The IRS Is Aware That a Significant Proportion of Form 1023-EZ

Taxpayer Advocate Service — Fiscal Year 2017 Objectives Report to Congress — Volume One 181

Preface

2016 Filing

Season

Areas of Focus

TAS Research

Initiatives

Efforts to Improve

Advocacy

TAS Technology Appendices

AREA OF

FOCUS #14

The IRS Is Aware That a Signiﬁcant Proportion of Form 1023-EZ

Applications It Approves Are Submitted by Organizations That Do

Not Meet the Legal Requirements for IRC § 501(c)(3) Status,

But It Has Not Acted to Correct Known Errors and Has Not

Revised the Form to Prevent These Erroneous Approvals

TAXPAYER RIGHTS IMPACTED

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The Right to Quality Service

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The Right to Finality

IRS Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the

Internal Revenue Code, introduced in July 2014, requires applicants merely to attest, rather than demon-

strate, that they meet fundamental aspects of qualiﬁcation as an exempt entity. Because Form 1023-EZ

does not solicit any narrative of the organization’s activities, ﬁnancial data, substantiating documents,

or explanatory material, the National Taxpayer Advocate believes the form is insufﬁcient to allow the

IRS to make a determination as to an applicant’s exempt status. Because Internal Revenue Code (IRC)

§ 501(c)(3) organizations are generally not required to pay tax on their related income and may receive

tax deductible contributions, erroneously conferring IRC § 501(c)(3) status on ineligible entities contrib-

utes to the tax gap.

The IRS has announced from the outset its intention to address possible noncom-

pliance through post-determination audits.

This approach is a departure from principles of sound tax

administration. No one would suggest the IRS stop preventing questionable Earned Income Tax Credit

(EITC) refunds from being paid and instead rely solely on post-refund EITC audits to drive compliance.

As reported in the National Taxpayer Advocate’s 2015 Annual Report to Congress, TAS undertook a

study of a representative sample of corporations in 20 states that make articles of incorporation viewable

online at no cost whose Form 1023-EZ was approved by the IRS.

TAS’s analysis showed that the ar-

ticles of incorporation for 37 percent of the organizations in the sample did not satisfy the organizational

test, a legal requirement for exempt status as an IRC § 501(c)(3) organization.

We recommended that

the IRS revise Form 1023-EZ.

See Taxpayer Bill of Rights (TBOR), www.TaxpayerAdvocate.irs.gov/taxpayer-rights. The rights contained in the TBOR that

was adopted by the IRS are now listed in the Internal Revenue Code (IRC). See Consolidated Appropriations Act, 2016,

Pub. L. No. 114–113, Division Q, Title IV, § 401(a) (2015) (codified at IRC § 7803(a)(3)).

See IRC §§ 501 and 170(c)(2).

Tax Exempt and Government Entities (TE/GE) Business Performance Review (BPR) First Qtr 2015 Appx. B, TE/GE Risk Register

(Feb. 2015) (noting that “[p]erceived inadequate oversight of the tax exempt sector as we undertake strategic shifts in how we

conduct the up-front review of applications for tax-exempt status…” will be mitigated by “[e]xpanded compliance efforts.”).

National Taxpayer Advocate 2015 Annual Report to Congress vol. 2, 1-31 (Research Study: Study of Taxpayers that Obtained

Recognition as IRC § 501(c)(3) Organizations on the Basis of Form 1023-EZ).

To satisfy the organizational test, an applicant’s organizing document must contain an adequate purpose and, in general, an

adequate dissolution clause. See Treas. Reg. §§ 1.501(c)(3)-1(b)(1)(i)(a), (b); 1.501(c)(3)-1(b)(4). “Articles of organization”

includes “the trust instrument, the corporate charter, the articles of association, or any other written instrument by which an

organization is created.” Treas. Reg. § 1.501(c)(3)-1(b)(2). In some states, known as cy pres states, a nonprofit corporation’s

articles need not include a specific dissolution provision because by operation of state law the organization’s assets would be

distributed upon dissolution for one or more exempt purposes, or to the federal government, or to a state or local government,

for a public purpose. See Treas. Reg. § 1.501(c)(3)-1(b)(4).

Section Three — Areas of Focus 182

TAS TechnologyAppendices

Efforts to Improve

Advocacy

TAS Research

Initiatives

Areas of Focus

2016 Filing

Season

Preface

On December 21, 2015, TAS provided Tax Exempt and Government Entities (TE/GE) with a list of

149 organizations in the TAS study whose Form 1023-EZ applications were approved even though the

organizations do not qualify as IRC § 501(c)(3) organizations because their articles of incorporation lack

an adequate purpose clause or required dissolution clause (or both). We recommended that TE/GE

advise the organizations on the list of the deﬁciencies in their articles and require them to demonstrate

(not simply attest) that they amended their articles to comply with the requirements for qualiﬁcation as

IRC § 501(c)(3) organizations.

When TAS followed up with the Exempt Organizations (EO) function in February 2016 by asking

how many organizations on the list had been contacted and how many had responded, the Director of

Rulings and Agreements replied “the applicable procedures do not provide for contacting these taxpay-

ers to request books & records in this context.”

In a telephone conversation, the Director explained his

view that such contact might constitute an audit. When TAS then inquired of the Acting Director,

TE/GE EO, whether the 149 organizations would be included in its Form 1023-EZ post-determination

audit program, the response was:

The selection of cases for the 1023-EZ post-determination compliance program in EO exam

is based on a statistical sample. So if any of those organizations are selected as part of the

sample, then they will be examined. We cannot just pull those cases into the sample, as that

would invalidate the sample. To select a case for examination, we have to follow very speciﬁc

examination procedures. These procedures provide internal controls on the selection of cases

for examination to ensure that the returns selected for examination follow the examination

strategy and are selected in a fair and unbiased manner. Currently, cases are selected for ex-

amination using three different methods, statistical sample, the 990 model queries, and refer-

rals. Exam accepts both internal and external referrals. If you would like to submit a referral

for these organizations, we would provide those referrals to our Referral Classiﬁcation Unit

for evaluation. I have attached the Form 5666 for your convenience.

TAS then suggested that EO simply conduct compliance checks on the 149 organizations, which would

not amount to an audit.

It remains to be seen whether EO will accept this suggestion.

As of May 27, 2016, all but seven of the 149 organizations continued to be listed on Select Check, an

IRS-maintained public database, as those to which tax deductible contributions may be made.

Email from Director, EO – Rulings & Agreements (Feb. 8, 2016), on file with TAS.

Email from Acting Director, TE/GE EO (Feb. 8, 2016), on file with TAS.

See IRS Pub. 4386, Compliance Checks: Examination, Audit or Compliance Check? (2006) noting “a compliance check is a

review conducted to determine the following: Whether an organization is adhering to record keeping and information report-

ing requirements; Whether an organization’s activities are consistent with its stated tax-exempt purpose” and “[c]ompliance

checks are not audits and do not directly relate to determining a tax liability for any particular period. Initial contact letters

for compliance checks will include Pub 4386, Compliance Checks, explaining the distinction.”). The publication also notes

that a compliance check “is a review of information and forms that we require organizations to file or maintain — for example,

Forms 990, 990-T, 940, 941, W-2, 1099, or W-4. The check is a tool to help educate organizations about their reporting

requirements and to increase voluntary compliance.”

EO Select Check is an online search tool, http://apps.irs.gov/app/eos/, that allows users to search for organizations eligible

to receive tax deductible contributions, organizations whose tax exemption has been automatically revoked for not filing a Form

990-series return or notice for three consecutive years, and organizations that have filed a Form 990-N (also called an e-Post-

card), an annual notice required to be filed by small exempt organizations.

Taxpayer Advocate Service — Fiscal Year 2017 Objectives Report to Congress — Volume One 183

Preface

2016 Filing

Season

Areas of Focus

TAS Research

Initiatives

Efforts to Improve

Advocacy

TAS Technology Appendices

FOCUS FOR FISCAL YEAR 2017

In Fiscal Year 2017, TAS will continue to:

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Advocate (including through the National Taxpayer Advocate’s issuance of a Taxpayer Advocate

Directive) that TE/GE address the needs of the 149 organizations TAS identiﬁed as having

submitted Forms 1023-EZ that were erroneously approved. The organizations should be required

to demonstrate they amended their articles to comply with the requirements for qualiﬁcation as

IRC § 501(c)(3) organizations;

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Evaluate, on the basis of the results of TE/GE’s post-determination audits of Form 1023-EZ

ﬁlers, the extent to which the audits show signiﬁcant levels of noncompliance and whether the

noncompliance could have been averted through simple revisions to Form 1023-EZ; and

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Evaluate the extent to which TE/GE’s broader compliance framework yields information about

the behavior, needs, and preferences of exempt organizations.