How to become a tax-exempt nonprofit organization with the IRS?
A nonprofit organization is an entity that is established to advance a social cause or further a charitable purpose. The major difference between nonprofit organizations and for-profit entities is that nonprofit organizations retain their profits to advance their causes while for-profit organizations distribute their profits to their owners and shareholders. Because nonprofits provide a “public good,” they enjoy an exemption from paying some federal taxes. The Internal Revenue Code (26 U.S.C. § 501(c)) define 29 types of nonprofits who are exempt from federal taxes.
The most common type of tax-exempt nonprofit organization is the 501(c)(3). These organizations are defined to have activities with the following purpose; charitable, religious, educational, scientific, literary, testing for public safety, fostering amateur sports competition, or preventing cruelty to children or animals.
Prior to 2014, all nonprofits that desired to apply for the 501(c)(3) tax exemption filed what is known as a 1023 form. The 1023 form is an extensive application that requires meticulous detail and documentation. The associated fee is $850.
In 2014, the Internal Revenue Service (IRS) passed a major regulation that introduced the 1023ez form. The 1023ez form is intended to ease and speed the application process for smaller nonprofits. Furthermore, it is more cost effective, reducing the fee by two-thirds. However, in order for a nonprofit to be eligible to file for a 1023ez, the organization must satisfy a list of prerequisites in terms of its purposes, legal structure, and finances. For example, an organization must have less than $50,000 in annual gross receipts for all three prior years, if applicable, and anticipates less than $50,000 in annual gross receipts each year for the coming three years. Also, the organization’s total assets must be valued at an amount lower than $250,000.
The 1023ez has been extremely helpful for smaller nonprofit organizations. Instead of waiting 4-6 months for the 1023 application to be processed, sometimes even longer, they can submit the 1023ez and get approved within two weeks. Moreover, the required documentation is minimal and the fee is $275, as opposed to $850 for the 1023. Additionally, because the application is much simpler and less time demanding, the legal fees for filing a 1023ez are also less.
Still, there are some complications that come with using the 1023ez for your organization. For example, the IRS normally made a determination regarding the charitable status of your organization. Under the 1023ez, however, you are required to make a legal attestation under penalty of perjury that you do in fact qualify for tax exemption. This and other complications make the 1023ez a less obvious choice for small non-profits.
If you’re thinking about applying for a 501(c)(3), consult with an attorney who can best identify whether you need to file a 1023 or 1023ez. An experienced nonprofit and business law attorney can make all the difference on your path to becoming a nonprofit.