The Internal Revenue Service improperly granted tax-exempt status to more than a third of nonprofits that used a new short-form application, according to the National Taxpayer Advocate’s annual report to Congress.
The report suggested that the agency rubber-stamped applications rather than subjecting them to the most basic review.
The IRS first offered the three-page form in July 2014 for organizations with gross revenue of $50,000 or less and assets of $250,000 or less. For qualifying applicants, it replaced a 26-page form. The agency said the new form would help reduce a backlog of applicants, while critics complained that the longer form helped weed out cheats.
In a study of 408 nonprofits in 20 states, the advocate’s office found that 37 percent of applicants using the 1023-EZ application form did not meet the organizational test required of nonprofits. One-third of applicants did not provide an acceptable purpose clause, which defines the group’s mission, and 23 percent did not provide for an acceptable distribution of assets should the organization dissolve.
‘Almost Right’ Applications
In more than 90 percent of cases in which a nonprofit failed to meet the test, researchers identified the problem in less than five minutes, the study found, suggesting applications were “almost right” but did not meet legal standards.
For instance, an organization’s purpose clause might suggest the nonprofit will have a tax-exempt mission, like feeding the poor, but fail to state that the nonprofit’s work will be exclusively directed to that purpose. Similarly, a nonprofit’s articles of incorporation might direct that its assets be distributed to a certain organization if it closes its doors, but the articles might lack a provision ensuring the assets will be directed to a charitable purpose, the report said.
Applicants for nonprofit status that “inartfully” drafted their articles of incorporation “did not receive the minimal amount of service needed to identify the deficiency and notify the organization of the need to correct it,” wrote Jill MacNabb, senior attorney adviser to the National Taxpayer Advocate, the report’s primary author.
“Organizations that misrepresented their qualifications as exempt organizations, intentionally or not, were aided by the IRS in misleading the public,” she wrote. “Taxpayers’ right to quality service and their right to be informed were thereby undermined.”
The shorter form may have helped reduce the IRS’s backlog of applications, but it has invited fraud, said Tim Delaney, president of the National Council of Nonprofits. Not only does the agency need to devote resources to weeding out improperly filed forms but states and localities may lose tax revenue from groups that don’t deserve a tax exemption.
“The IRS is handing out tax-exempt statuses like it’s Halloween candy,” he said.