Q&A #46 – What are the downsides of using the Form 1023-EZ instead of the Form 1023?
Question: I recently formed a nonprofit organization, and I am exploring my options for applying for 501(c)(3) status. It appears that my organization would qualify to use the short-form application, Form 1023-EZ, and I have heard that it is easier, faster, and cheaper to prepare. Are there any downsides that I should be aware of?
Answer: True to its name, the Form 1023-EZ is certainly an easier, faster, and cheaper way to apply for 501(c)(3) status for organizations that meet the eligibility criteria (mainly, organizations that are not projecting more than $50,000 in gross receipts in any of their first 3 years and do not currently have more than $250,000 in assets, among other requirements). But there are some downsides that should be considered, especially since both the Form 1023 and Form 1023-EZ are public documents.
First, the Form 1023-EZ provides less assurance than the traditional Form 1023. The Form 1023 is a rigorous application that requires a detailed narrative of the organization’s mission and planned activities, disclosure of the organization’s governing documents, financial projections, and numerous questions designed to highlight key compliance concerns. While this process entails significantly more front-end work, organizations who receive approval of their 501(c)(3) status using the Form 1023 are generally entitled to rely on this determination that their mission, activities, and governance structure are consistent with section 501(c)(3).
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By contrast, the Form 1023-EZ involves little or no vetting process, and is more akin to a promise to the Internal Revenue Service (IRS) that the organization qualifies for 501(c)(3) status and will comply with the rules. An organization whose Form 1023-EZ application is approved is entitled to treat itself as a 501(c)(3) organization, but there is greater risk of the IRS revoking the organization’s 501(c)(3) status in the event of an audit. This risk may not be worth it, especially for organizations that have developed new, innovative approaches that are unlike other, more common types of charities.
Planning Tip – Regardless of which form you use to apply for 501(c)(3) status, preparing a 3-year projection of expected revenue and expenses is an important exercise. In addition to being helpful for planning the organization’s operations, these 3-year projections are a required component of the Form 1023. If you opt to use the Form 1023-EZ (which does not require detailed financial information), these projections can help support your conclusion that the organization qualified to use the Form 1023-EZ. In the event that you exceed the $50,000 threshold, the IRS can retroactively revoke your organization’s 501(c)(3) status if you are unable to make a persuasive case that you met the Form 1023-EZ eligibility criteria at the time you applied.
Second, there is a risk that major donors, foundations, and other grantmaking organizations will be more hesitant to fund new organizations that got their 501(c)(3) status by filing the Form 1023-EZ, since that process is so easy. In the ultra-competitive world of grants and major donations, organizations that used the traditional Form 1023 may stand out as more serious, robust, and better prepared. Moreover, filing the Form 1023-EZ gives the impression that you expect your organization to be small, which may not be how you want potential grantors and donors to perceive the organization.
Lastly, and perhaps most importantly, organizations that use the Form 1023-EZ miss an important opportunity for learning the rules governing 501(c)(3) organizations. The Form 1023 requires new organizations to give serious thought to difficult concepts like the exempt purpose test, public charity status, and the private benefit, excess benefit, and inurement rules. Organizations that use the Form 1023-EZ are more likely to be tripped up by these rules later, which can be a major setback that jeopardizes the reputation your organization has worked so hard to build.
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Q&A #83 – What happens if my organization files Form 1023-EZ and then exceeds $50,000 in revenue?
