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MSP #5: EXEMPT ORGANIZATIONS

Form 1023-EZ, Adopted to Reduce Form 1023 Processing Times, Increasingly Results in Tax Exempt Status for Unqualified Organizations, While Form 1023 Processing Times Increase

TAS Recommendations and IRS Responses

1
1.

TAS RECOMMENDATION #5-1

Require Form 1023-EZ 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: ​​The IRS will not require Form 1023-EZ applicants to submit their organizing documents. The Deputy Commissioner for Services and Enforcement previously rescinded the portion of the 2016 Taxpayer Advocate Directive ordering the IRS to require submission of organizing documents and observed that such requirement does not reflect how the organization will operate, and how the organization operates is a determinative factor regarding tax-exempt status. Form 1023-EZ will continue to require an applicant to attest, under penalties or perjury, to information regarding its operations and organization.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The IRS’s assertion that organizing documents do not reflect how an organization will operate does not withstand even minimal scrutiny. As TAS has demonstrated in three research studies, IRC § 501(c)(3) status is inappropriate in some cases because an applicant’s organizing document exactly reflects how the organization will operate. For example, the purpose articulated in the articles of incorporation of one organization described in this year’s report, to establish and operate a farmer’s market, was likely an accurate reflection of how the organization operates. That purpose, per the IRS’s own guidance,2 made the organization not eligible for 501(c)(3) status; and yet through the 1023-EZ process the IRS provided that organization a determination letter stating it was an exempt organization under IRC § 501(c)(3). The IRS should have gathered more information about this applicant before approving its Form 1023-EZ application.

Moreover, at a bare minimum, requiring organizing documents would allow the IRS to identify applicants like the one described in this year’s report that had been involuntarily dissolved by the state of incorporation at the time it applied and when exempt status was conferred.

In any event, in addition to meeting the operational test, organizations are required to meet the organizational test, and the IRS cannot carry out its oversight responsibility to ascertain whether the organizational test has been met without inspecting the organizing documents. As TAS studies repeatedly and consistently show, applicants’ attestations that the organizational test has been met are frequently — at least 42 percent of the time — unreliable.

The National Taxpayer Advocate agrees that “how the organization operates is a determinative factor regarding tax-exempt status,” but it is only one determinative factor. Failing to meet the organizational test is the threshold factor and may have real consequences, even where the operational test is met. For example, in the 2015 TAS study, 23 percent of the organizations in the representative sample did not have adequate dissolution clauses. As the National Taxpayer Advocate explained in a May 16, 2018 blog,3 according to the IRS’s Select Check database, the exempt status of about a third of the 15,000 organizations whose Form 1023-EZ applications were approved in 2014 was automatically revoked for failing to file required returns or notices for three consecutive years. Automatic revocation of exempt status may prompt an organization to dissolve, and there may be no accountability for assets an organization accumulated during the years it held exempt status.

The IRS’s ongoing refusal to address these concerns is nothing short of an abdication of its oversight responsibilities.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

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

2
2.

TAS RECOMMENDATION #5-2

Require Form 1023-EZ applicants to submit summary financial information such as past and projected revenues and expenses.

IRS RESPONSE TO RECOMMENDATION: ​​​​The IRS will not require that Form 1023-EZ applicants submit summary financial information such as past and projected revenues and expenses. The Deputy Commissioner for Services and Enforcement previously rescinded the portion of the 2016 Taxpayer Advocate Directive ordering the IRS to require submission of summary financial information and observed that such requirement does not reflect how the organization will operate, and how the organization operates is a determinative factor regarding tax-exempt status. Form 1023-EZ will continue to require an applicant to attest, under penalties of perjury, to information regarding its operations and organization. Moreover, an organization is eligible to use Form 1023-EZ only if its annual gross receipts in the past three years, and projected gross receipts for the next three years, do not exceed $50,000 and its total assets have a fair market value of less than $250,000.

CORRECTIVE ACTION: N/A

TAS RESPONSE: At a minimum, requiring applicants to provide summary financial information such as past and projected revenues and expenses would allow the IRS to identify those that clearly do not plan to operate as exempt under IRC § 501(c)(3). It would also force applicants to more carefully consider what their activities will entail, and whether exempt status under IRC § 501(c)(3) is needed or appropriate. The result could be an educational experience for applicants, especially smaller organizations eligible to use Form 1023-EZ, and fewer requests for IRC § 501(c)(3) exempt status.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

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

3
3.

TAS RECOMMENDATION #5-3

Revise Form 1023-EZ to include a question about whether the organization has a conflicts of interest policy.

IRS RESPONSE TO RECOMMENDATION: ​​​The IRS will not revise Form 1023-EZ to include a question as to whether a small organization meeting the Form’s eligibility criteria has adopted a conflict of interest policy. Adoption (or non-adoption) of a conflict of interest policy is not determinative as to how an organization operates or whether it qualifies for tax-exempt status.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The National Taxpayer Advocate is perplexed by the IRS’s unwillingness to include this question, which is already part of the Form 1023 application, on Form 1023-EZ. The National Taxpayer Advocate acknowledges that a conflict of interest policy is not required for qualification as an IRC § 501(c)(3) organization. However, asking applicants whether they have a conflict of interest policy may prompt them to more carefully consider whether they are organized and will operate exclusively for exempt purposes. Asking the question may also have the effect of encouraging organizations to adopt a conflict of interest policy and may alert them to potential issues of inurement and private benefit, which are determinative of tax exempt status.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

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

4
4.

TAS RECOMMENDATION #5-4

Accept electronically Form 1023-EZ supporting documents, such as articles of incorporation.

IRS RESPONSE TO RECOMMENDATION: ​​The IRS will not require that Form 1023-EZ applicants submit their organizing documents. The Deputy Commissioner for Services and Enforcement previously rescinded the portion of the 2016 Taxpayer Advocate Directive ordering the IRS to require submission of organizing documents.

CORRECTIVE ACTION: N/A

TAS RESPONSE: Taxpayers’ right to a fair and just tax system includes the right to expect the tax system to consider facts and circumstances that might affect their underlying liabilities, and the right to privacy includes the expectation that IRS actions will be no more intrusive than necessary. The skeletal Form 1023-EZ does not solicit enough information to allow the IRS to determine, with sufficient accuracy, whether an organization qualifies for IRC § 501(c)(3) status and is therefore exempt from tax on its receipts. The IRS’s excessive reliance on attestations, which may prove inaccurate only upon a subsequent intrusive audit, is poor tax administration and undermines taxpayers’ rights.

Taxpayers have the right to an actual determination about their exempt status, based on supporting documentation, from the outset. This is not just a matter of concern for the organizations applying for exempt status; rather, IRS awards of exempt status to ineligible organizations harms donors and taxpayers at large, and weakens the public fisc. It is unfortunate that, as the IRS’s response throughout makes clear, it will not take steps to protect the public unless it is forced to do so.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Not Adopted

OPEN or CLOSED: Closed

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

5
5.

TAS RECOMMENDATION #5-5

Make a determination about qualification as an IRC § 501(c)(3) organization only after reviewing a Form 1023-EZ applicant’s narrative statement of actual or planned activities, organizing documents, and any other supporting documents.

IRS RESPONSE TO RECOMMENDATION: ​​​​The IRS trained its Form 1023-EZ tax examiners on exempt organization tax law prior to implementation of the requirement for a narrative description of actual or planned activities on Form 1023-EZ. With the January 2018 implementation of this Form 1023- EZ revision, the IRS determines qualification as an IRC Section 501(c)(3) organization only after reviewing the narrative statement of actual or planned activities. The IRS does not plan to require organizing documents or summary financial information as indicated in our responses to Recommendations #5-1 and #5-2. Requiring submission and review of such information would increase burden on small organizations applying for recognition of exemption and increase IRS processing times, and would therefore be inconsistent with the risk-mitigated goals and benefits of the existing Form 1023-EZ process.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The National Taxpayer Advocate is pleased that Form 1023-EZ was revised to include a narrative statement of actual or planned activities, something she first recommended in her 2015 Annual Report to Congress and later ordered in a Taxpayer Advocate Directive dated September 26, 2016. She does not agree that requiring applicants seeking IRC § 501(c)(3) status to furnish organizing documents and basic financial information imposes an unacceptable or inappropriate burden on them. Reviewing such additional information may increase IRS processing times, but the IRS has not provided any data or estimates of what those increased times could be, nor has it devised strategies for managing any increase in processing times. On the other hand, reviewing these materials would likely reduce the rate at which the IRS erroneously confers IRC § 501(c)(3) status.

ADOPTED, PARTIALLY ADOPTED or NOT ADOPTED: Partially Adopted

OPEN or CLOSED: Closed

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

6
6.

TAS RECOMMENDATION #5-6

Make the primary purpose of the contract with MITRE to investigate how to improve procedures for reviewing every application for IRC § 501(c)(3) status, before conferring that status.

IRS RESPONSE TO RECOMMENDATION: ​​​​​IRS contracted with The MITRE Corporation for an independent assessment of the validity of its Form 1023-EZ pre- and post-determination compliance findings. The contracted Scope of Work with MITRE to provide strategic, analytic, program management, data and information services, and other support to TE/GE includes a task to identify 1023 and 1023-EZ filings in need of closer inspection before official determinations are made. Other tasks include quantifying the accuracy and precision of current Form 1023-EZ sampling practices and evaluating current sampling practices to increase the understanding of the full population, reduce the IRS resources required to develop that understanding, and/or reduce the filing burden. The IRS believes that all tasks will function together to provide a comprehensive assessment of the form and its use. The IRS will carefully consider any recommendations made by MITRE to improve the statistical rigor of information gained from, and overall compliance results of, the program as well as recommendations to improve TE/GE’s ability to continually monitor and improve its operations.

CORRECTIVE ACTION: N/A

TAS RESPONSE: The National Taxpayer Advocate will be very interested to learn the results of MITRE’s commitment to identify 1023-EZ filings “in need of closer inspection before official determinations are made,” especially because TAS studies show that at least 42 percent of 1023-EZ filings need closer inspection before being approved.

However, it does not appear that the difficulty lies in identifying applications that need further review, but rather in designing an application that solicits enough information to allow the IRS to distinguish qualified applicants from those that do not qualify for IRC § 501(c)(3) status. The current Form 1023-EZ does not accomplish this, much less allow the IRS to develop an “understanding of the full population.”

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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