organizing documents. Under the recommendation, corporations organized in states that have documents viewable on-line would not need to submit them. This recommendation would result in disparate treatment of applicants, potentially causing confusion and decreasing customer satisfaction. Moreover, a requirement for organizing documents would preclude electronic filing. Additionally, review of organizing documents would increase case processing time, disrupting the efficiencies gained through the EZ process. The IRS continues to rely on pre- and post-determination reviews to identify potential compliance problems associated with the form.

Update: The IRS will continue to pursue collaborative efforts with state agencies working toward an on-line multi-state charity registration system. The Multistate Registration and Filing Portal will be an online system that will allow nonprofit organizations and their professional fundraisers to comply with all states’ registration and annual filing requirements through a single online portal. The Exempt Organizations Federal and State Liaison continues to be on the advisory board for the project. At the moment, the system is still in development stage. This is a multi-year effort of the states. Funding by the states is the primary focus and is currently under way. Based upon recent conversations with a state regulator involved in the project, an anticipated launch date has not been set. Based upon the progress to date, we would not anticipate a launch of this portal for several years.

CORRECTIVE ACTION: The IRS will continue to pursue collaborative efforts with state agencies working toward an on-line multi-state charity registration system.

TAS RESPONSE: Seeking access to an online multi-state charity registration is an admirable long term goal, although it does not constitute action taken to address the National Taxpayer Advocate’s concern. In the meantime, there is nothing improper about requiring organizations to submit their articles of incorporation as part of their Form 1023-EZ application, or excepting from the requirement those whose documents are already available online. Moreover, it is not the case that documents cannot be attached to electronic IRS filings. This is already being done for applicants seeking certification as a Certified Professional Employer Organization (CPEO). TE/GE could explore the feasibility of a similar system for accepting Form 1023-EZ applications. Unless TE/GE is able to quantify the extent to which reviewing organizing documents would increase case processing time, the basis for concluding that such “efficiency disruption” is not justified is unclear. Reviewing organizing documents, which would lead to a lower rate of erroneous approvals, would not necessarily result in unacceptable processing times.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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2.

TAS RECOMMENDATION #3-2

Revise Form 1023-EZ to require applicants to provide a description of their actual or planned activities and submit summary financial information such as past and projected revenues and expenses.

IRS RESPONSE TO RECOMMENDATION: NTA Recommendation Not Adopted. Activity descriptions and financial information are an unnecessary burden on smaller organizations that historically contributed little to overall compliance efforts. The IRS must balance risks to the Treasury against the resources available when administering the tax law. A significant portion of the time spent by a revenue agent in review and development of a Form 1023 application relates to an organization’s description of its activities, with concomitant burden on the applicant. Substantially all efficiencies derived from the Form 1023-EZ would be lost, and overall taxpayer burden would increase. An IRS form becomes “EZ” precisely by removing narratives, attachments, or material that requires manual processing; for comparison, the widely-used Form 1040-EZ attaches no schedules. The IRS continues to rely on pre- and post-determination reviews to identify potential compliance problems associated with the form.

CORRECTIVE ACTION: N/A

TAS RESPONSE: TE/GE has clarified in a separate conversation with TAS that its reference above to having “historically contributed little to overall compliance efforts” relates to small organizations rather than to activity descriptions and financial information; TE/GE does not express any position on the effect of requiring activity descriptions and financial information on compliance. In fact, TE/GE has never measured whether requiring this additional information drives better compliance. The National Taxpayer Advocate can attest from personal experience, on the other hand, that requiring an applicant to identify and describe in writing its intended activities is an indispensable first step for the organization to understand whether it qualifies for IRC § 501(c)(3) status. If not, the organization may revise its planned activities in order to meet the statutory requirements, or decide not to apply for exempt status at all; either outcome saves IRS compliance resources. The assertion that efficiencies would be lost if applicants were required to provide, and the IRS to evaluate, a purpose statement is perplexing. TAS found that it takes very little time to review a purpose statement and most purpose statements are acceptable. Form 1023-EZ is already streamlined; soliciting and considering fundamental information about the applicant would presumably still yield efficiencies, compared to Form 1023 processing, but with less incidence of erroneous determinations. Finally, TE/GE does not quantify the cost of pre-determination reviews or post-determination audits. Its basis for concluding that its approach is a better use of resources is unclear.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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3.

TAS RECOMMENDATION #3-3

Make a determination only after reviewing the Form 1023-EZ application, the applicant’s organizing documents, its description of actual or planned activities, and its financial information.

IRS RESPONSE TO RECOMMENDATION: NTA Recommendation Not Adopted as Written, but IRS Actions Taken to Address Issues Raised by NTA. The IRS makes a determination only after reviewing the Form 1023-EZ application. Historically, the IRS denied exemption to less than 1% of all applications for exemption, even after submission and review of organizational documents, activity descriptions, and financial data.

CORRECTIVE ACTION: To improve accuracy in the Form 1023-EZ process, the IRS has, for example, modified the on-line submission to request verification of the Employer Identification Number (EIN). Out of concern for accuracy in the determination process, the IRS has instituted pre-determination and post-determination review of statistically valid samples of Form 1023-EZ applications.

TAS RESPONSE: The fact that TE/GE reviews Form 1023-EZ in its current form does not constitute an action taken to address our concerns, and we view this response as declining to adopt our recommendation. It is true that TE/GE has instituted pre-determination reviews, but it ignores the data these reviews provide. TE/GE appears unimpressed to learn that there is a significant difference in outcome depending on whether an application is subject to pre-determination review or not (77 percent vs. 95 percent). It seems equally unconcerned that the TAS sample found deficiencies in the dissolution and purpose clauses of applicants’ publicly available organizing documents. It is not clear whether TE/GE reviewed all organizations in the TAS sample, but TE/GE notes that of organizations in the TAS sample whose articles it reviewed, up to half had inadequate clauses. It is admirable that TE/GE has sought to ensure that the proper EIN is being used, but as long as it refuses to take into consideration its own data, its “concern for accuracy” appears overstated. The outcomes of post-determination audits remain to be seen.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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4.

TAS RECOMMENDATION #3-4

Where there is a deficiency in an organizing document, require an applicant to submit a copy of an amendment to its organizing document that corrects the deficiency and has been approved by the state, even where the documents are available online at no cost, before conferring exempt status.

IRS RESPONSE TO RECOMMENDATION: NTA Recommendation Not Adopted as Written, but IRS Actions Taken to Address Issues Raised by NTA. There is little risk associated with attestations as to organizational documents. Historically, failure of the organizational test seldom has been the basis for denial. On exam, a defect in organizational documents rarely has led to revocation or directly linked to non-compliant activity. In the past, the IRS pursued perfection by the organization of flaws in its organizing documents.

Update: Interim Guidance (IG) drafted that is currently in the clearance process which will likely take a few weeks. This IG Memo will be issued immediately upon clearance. The  IG outlines procedures for revocation due to failure of the organizational test when an applicant attested during the determination process that it would amend an organizational document but did not do so.

IG-04-0117-0007 was issued on 1/30/2017

IG-04-0117-0007 was revised on 2/18/2017

CORRECTIVE ACTION: The IRS plans to specify procedures for revocation due to failure of the organizational test when an applicant attested during the determination process that it would amend an organizational document but ultimately made no good faith effort to do so.

TAS RESPONSE: Historically, the IRS required organizations to adjust their organizing documents to conform to the legal requirements, which as the IRS notes averted denials and revocations. With Form 1023-EZ, that safeguard is no longer in place. Every Form 1023-EZ applicant attests that its organizational documents conform to the legal requirements, yet many of them do not actually conform, as TE/GE’s own pre-determination reviews and the TAS study demonstrate. These organizations are not required to demonstrate that any deficiency, even if discovered in a pre-determination review, has been corrected. Organizations should not have to wait for an audit to learn of a defect in their organizing document, whether the defect results in revocation or not.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Partially Adopted

OPEN or CLOSED: Closed

DUE DATE FOR ACTION (if left open): N/A

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