IRS Defends Charity Approval Process But Signals Changes

The Internal Revenue Service is standing by the achievements of its streamlined nonprofit application process despite intense scrutiny following high-profile mistakes. But the agency also appears to be opening the door for change. It may begin requiring charities to upload organizational documents with 1023-EZ applications.

Sunita Lough, the top official over the IRS Tax Exempt and Government Entities division, recently posted an article titled “Streamlining the 1023 – A Success Story.” Lauding the pursuit of simplicity in filings without sacrificing compliance, she presented a case to show that the 1023-EZ is “a great example of this balancing act.”

Nonprofits generally apply for tax-exempt recognition using the 1023 form, which Lough notes are 14 pages long with numerous potential addendums required. Many groups, including churches, schools, and hospitals, still must use this application. But in 2014 the agency introduced a streamlined 1023-EZ for charities anticipating no more than $50,000 in gross receipts and total assets of $250,000 or less. Lough suggested this much shorter and less expensive form helped agency leaders clear a serious backlog in tax-exempt applications, and it now accounts for 65 percent of such requests.

“Form 1023-EZ has reduced the burden on the smallest organizations applying for tax-exempt status and increased the efficiency of the Exempt Organization division’s operations,” she said.

The IRS has modified the 1023-EZ before. For example, in 2018 at the urging of the Taxpayer Advocate Service, an internal watchdog at the IRS, the agency began to require brief descriptions of planned activities. It also added questions to the form to ensure applicants double-checked their eligibility to actually use it.

Now the agency appears ready to consider a new change — the addition of governing legal documents. Lough said applicants and agency staff have saved time without the inclusion of these documents, but “experience and stakeholder comments” suggest it may be worth the trade-off.

“Although this would expand an otherwise streamlined process, the documents may help further ensure the accuracy of the applications,” she wrote.

Among stakeholders who have questioned the agency’s 1023-EZ processes is Rep. Bill Pascrell (D-N.J.), who chairs the powerful oversight panel of the U.S House Ways and Means Committee. Already a vigorous critic of the agency’s leadership, Pascrell was alarmed by reports that a fake charity ring duped givers into sending a New York City man at least $152,000 in donations. The fraudster, a known convict in a stock market scam, was able to secure tax-exempt status from the IRS for 76 fake charities. His filing method of choice was the 1023-EZ.

In a letter to IRS Commission Charles Rettig in July, Pascrell noted the “minimal information” required by the 1023-EZ and criticized “lax oversight by the IRS.” He also pointed to a 2019 report from the Taxpayer Advocate Service that determined that 46 percent of groups approved through the 1023-EZ didn’t actually qualify for 501(c)(3) status.

“Once approved, bogus charities scam unwitting donors who trust IRS-certified 501(c)(3) organizations to be properly vetted and legitimate,” Pascrell wrote. “The IRS has failed these citizens.”

Sunita Lough, however, seems convinced of the benefits of the 1023-EZ. She suggested in her blog post that the form’s existing efficiencies and the infusion of resources from the Inflation Reduction Act will help her team greatly in their work of ensuring compliance among tax-exempt filers.

“The investment of these important resources is designed to support honest, compliant taxpayers who follow the law,” she said.

ECFA will continue to monitor this matter.

This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.