Olivia had her new charitable organization’s file-stamped articles of nonprofit incorporation and her organization’s bylaws, signed by her organization’s newly appointed directors, in hand. She was relieved and pleased that things had gone so well for her with these early steps. But applying to the IRS for recognition as a 501(c)(3) organization intimidated her. She had taken a peek at the application instructions and forms but already had so many questions. 

Recognition

In enacting Internal Revenue Code Section 501(c)(3), Congress granted qualifying charitable organizations exemption from federal income taxes. If your organization meets the conditions that Section 501(c)(3) sets forth, then your organization is tax exempt. Yet your donors and others who wish to rely on your organization’s tax exemption generally want assurances. Those assurances come in the form of 501(c)(3) recognition from the IRS. In practice, your organization applies, and if the application satisfies IRS examiners, the IRS issues a two-page determination letter to your organization saying the IRS has recognized your organization as tax exempt under Section 501(c)(3). Your organization can then share copies of its determination letter with donors, grantors, and others needing or desiring that assurance.

Difficulty

Some organizations find it relatively easy to complete the IRS application and obtain 501(c)(3) tax-exempt status. Others find applying to be hard and confusing, while still others find satisfying IRS examiners to be even harder, to the point of failing. Just how easy or difficult your organization’s application may be can depend on whether your organization has already operated without 501(c)(3) recognition, whether your organization’s purpose isn’t obviously charitable and instead appears competitive, commercial, or ambiguous, how clearly you can describe your organization’s planned charitable activities, and whether your organization intends foreign operations. You may already be able to tell that your organization’s application will be challenging and complex. If so, get help from the sources mentioned above, especially a qualified lawyer, skilled accountant, or experienced charitable-organization leader.

Resources

The IRS knows that 501(c)(3) applications can challenge the many lay visionaries and dreamers who want to qualify their new charitable organizations as tax exempt. The IRS also knows that few enough of them can afford or find qualified legal representation to assist them. The IRS thus offers relatively abundant and helpful online resources, including not only the typical IRS publications and bulletins but also online courses, in either video or presentation versions. You can readily locate those resources with a search of the IRS website at irs.gov. If the 501(c)(3) application instructions and forms are already mystifying you, then watch or review the online courses, and refer to the other IRS publications and bulletins. The rest of this chapter addresses common questions and issues completing the relevant IRS forms to qualify for 501(c)(3) recognition.

EIN

In any dealings with the IRS, individuals and organizations need identifying numbers. Social Security numbers provide the IRS identifier for individuals. Organizations, though, do not qualify for Social Security numbers. The IRS thus assigns organizations an employer identification number (EIN) to use in dealings with the IRS. Other government agencies, and other private entities like banks, also use and require an IRS EIN from organizations with which they deal. So, your first step in applying for your organization’s 501(c)(3) recognition is to obtain an EIN from the IRS using IRS Form SS-4. Form SS-4 appears among the other templates at the back of this guide. But use the IRS’s online EIN application tool. When you do, be sure that you apply for your organization’s EIN using your organization’s precise name, commas and periods included. If the name on your organization’s articles of nonprofit incorporation, IRS 501(c)(3) application, and EIN number do not all match exactly, the IRS is likely to reject your organization’s application or require corrections.

Forms

The IRS offers two forms on which to apply for 501(c)(3) recognition, Form 1023 and Form 1023-EZ. Both forms appear at the back of this guide. The IRS won’t let you use the EZ (easy) form unless you complete the Eligibility Worksheet, which appears about halfway through the lengthy IRS Instructions for Form 1023-EZ. If you answer yes to any of the Eligibility Worksheet’s eleven questions, you can’t use the easy form and must instead complete the full Form 1023. The key question tripping up applicants and requiring that they use the full Form 1023 is generally whether you expect receipts over $50,000 in any of the next three years. In other words, smaller organizations expecting fewer donations may be able to make a simpler application, while larger organizations expecting more donations will not. Determine which form you must use to apply.

Submission

The IRS currently requires that you submit Form 1023 or Form 1023-EZ online. To do so, you must open a Pay.gov account because you will be submitting a fee with your application and submitting the form through the Pay.gov website. The Pay.gov website has a See All Forms link taking you to a page of all the submissions made through Pay.gov. One of those submissions, found in alphabetical order, is Application for Recognition of Exemption Under Section 501(c)(3). That’s where you will submit your completed application. Once you complete your application using Form 1023, you must append your file-stamped articles of nonprofit incorporation, bylaws, and supplemental documents to your Form 1023 in one, big, electronic file, to submit through the Pay.gov portal. In other words, you’ll be doing everything online.

Expedition

If you have a legitimate reason to hurry your 501(c)(3) application through the IRS’s review process, you may request the IRS to expedite your organization’s application. The IRS ordinarily reviews applications in the order received. Qualifying for expedited review jumps the queue, potentially saving weeks or even months in receiving back your organization’s IRS determination letter. Organizations providing disaster relief ordinarily qualify for expedited review. Your organization may alternatively qualify for expedited review based on a compelling reason for expedited review, such as that your organization may lose a key grant, resulting in a hardship on the organization, with a delay in approval. Submit a written request for expedited handling, explaining in reasonable detail your compelling grounds, if you believe that your organization should have that relief. A rush to get started with helping others is not alone compelling grounds. Your expedited-review request must give a good reason for the rush, connected with organization hardship.

Flags

Completing Form 1023 or its easier version generally begins with filling in relatively simple information like names, numbers, and addresses. You must then answer many questions either yes or no, with your responses triggering further duties to supply explanations. The IRS designs the form’s yes-or-no questions to raise red flags about your organization that might disqualify it from 501(c)(3) recognition. You must answer the questions truthfully but would generally hope to answer in ways that trigger fewer requests for explanations. In other words, the cleanest applications, raising the fewest red flags potentially disqualifying the organization, are the ones with fewer explanations. 

Foreign

Take an organization’s plan to operate charitable programs in a foreign location as an example of a significant red flag. Ostensibly charitable programs operating in foreign countries have unfortunately played significant roles in the funding of terrorism seriously affecting U.S. and other interests. Terrorists misuse charities to launder money. If your organization plans foreign operations, your organization must so indicate on its Form 1023. The IRS may then require your organization to show that it has completed other forms and applications, such as with the U.S. Office of Foreign Asset Control (OFAC), to obtain approval for those operations. The requirements for those approvals may include identifying the foreign charitable organizations with which your organization will responsibly partner, to ensure the security and integrity of those operations. Foreign charitable operations introduce significant additional complexity. If that is your organization’s intention, consider partnering with an established U.S. charity already approved for those operations. If you don’t wish to partner, then your organization will have to do significant extra work convincing the IRS that it will act safely and securely.

Reporting

As to completing Form 1023 or its easier version, the first issue many face has to do with a question regarding whether your organization must file an annual Form 990 information return. An information return is like a tax return but without paying any taxes. An information return includes the organization’s financial information, sufficient to reassure the IRS of the organization’s charitable nature. Information returns are public documents, readily found online by anyone wishing to review a charity’s finances. Although Form 990s can be useful to show prospective donors the integrity of your organization’s finances, you would generally prefer not to file annual Form 990 information returns if you can avoid it, because of the associated time, trouble, and expense completing them requires and because of the public disclosure. Generally, organizations with gross annual receipts exceeding $50,000 must file Form 990 or its easier version. If you expect your organization to receive under that amount in coming years, you may check the box indicating that your organization is exempt from the filing and then provide your supplemental information explaining so. A later chapter addresses Form 990 information returns and other reporting requirements.

Supplements

As the prior paragraph indicates, completing Form 1023 may require you to provide supplemental information and explanations that do not fit on the form itself. For your supplemental information, use a word-processing file into which to record your supplements, clearly marking each supplement as responsive to the form’s relevant question. For example, your supplement might indicate, “SUPPLEMENTAL INFORMATION TO PART I. QUESTION 10,” followed by your detailed information. Continue on in that fashion for each response requiring supplementation, and then print and append the supplemental information to your application file. That way, the IRS examiner will have all the necessary information to review and approve your application, at the examiner’s fingertips.

Activities

Another key section of Form 1023 with which applicants have issues is the Part IV Narrative Description of Activities. Form 1023 requests that you attach a “thorough and accurate” narrative describing the organization’s “past, present, and planned” activities. To make your description sufficient, use subheadings past activities, present activities, and planned activities, so that the IRS examiner can clearly see that you have met the description’s full requirements, even if for past and present activities you put “none” while explaining that your organization is awaiting IRS recognition to begin activities. As you draft your organization’s narrative of planned activities, be sure to answer the questions who, what, when, where, how, and why. Tell by name, role, or qualifications who will carry out the activities, what they will do, the seasons or schedule on which they will do it, the location including a building or facility description, and the methods, while relating all this information to your organization’s charitable purpose. As the request invites, refer to and attach plans, flyers, brochures, programs, and anything else enhancing the detail and credibility of your submission. Go for it. Give ‘em everything you’ve got, in an articulate, well-organized, and thoughtful narrative.

Participants

Part V on officer, director, employee, and contractor compensation is another key section of Form 1023 with which applicants have issues. Part V requires that you name your officers and directors including their addresses and compensation. You should indicate no compensation for officers and directors, consistent with required policy and best practices. Part V of Form 1023 also requires that you list your five highest-compensated employees and independent contractors earning at least $50,000 annually. If your organization is new and has not yet attracted funds to employ workers and retain contractors, lacking 501(c)(3) recognition, you may indicate that your organization has none. Otherwise, you’ll need to list those employees and contractors, with titles, addresses, and compensation. Notice how the other questions in Part V require you to reflect the integrity with which your organization treats officer, director, and employee duties of loyalty and potential conflicts of interest. Here is where your organization’s conflict-of-interest policy, already adopted along with your organization’s bylaws, will meet IRS requirements.

Benefits

Part VI of Form 1023 requires you to describe the goods, services, and other benefits your organization intends to provide to individuals, groups of individuals, and organizations. Your organization may certainly serve individuals, but it should not be operating for the benefit of a single individual. Avoid focusing your organization’s overall activities on a single individual or family, or the IRS may determine that your organization is operating for private rather than public benefit. Your organization may also serve groups of individuals, but beware unlawful racial discrimination in your organization’s services. Serving disadvantaged groups of individuals is certainly lawful, while serving only certain racial groups implicates Title VII discrimination concerns. The IRS may deny your organization’s application if it believes your organization will engage in unlawful discrimination by restricting benefits to only certain racial groups while excluding other racial groups. Your organization may likewise serve other organizations, but those organizations should also be providing charitable service, and your organization should avoid solely serving other organizations, or the IRS may reclassify it as a Section 509(a) supporting organization rather than the public charity you are pursuing.

Fundraising

Part VIII, Question 4.a., of Form 1023 requires you to describe your organization’s fundraising plan. You should already have developed those plans. Adding them to your Form 1023 supplemental information should suffice. Be sure, though, that your plans include specific-enough descriptions of the means by which you will raise your organization’s one-third donation support, to meet the public-support test. In other words, describing only sales of charitable goods and services, and government and private-foundation grant support, may not meet IRS requirements. Your plan should include the fundraising event solicitation, website, email, and mail solicitation, and other means by which you expect your organization to raise donations. Spend enough time planning your fundraising to be able to give reasonable specifics.

Finances

Part IX of Form 1023 on organization finances is the next section with which applicants have common problems. If your organization is a new organization without prior finances, you must estimate expenses and receipts for the current year and two succeeding years. If your organization has prior-year finances, you should enter those prior years in Form 1023’s table in this section. Either way, be sure that you have three full years of entries, or IRS examiners will reject your application, requiring a full three years of information or estimates. Also, be sure your numbers add up, or IRS examiners may require you to redo your figures. If you haven’t already done this kind of budgeting in your planning, use Form 1023’s financial information table to develop your organization’s budget for the current and coming two years. Recall that if your entries show receipts greater than $50,000 in any of these three years, your organization will have to file Form 990 information returns. Part IX also requires your disclosure of current organization assets. If your organization is new, it may have no assets, making this disclosure easy. Otherwise, disclose accurate account balances, while giving best estimates of the value of real or personal property.

Status

Part X of Form 1023 requires you to check the appropriate boxes to seek and receive public charity status. For Question 1.a. of Part X, you’ll answer no, allowing you to skip to Question 5. For public charity status, you’ll likely choose Question 5’s option h, “an organization that receives a substantial part of its financial support in the form of contributions from publicly supported organizations, from a governmental unit, or from the general public.” Part X concludes the main portion of Form 1023 with a signature blank for you to sign and adjacent spaces to enter your printed name and your organization title, likely Incorporator, President, or Secretary. 

Schedules

Form 1023 includes a series of Schedules A through H. You may not need to complete any of those schedules. The schedules are for special forms of charitable organizations including churches, schools, hospitals, supporting organizations, organizations already in existence for more than twenty-seven months, organizations providing homes for the elderly, handicapped, or low income, successor organizations, and scholarship, educational loan, and education grant organizations. Each of these special organizations can add a significant level of complexity to a 501(c)(3) application and can require meeting other qualifications to conduct their activities. For instance, schools generally require state department of education review and approval, while hospitals may face elaborate state health department review and approval procedures. Don’t undertake school or hospital qualification without qualified legal representation. Churches may find it easier to complete the relevant Schedule A without substantial assistance.

Checklist

The IRS requires that you complete the checklist at the end of Form 1023 to ensure that your organization’s application meets all requirements. So many applicant organizations have missed so many requirements that the IRS finally adopted the checklist to help. Use the checklist to ensure that you have completed and included all required information and every required form, document, supplement, fee, and certification. The IRS filing fee for the full Form 1023 is $600, while the fee for filing the abbreviated Form 1023 is $275. Your organization may pay the fee, or you may advance the funds expecting your organization’s reimbursement when it receives donations.

Key Points

• The IRS issues determination letters recognizing 501(c)(3) status.

• Applying for IRS 501(c)(3) recognition varies in difficulty.

• The IRS offers online videos and other resources for help applying.

• Organizations must get an EIN from the IRS to apply for a 501(c)(3).

• Apply for 501(c)(3) recognition on Form 1023 at Pay.gov.

• Organizations with less income may be able to use Form 1023-EZ.

• Request expedited review if waiting may lose a grant or donation.

• Form 1023 responses flag potentially disqualifying information.

• Supplement your Form 1023 responses with attached information.

• Describe your organization’s planned activities in abundant detail.

• Name officers and directors, indicating no compensation.

• Identify program beneficiaries without racial discrimination.

• Disclose a reasonably detailed fundraising plan for public donations.

• Disclose budgets for three years and current assets, if any.

• Choose the correct public-charity status for your organization.

• Special organizations like churches and hospitals complete schedules.

• Complete the checklist and pay the $600 fee ($275 for EZ form).

Read Chapter 9.