nonprofit federal tax exemption Swyft Filings

So, you've decided to start a nonprofit. That's fantastic news! The world needs organizations like yours out there doing good.  

If your organization is going to operate for charitable purposes, it could claim tax-exempt status. To qualify, nonprofits and charitable organizations must operate strictly in the public's interest or for charitable purposes. They cannot work for the profit of any individual or group.

The Internal Revenue Service sets the tax rules for all nonprofits and charitable organizations in the U.S. The IRS recognizes many types of nonprofits, but because 501(c)(3) is the most common type of exemption, we'll focus on that.  

Benefits of Federal Tax Exemption

There are many benefits to obtaining tax-exempt status. Of course, the most obvious advantage is that any grants, donations, and fundraising income your nonprofit collects are not subject to taxation. This saves your organization precious financial resources, frees up funds for pursuing your mission, and lets you devote more time and attention to serving the public's interests.

Additional benefits of tax-exempt status include:

  • Exemption from federal income tax
  • Eligibility for U.S. Postal Service discounts
  • Access to funding for tax-exempt organizations
  • Increased credibility
  • Tax-deductible donations for donors

Form 1023 vs 1023-EZ

Your organization must apply with the IRS to gain 501(c)(3) tax-exempt status. To do this, you'll be required to fill out one of two forms — Form 1023 or Form 1023-EZ, respectively referred to as the long form and short form.

For decades, Form 1023 was the only form available to apply for federal tax exemption. In 2011, the National Taxpayer Advocate recommended that the IRS create an easier, less extensive form — particularly for small nonprofits. This resulted in Form 1023-EZ.

Which form you need to fill out for your nonprofit depends on several factors.

Differences Between Form 1023-EZ and Form 1023

As its name suggests, Form 1023-EZ is easier to fill out and less extensive than the standard form.

Original Form 1023 is 26 pages long and contains complex, technical questions. It requires extensive documentation, including a 3-year budget, a written description of proposed programs, copies of leases, board meeting minutes, contracts, the resumes of all officers and directors, Articles of Incorporation, bylaws, and more. The complete, final package generally runs from 50 to 100 pages.

On the other hand, Form 1023-EZ consists of only three online pages featuring mostly yes and no answers. It doesn't require a budget or any narrative, just a purpose statement. Form 1023-EZ is also less expensive than the long form. The filing fee for the 1023-EZ is currently $275, while the standard Form 1023 filing fee is $600.

What Form Is Right for Your Organization?

The short answer is that the short form, 1023-EZ, will be perfect for most nonprofits that are just starting out. However, your organization's size, purpose, and activities could mean you'll need to do the original long form instead.

Organizations That Need Form 1023

The 1023 long form is intended for organizations that undergo more regulations based on their purpose and what they do. Churches, schools, and hospitals require the long form. Organizations that generate more than $50,000 per year also require the long form.

Organizations That Qualify for Form 1023-EZ

Form 1023-EZ is intended for smaller nonprofits that aren't as heavily regulated. If you're running a micro-charity with simple localized programs, or you don't intend to seek corporate donations and grants, the easy form is ideal.

You're eligible to complete the short form if you can honestly answer "no" to 30 qualifying questions listed on Form 1023-EZ. Those questions include the following:

  • Do you project an annual income exceeding $50,000 in the next three years?
  • Have you exceeded $50,000 in any of the past three years?
  • Do your nonprofit's total assets exceed $250,000?
  • Was your business formed under the laws of a foreign country?
  • Are you a business entity other than a corporation, unincorporated association, or trust?
  • Are you formed as a for-profit entity?
  • Have you been or are you tax-exempt under another section of IRC 501(a)?
  • Are you a church, school, college, university, hospital, or agricultural research organization?

The IRS requires the 1023 forms to be filled out in good faith. That means you should not use Form 1023-EZ if you have assets over $250,000, have exceeded $50,000 in donations in the last three years, or already have donation commitments of more than $50,000 for each of the next three years. The IRS can revoke your tax-exempt status if the estimate in your form 1023-EZ is outrageously low.

However, don't let lofty goals keep you from using the simpler form. If you have stretch goals that exceed $50,000 in donations over one of the next three years, but your realistic expectations are lower, that could justify your filing of the 1023-EZ in good faith. If you exceed your good faith expectations and meet your stretch goals, you will have to file the longer 1023 tax return disclosing your bonanza to the IRS.

Items Needed for the Long Form Application

The long form requires that you answer many questions with detailed answers. Some of the items required include:

  • List of past, present, and planned activities
  • Articles of Incorporation
  • Bylaws
  • Conflict of Interests Policy
  • Compensation of leadership members, including directors, officers, trustees, and certain highly paid employees and contractors
  • Sales and/or contracts with other organizations
  • Information on fundraising programs
  • Relationships, including business and family, among key players in the nonprofit, including trustees, directors, and officers
  • List of funds, services, and goods given to individuals or organizations
  • 3-4 years of company financials
  • IRS filing fee of $600

The IRS also requires your nonprofit to have a board of directors with at least three members. It generally takes the IRS three to six months to approve Form 1023.

Items Needed for the Short Form Application

  • List of directors
  • NTEE code
  • Mission statement
  • A few questions regarding classification
  • $275 IRS Filing Fee

The IRS takes two to four weeks to approve  Form 1023-EZ.

Instructions for Filling Out Short Form 1023-EZ

Filling out Form 1023-EZ is straightforward. Start by registering for an account on Pay.gov. On the Pay.gov site, enter 1023 in the search box and select Form 1023-EZ. From there, you will be guided to fill out the form, which you will submit once completed.

Starting a nonprofit is a challenging undertaking. Anything you can do to cut down on paperwork and red tape is welcome. Filling out the 1023-EZ form to apply for recognition of exemption can make your job a little easier.

What Happens Next?

After you apply with either form, the IRS will decide your organization's status. The review process can take anywhere between two and 12 months. Once complete, you'll receive an IRS 501(c)(3) Determination Letter informing you of their decision. Approval means you can officially begin operating as a tax-exempt entity. See our article "What To Expect From a 501c3 Determination Letter" for more information on the approval process and what to do if your application is rejected.

You have a little more work to do after you receive your Determination Letter. The next step is getting tax-exemption at the state level. This has some significant perks, including getting your organization out of paying state income taxes and possibly even some sales taxes.

Fortunately, once you've obtained federal tax-exemption, you've already done most of the work toward getting the same for state-level. See our article "How to Apply for State Tax Exemption for Your Nonprofit" for more information.


Need Help With Your 501(c)(3) Application?

While submitting your 501(c)(3) application is a crucial step in receiving your state and federal tax exemptions, the process can be daunting. Swyft Filings can help you prepare your application, so you can focus on bringing your mission to life. Check out our 501(c)(3) Application page today to learn more.