IRS Further Lowers the Barrier for Entry into the Nonprofit Sector

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By http://www.flickr.com/photos/giovannijl-s_photohut/ Gio JL [CC BY-SA 2.0], via Wikimedia Commons

August 16, 2016, AccountingWEB

If you are concerned there is no meaningful barrier to entry into our sector, the IRS just made the problem worse by reducing the fee from $400 to $275 for Form 1023-EZ (the Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code).

If you suspect that the IRS overreacted to its “Tea Party scandal” involving applications for tax-exempt status by conservative groups and the huge backlog in processing applications at the IRS by creating this “EZ” form, this IRS Form 1023-EZ First Year Report will not ease your anxiety. Here is Jason Bramwell, a staff writer for AccountingWEB, summing up the essential numbers from that first-year report:

The average processing time for Form 1023-EZ was 13 days, compared to the average processing time of 192 days for the 26-page Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, during the same six-month time period (October 2014 to March 2015). In addition, the IRS approved 95 percent of all Form 1023-EZ applications submitted and closed during the first year, according to the report.

In fact, it appears that the IRS may have overcorrected in its application processes. You can read more about how this has played out in a recent in-depth interview with Virginia Gross about how IRS regulatory and monitoring activities are changing. This should be required reading for all nonprofits and their boards.

So are we worried about too many nonprofits? Not exactly, and especially not in terms of competition for revenue. Extensive research conducted by George McCully and others at the Catalogue for Philanthropy analyzed the nonprofit community in Massachusetts and found that a fraction of so-called “nonprofits” are philanthropic. Specifically, they found that only “three percent, or about eight percent of the total of ‘nonprofits,’ are actively engaged in public fundraising.” That is to say that of the nation’s current 1,571,056 tax-exempt organizations in more than twenty-five 501(c) categories, there are likely less than 300,000 charities nationwide that are raising money for private initiatives for public good.

There are a number of other indicators supporting this thesis. At GuideStar, among the 2.4 million organizations listed (including organizations no longer in operation), only 107,000 nonprofits updated their profile with only 1,200 nonprofits self-reporting demographic data. The 2016 Fidelity Charitable Giving Report shows that its 132,000 donors gave $3.1 billion in grants to only 106,000 organizations in every state and around the world. Dean Karlan, a Yale professor of economics and founder of Innovations for Poverty Action, reports in this 2014 op-ed in the L.A. Times that only some 55,000 nonprofits with more than $1 million in annual revenue account for 94 percent of all donations to public charities.

Those small charities applying for federal tax exemption by using the Form 1023-EZ are not the competition, and private contributions are not the only form of revenue. According to the National Center for Charitable Statistics, in 2013, public charities reported $1.74 trillion in total revenues. Of this revenue, only 21 percent came from contributions; 72 percent came from program service revenue, including government fees and contracts; and seven percent came from “other sources,” including dues, rental income, and so on.

As an ecosystem, small charities make up a vast and varied landscape. Many if not most of the very large organizations rely almost entirely on fees and contracts and often raise less through fundraising than the small charity that is entirely reliant on private contributions.

The real problem with the IRS making it “EZ” for almost anyone to open a 501(c)(3) down the street, and one that’s likely a major problem for the rest of us, is that with less judgment applied at entry, there may be many more faux and fraudulent nonprofits among us. If they violate public trust, they weaken the reputation of the sector—and reputation is a very important coin in our realm.—James Schaffer

Correction: This newswire has been amended from its original form. The new fee for the Form 1023-EZ is $275.

  • Mathieu Despard

    Interesting move by IRS. Seems it’ll just increase downstream costs related to revocations for an already stretched IRS. Whether $250 or $400, there’ll continue to be interest in starting new nonprofits and often not from potentially fraudulent actors, but from individuals and groups with a sincere desire to improve their communities who – for whatever reasons – cannot or will not seek to partner with existing nonprofits in their communities.