Q&A #158 – What happens if a fraudulent Form 1023-EZ is filed for my organization?
Question: Our recently formed nonprofit organization has already raised $100,000 and plans to raise an additional $1 million over the next three years. We hired an accountant to help with our application for 501(c)(3) status and he said that using Form 1023-EZ would be quicker and less expensive. I provided the financial information listed above and mentioned that it appeared that we did not qualify to use Form 1023-EZ, but the accountant replied that the IRS wouldn't do anything about it so we shouldn’t be concerned. I have since learned that the accountant went ahead and filed the Form 1023-EZ on our behalf even though we never approved of this filing or signed any tax form. Can our 501(c)(3) status be revoked and could our organization face criminal charges?
Answer: Despite what some unscrupulous service providers may tell you, there are potentially serious penalties for submitting a Form 1023-EZ application for an organization that is clearly ineligible to do so. In addition to revocation of 501(c)(3) status, this can include criminal fines and even prison pursuant to the Internal Revenue Code’s fraud and false statements provisions (26 U.S.C. § 7206). However, if a Form 1023-EZ was fraudulently filed without your knowledge, approval, or participation then these criminal sanctions very likely will not apply.
Unfortunately, it is not uncommon for nonprofit organizations to get bad advice about the process of applying for tax-exempt status from professionals who should know better, such as attorneys, CPAs, tax professionals, consultants, and others. Because of the speed and relatively loose oversight of the Form 1023-EZ process, this problem has been exacerbated, with some unethical service providers convincing unsuspecting nonprofits that the Form 1023-EZ is a quick, inexpensive, and easy way to get 501(c)(3) status without regard to eligibility or risk of consequences. Moreover, some of these service providers use the low cost of the Form 1023-EZ as a selling point, but are actually overcharging based on the low amount of time and effort that they put into this application.
As discussed in Q&A #46, there are strict eligibility requirements to use the Form 1023-EZ. Mainly, organizations cannot use the Form 1023-EZ if their gross revenue has exceeded $50,000 in any of the past 3 years, if they project to have gross revenue exceeding $50,000 in any of the next 3 years, or if they currently have assets with a fair market value of more than $250,000, among other requirements detailed in the official Instructions for Form 1023-EZ.
Some of these requirements, such as the revenue projections, have inherent ambiguity and cannot be gauged with total certainty, as discussed in Q&A #83. These more “subjective” requirements generally have a bit more leeway. However, submitting a Form 1023-EZ instead of the Form 1023 when the organization objectively does not qualify is a serious problem, as is made clear in the instructions and the Form 1023-EZ itself.
At the very top of the Form 1023-EZ, there is a box that must be checked in order to file the form which states: "Check this box to attest that you have completed the Form 1023-EZ Eligibility Worksheet in the current instructions, are eligible to apply for exemption using Form 1023-EZ, and have read and understand the requirements to be exempt under section 501(c)(3)." This attestation emphasizes the importance of the eligibility rules.
Additionally, the signature line, which must be electronically signed by an officer, director, or trustee listed in Part I, line 8 of the Form 1023-EZ, includes a required declaration that says: "I declare under the penalties of perjury that I am authorized to sign this application on behalf of the above organization and that I have examined this application, and to the best of my knowledge it is true, correct, and complete." (emphasis added). This includes the attestation regarding eligibility.
The mention of “penalties of perjury” in a tax form such as the Form 1023-EZ is a reference to the fraud and false statements provisions of the Internal Revenue Code at 26 U.S.C. § 7206. Under this statute, any person who commits following actions shall be guilty of a felony:
“Willfully makes and subscribes any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter; or
Willfully aids or assists in, or procures, counsels, or advises the preparation or presentation under, or in connection with any matter arising under, the internal revenue laws, of a return, affidavit, claim, or other document, which is fraudulent or is false as to any material matter, whether or not such falsity or fraud is with the knowledge or consent of the person authorized or required to present such return, affidavit, claim, or document…”
These actions, along with other similar actions listed in 26 U.S.C. § 7206, can lead to potential fines of up to $100,000 ($500,000 in the case of a corporation) plus the costs of prosecution, and/or imprisonment for up to 3 years.
Of course, if an organization was clearly ineligible to use the Form 1023-EZ at the time of application then revocation of 501(c)(3) status is also very likely in the event the IRS audits the organization. As stated in IRS Revenue Procedures (most recently Rev. Proc. 2023-5), the IRS can retroactively revoke or modify an organization’s 501(c)(3) status if there has been a “misstatement of material information” in the Form 1023-EZ, including “an incorrect attestation as to … the organization's eligibility to file Form 1023-EZ.”
The Form 1023-EZ can only be submitted electronically and, as mentioned above, must be signed by an officer, director, or trustee of the organization. If a service provider has submitted a Form 1023-EZ for your organization without any kind of written approval or authorization from an officer, director, or trustee of the organization, then it is highly probable that the service provider has submitted perjurious statements, including but not limited to falsely stating that the service provider is the person whose name the service provider listed when electronically signing the application.
In a case like yours, it is likely that your service provider is at more risk of criminal sanctions than the organization itself or its directors or officers. Nonetheless, the organization could still be at serious risk of having its 501(c)(3) status revoked.
Planning Tip – When looking for professional service providers such as attorneys and accountants to help with the process of forming a new nonprofit organization, do preliminary research on your project and issues prior to interviews. Observe carefully how service providers respond to your questions. Attempts to deflect your questions with statements about how the IRS is unlikely to audit or catch the issue is a major red flag. Unfortunately, professional credentials such as Bar admissions and CPA licensure cannot by themselves provide total assurance that the service provider will act ethically, correctly, or even legally. As we discussed in this article, a careful interview and due diligence process is the best way to find service providers who have the organization’s best interests as their number one priority and are not just looking for easy solutions.
The Form 1023-EZ is a one-time choice that cannot be supplemented by an amendment or a subsequently filed Form 1023, so the options going forward in these situations are limited. Ultimately, you may need to choose between two: (1) living with the risk of an IRS audit to address the organization’s improper Form 1023-EZ application; or (2) dissolving the organization and starting over. You could also consider reporting the unscrupulous service provider to the IRS and/or state licensing authorities. In any case, you should consult a reputable and knowledgeable attorney before making decisions about next steps.
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