Deja: Form 1023-EZ and Private Foundation Misclassifications

Sandy Deja recently determined that a high number of Form 1023-EZ applications resulted in classification as a private foundation, likely incorrectly in many instances. Here is a description of the problem from her submission to the IRS through its Systemic Advocacy Management System:

Form 1023-EZ, meant to streamline the 501(c)(3) application process, has, instead, harmfully prolonged the process for tens of thousands of small charities. Half of 1023-EZ private foundation classifications appear to be wrong. Many of these applicants actually meet IRS guidelines for public charity status. Misclassifications mean millions of dollars in unnecessary IRS fees, missed funding opportunities, unanticipated paperwork, even loss of exempt status. In addition, misclassifications are a damper on charitable activity and a needless drain on scarce IRS resources. Form 1023-EZ, introduced in 2014, and its instructions, are to blame. Part IV of Form 1023-EZ, Foundation Classification, is oddly worded and ignores the public charity tests that specifically apply to most 1023-EZ applicants. The more detailed description of the public support tests for new charities in the EZ instructions simply does not appear in any other current IRS guidance. Providing inconsistent guidance is a violation of the taxpayer's right to be informed. The obvious solution would be to change the wording of Part IV of Form 1023-EZ and its instructions to make them consistent with tax law and with other similar IRS Forms. A more comprehensive solution would include stepped-up IRS review of Forms 1023-EZ that indicate private foundation status, as well as User Fee adjustments.

Actions Taken: If any of the IRS offices I have contacted about this issue have taken action, I am not aware of it. Although I have also alerted EO tax professionals and non-profits themselves, it is really up to the IRS to fix this. The 2,000 character limit for Form 14411 means that relevant authorities and guidance, sample language, examples, charts, links and a more complete description of actions taken have been omitted from this submission. 

And here is more information from her research:

The percentage of newly approved small 501(c)(3)s classified as private foundations immediately jumped in 2014 when Form 1023-EZ was introduced and has steadily increased. In 2013, before Form 1023-EZ, less than 5% of newly approved 501(c)(3) organizations were private foundations. . . . .

By the end of 2014, less than a year after the introduction of Form 1023-EZ, misclassified 1023-EZ users were already applying for and receiving reclassification. By the end of 2022, close to 9,000 EZ-origin private foundations (almost 20% of the 9-year total) had applied for and received reclassification, and an additional 30% had disappeared from the IRS database of charities. At the end of 2022, less than half of 1023-EZ applicants initially determined to be private foundations still had that status. In contrast, close to three quarters of applicants determined to be private foundations back in 2013, pre-1023-EZ, still had that status in late 2023.

Lloyd Mayer