AICPA Suggests Improvements to Form 1023 

    Published June 27, 2005

    December 2, 2002

     

    Ms. Amy Henchey

    Exempt Organizations Technical Division

    Internal Revenue Service

     

    1750 Pennsylvania Avenue, NW

     

    Washington, D.C.20224

     

     

     

    Re: Announcement 2002-92, Form 1023: Revision of Form

     

     

     

    Dear Amy,

     

     

     

    The AICPA Exempt Organizations Taxation Technical Resource Panel 1023 Task Force appreciates the opportunity to comment on the proposed revisions to Form 1023 (the Form). We have addressed the specific concerns outlined in Announcement 2002-92, based on our members' perspectives as Form 1023 preparers. We hope that these comments will help the IRS in its quest to improve the quality and efficiency of the exempt organization determination process.

     

     

     

    We understand the IRS has multiple goals in redesigning the Form:

     

     

     

    Make the exemption application process educational for applicant organizations by (a) explaining, in plain language, standards for qualifying for exemption; (b) describing how the IRS processes applications; and (c) making the Form more accessible and easier to complete with instructions for each part.

     

     

     

    Make the determination process more efficient for the IRS review staff by (a) requesting better quality information to facilitate qualifying the applicants; and (b) highlighting appropriate information to effectively and efficiently identify which applications need further review.

     

     

     

    We support these goals. We believe that the approach taken in the redesigned Form and its instructions goes far to accomplish them. However, we would suggest some revisions and long-term changes to improve the overall process.

     

     

     

    I. Ease of Comprehension

    II. Customer Burden

    III. Technical Accuracy

    IV. Sufficiency of Information

    V. Other Comments

    VI. Proposed Alternative Process

     

    I. Ease of Comprehension

     

     

     

    A. The new line-by-line instructions will greatly facilitate applicants' understanding of the Form 1023. We strongly suggest that the Form be cross-referenced to each line's specific instructions. This will increase both an applicant's ability to properly complete the Form and the likelihood that the Instructions will be utilized.

     

     

     

    B. The Form could flow in a more logical order. We suggest ordering the parts as follows: (1) organizational tests; (2) financial data; (3) activity discussion, including involvement of related parties; (4) public charity status, and (5) special issue questions and attachments. This order would better promote internal consistency and support the interactive nature of these areas. Specialized schedules should continue to be attached—at the end and only as applicable.

     

     

     

    We believe financial data should appear earlier in the Form. In our experience, assembling and discussing the projected financial data is a process that helps applicants crystallize plans for generating revenue, identify revenue sources, and decide how funds will be spent. This process allows organizations and their founders to better understand and describe their planned activities. It also allows applicants to realistically set priorities and give definition to those planned activities. By requesting financial information at the beginning of the Form, the IRS would encourage organizations to make this important analysis early on in the application process. In addition, an earlier focus on financial data will aid an applicant in providing information to answer the public charity status or the private foundation questions, as appropriate.

     

     

     

    We suggest reordering the activity information to ask for the general statement of activities first. This will allow the organization to tell its story prior to the detailed questions on qualification. In addition, this order will be more meaningful to members of the general public who read the application. It also allows the specific activities questions that follow to be read in context with the overall activities. We believe this will promote public understanding of the organization without hampering efficient processing of the application by the IRS.

     

     

     

     

     

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    II. Customer Burden

     

     

     

     

     

    A. As redesigned, the Form will not reduce an applicant's completion time. Describing an organization in an understandable manner with the detail requested is time-consuming and not dissimilar to preparing a business plan suitable for soliciting capital investment.

     

     

     

    B. We do, however, have the following concerns about the volume and depth of the financial information requested:

     

     

     

    Part X, Item 12, Gain or loss on sale of capital assets. The Instructions require a statement be attached detailing each asset sold, the purchaser and the amount received. A compliant answer could be extremely voluminous. In addition, for a newly formed organization, this level of detail may be very difficult to predict. We recommend that this detail not be requested. Although this information is required on the current Form 1023, in our experience, it is rarely, if ever, (a) submitted with an application; or (b) requested by the reviewing agents.

     

     

     

    Part X, Item 19, Other salaries and wages. The Instructions require a list of all employees with job descriptions, average number of hours worked per week, and annual compensation. Again this detail could be extremely voluminous and of questionable usefulness, particularly for non-management level employees. This detail exceeds the annual Form 990 disclosures and may be considered to violate employee privacy. Although this information is required on the current Form 1023, in our experience, it is rarely, if ever, (a) submitted with an application; or (b) requested by the reviewing agents.

     

     

     

    Part X, Item 23, Professional fees. The Instructions require an attachment that lists all independent contractors and copies of their contracts. Identifying various advisors—such as attorneys, outside auditors, etc.—by name, budgeted payments, and including copies of their contracts or agreements to provide services is overreaching and raises privacy and operational concerns. In addition, the information could be voluminous. We question the usefulness of much of this information. Although this instruction parallels that which is required on the current Form 1023, in our experience, the information requested is rarely, if ever, (a) submitted with an application; or (b) requested by the reviewing agents.

     

     

     

    Instructions, Part X. The Instructions direct an applicant to attach a statement explaining its planned method of accounting if the method is other than the cash receipts and disbursements method. The accrual method of accounting is widely used, well accepted, and required for any organization following Generally Accepted Accounting Principles (GAAP). Requiring an explanation for the accrual method under GAAP will not be useful. Furthermore, for those organizations not following GAAP, this request could be confusing and generate unnecessary information. We recommend organizations not be required to attach a statement of its planned method of accounting, unless they use neither the cash nor accrual methods. Although this information is required on the current Form 1023, in our experience, it is rarely, if ever, (a) submitted with an application; or (b) requested by the reviewing agents.

     

     

     

    C. Public Disclosure Concerns

     

     

     

    Considering today's privacy concerns and the intersection with public disclosure requirements, the request of voluminous, sensitive information on named individuals seems ill-considered. For all approved applications, the complete Form 1023 and all supporting documents become open for public inspection (including all correspondence between the organization and the IRS regarding the processing of the application). Only a very few items are permitted to be excluded from public inspection (see Instructions, page 6). We understand that transparency is desirable in the tax-exempt area. However, it may be unwise to add to the broad availability of information on the Internet at a time in which cases of identity theft are rising. We have concerns about information that is currently, or would be, disclosed from successful applications. Specifically:

     

     

     

    a)     Officer, director and trustee personal addresses. As with the Form 990, officers, directors and trustees should be permitted to use a preferred contact address. We recommend a specific instruction allowing the use of the organization's address.

     

     

     

    b)     Signatures of officers, preparers, and those being granted powers of attorney. While we agree the names of these individuals should be included on the application, copies of their signatures should not be part of ANY public inspection disclosure.

     

     

     

    c)     The CAF numbers. The CAF numbers of those individuals named on a Form 2848 Power of Attorney and Declaration of Representative should not be part of public inspection disclosure. Release of these numbers could allow unauthorized access to confidential taxpayer information.

     

     

     

    d)     Copies of checks. Checks attached to the Form should not be part of ANY public inspection disclosure. They contain not only detailed bank account information on an applicant, but also an authorized signers' signature. This is a major concern; one of our members recently received a copy of such a check as part of an IRS response to a Form 1023 copy request.

     

     

     

    e)     Part XI, Item 6(b.) The Form requires an organization requesting a definitive public charity status ruling to attach specific information that includes donor/payer-identified amounts. If this information is not redacted from public inspection copies, its release contradicts the general premise that donor/payer-identifying information is not subject to public disclosure. We note that the Form 990, Schedule B specifically excludes donor-identifying information from the public disclosure requirement. Requiring donor/payer information on the Form should only if done if an exclusion from public disclosure is explicitly provided.

     

     

     

    f)       Part XI, Item 7. Similarly, an applicant who notes an unusual grant is required to list the name of the donor/payer and the amount they remitted. As noted in the preceding paragraph, donor/payer-identifying should not be required unless an exclusion from public disclosure is explicitly provided.

     

     

     

    D. Miscellaneous

     

     

     

    Part XI, Item 6. Organizations are asked to extend the statute of limitations on certain tax issues and for certain years, without specifying the actual dates involved. This may be confusing to applicants and we suggest that dates be added.

     

     

     

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    III. Technical Accuracy

     

     

     

    A. Part VI. The redesigned Form distills the "organizational requirement" down to the two regulatory provisions (Regulation Sections 1.501(c)(3)-1(b)(1) and (4)). The questions in Part VI ask for language meeting the organizational purpose limitation and dissolution/dedication of assets set forth in the regulations. However, it is our experience that two additional paragraphs are required by the IRS Determinations Group: one stating a prohibition on "any other activities not permitted to be carried on by a corporation exempt under 501(501(c)(3)", the other prohibiting "private inurement". The Instructions need to clarify if these provisions will in fact, be required. We also recommend conforming the statements on the required organizational document language in the Form, its Instructions and Publication 557.

     

     

     

    B. Part VI. We suggest adding information to the Instructions and questions on the Form on language appropriately limiting lobbying and prohibiting political activity in the organizing documents, if these limitations will be required.

     

     

     

    C. Part III, Item 3. The question should be revised to ask "Do you now, or do you plan to, compensate officers, directors or trustees?"

     

     

     

    D. Part VIII. As mentioned earlier, we believe that Part VIII's list of "yes/no" questions should appear within the Form, after the Narrative of Activities (Part IX in the draft). In addition, we suggest that these questions each be cross-referenced to appropriate background information (e.g., applicable rulings or cases) in order to allow an applicant to apply these to the organization's specific operations.

     

     

     

    E. Part VII, Item 5, asks, "Are you submitting this application more than 27 months after the date you were legally formed?" Technically, the rule provides "27 months from the end of the month" in which the organization was formed (Regulation Sections 1.508-1(a)(2) and 301.9100-2(a)(2)(iv)).

     

     

     

    F. Miscellaneous

     

     

     

    Part V, Item 4. Trusts do not ordinarily have bylaws. The request for bylaws should be included within both Items 2 and 3 and removed from this item.

     

    Part VI, Item 1. We suggest using the phrase "charitable, educational, religious, scientific or other Section 501(c)(3) purpose" to parallel the statute.

     

    Instructions, Page 3. The Section 509(a)(1)/170(b)(1)(A)(vi) alternative "facts and circumstances" test should be included here.

     

     

     

    Instructions, Page 3. The description of Section 509(a)(2) nonprivate foundations should be corrected to state that they must receive "more than one-third of its total support from gifts, grants…."

     

     

     

    Instructions, Page 7. The information on Canadian organizations appears to contradict the procedures set forth in IRS Notice 99-47.

     

     

     

    Instructions to Part III, Item 5. The question uses the term "substantial influence". The related Instructions provide a definition of the term that is neither referenced to, nor consistent with Section 4958(f). Thus, public charity applicants may interpret incorrectly. Private foundation applicants should be referred to Chapter 42 rules on "disqualified persons". We believe this term and the related instructions will be confusing to applicants.

     

     

     

    Instructions to Part V, Item 3. The text regarding limited liability companies is very confusing. We suggest this be rewritten to clarify that LLC applicants need to submit their organizing documents.

     

     

     

    IV. Sufficiency of Information

     

     

     

    A. Although we believe that the revised Form will elicit more complete and relevant information, we note that the overlay of a "Yes/No" question format, along with Instructions that point out areas of qualification-sensitive information may have an unintended effect of suppressing full disclosure. The format and Instructions point applicants in the direction of "correct" answers with respect to their intended activities. Furthermore, if the voluminous level of detail required with respect to the financial disclosures is maintained, this format and such detail will encourage organizations to apply for tax-exempt status as early after formation as possible. This would occur because it arguably would be to an organization's advantage to apply before employees are hired and advisors retained, if for no other reason than to limit the cumbersome, detailed disclosures.

     

     

     

    B. We acknowledge transactions that carry a risk of inurement or private benefit will be addressed in greater detail through questions in Part III. However, we expect that the revised Form will point applicants to adopt a "less is more" approach in answering the Form's questions. Thus, the apparent goal of increased disclosure may not be accomplished.

     

     

     

    C. While we agree the redesigned Form is an improvement over the existing Form 1023, we are concerned that there will continue to be a lack of appropriate scrutiny of an applicant's actual (rather than projected) programmatic and administrative operations.

     

     

     

    See Section VI for proposed alternative process.

     

     

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    V. Other Comments

     

     

     

    A. The redesigned Form and Instructions are heavily skewed toward public charities (which we understand are the vast majority of all applicants). Rather than add extra weight to the application package to address private foundations, we suggest that a separate "Form 1023-PF for Private Foundations" be developed. A separate Form 1023-PF would allow certain schedules on the redesigned Form to be eliminated. The Form 1023-PF would focus on those items necessary to grant tax-exempt status to private foundations. The use of two forms would allow the Instructions in each to focus on areas of concern for the specific type of organization. For example, information on excess benefit transactions in a public charity context could be provided without risk of confusion with the rules on self-dealing transactions that exist for private foundations; similarly, "disqualified persons" under Section 4958 versus Section 4946 would be distinctly defined and covered on each form. Two forms might also alleviate the situation we now see, where an organization desires to be a private foundation, is granted public charity status at the Service's suggestion, but at the end of the advance-ruling period is determined indeed to be a private foundation.

     

     

     

    B. Part I, Item 6. The Instructions should state that the organization's fiscal year should match the fiscal year identified in the organization's bylaws.

     

     

     

    C. Part VIII. We applaud the addition of more specific questions reflecting current areas of concern and sensitivity regarding operations. We strongly recommend that the IRS review and update this Part on a periodic basis particularly to conform to information learned through the market-segment studies and other Examination initiatives.

     

     

     

    D. Part VIII, Item 1. We believe that a stronger statement should be made regarding the prohibition of political activity.

     

     

     

    E. Part VIII, Item 4. We suggest that the Instruction to this Item specifically ask for agreement(s) with third parties conducting bingo or other gaming operations for the applicant. We also note that the requirement to provide the amount of time spent on gaming operations is burdensome (see next comment). It is of dubious utility when the gaming occurs as a fundraising activity.

     

     

     

    F. Part VIII, Item 5. The item requests "the time you spend on these activities as compared to your total activities." This requirement is burdensome. We are concerned that applicants in a start-up phase will not be able to accurately project this information. Any answers given may be meaningless.

     

     

     

    G. Part VIII, Item 8a. Adding a schedule with the standard follow-up questions regarding tax-exempt bonds would eliminate the need to send a letter and should expedite application processing.

     

     

     

    H. Part VIII, Item 16. This question and its instructions are vague, and would likely result in a loss of clear, useful information. Any organization using Internet-based e-mail could conclude it must answer "yes." The instructions should acknowledge that existing rules governing electronic activity apply to evaluate the nature of activity conducted on the Internet.

     

     

     

    I. Schedule B, Section II. In our experience, schools often apply for tax-exempt status prior to beginning their operations. Typically this is so they can raise funds to support the school's infrastructure needs, etc. In a start-up phase, is can be extremely difficult to predict the future demographics of yet-to-be-enrolled and yet-to-be-hired employees.

     

     

     

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    VI. Proposed Alternative Process

     

     

     

    We commend the Form 1023 redesign team for thoughtful improvements evidenced in the redesigned Form and its greatly enhanced Instructions. The redesigned Form may allow more cases to be merit closed and hopefully free up IRS personnel to perform additional oversight of exempt organizations. We are concerned that the enhancements to processing of exemption applications, without corresponding validation of actual operations after start-up, may only further erode the public's confidence in the operations of the charitable sector.

     

     

     

    As stated earlier, we believe many applicants avoid potential questions about qualification by narrowly describing present and future intended operations. In turn, such a presentation, albeit in good faith, unduly approves an ideal version of operations that may never materialize. It is generally recognized that whatever activities the applicant eventually conducts are unlikely to be subjected to further IRS review or audit. Realistically, the redesigned Form 1023 cannot remedy the applicants' idealization of operations or the infrequency of exempt organization audits. Evaluating applications based on planned, but not implemented, programs is not an effective use of IRS resources, nor does it achieve compliance or accountability.

     

     

     

    We have a proposal that we believe addresses these deficiencies. We suggest changing the determination process to bring additional scrutiny to the actual programmatic and administrative operations of organizations that have been issued determination letters. Our concept is to provide "Universal Advanced Rulings" (UAR's) that would be issued upon an applicant showing it meets the organizational requirements of Section 501(c)(3) (e.g. satisfactorily completing the redesigned Form's Part VI). A UAR would require that after a specific period of time, the IRS Determination Group review the actual operations conducted by the applicant. At that time a determination of ongoing tax-exempt status under Section 501(c)(3) would be made. More specifically, we envision the following:

     

     

     

    Based upon a shorter Form 1023 focused on Section 501(c)(3)'s organizational requirements, grant a provisional determination effective for a time-limited period (the UAR); we suggest the same five-year period now used for Sections 509(a)(1), 170(b)(1)(A)(vi) or 509(a)(2) advance rulings. We hope this could be done using a reduced number of personnel within the existing IRS Determinations Group.

     

    A definitive ruling for those organizations defined in Section 170(b)(1)(A)(i)-(v) could be provided by requiring such organizations to complete the redesigned Form 1023.

     

     

     

    Organizations granted UAR's would be required to annually submit supplemental information patterned upon the questions contained in Parts II, IV and VIII of the redesigned Form. Ideally, this requirement would be met through an attachment to Form 990. The benefit is that the questions would be answered based upon the applicant's actual activities. This submission (and Form 990) would be required regardless of the level of an organization's gross receipts during the UAR and would be subject to public disclosure.

     

     

     

    Near the end of the UAR's term, the IRS Determinations Group or the Examinations Division would conduct a correspondence audit of the filed Forms 990 (including the supplemental information submitted as described above). The organization would be referred to for a field audit if information raises the concern that qualification for ongoing tax-exempt status may be in jeopardy. In the absence of such concerns, a determination of ongoing, non-provisional tax-exempt status would be made.

     

     

     

    We believe such a revised process will provide the IRS, other regulatory bodies, and the public-at-large with better information to evaluate an organization's Section 501(c)(3) initial qualification and ongoing compliance. Answering specific activity-related questions annually based upon an organization's actual (rather than prospective or intended) conduct of operations, will assuredly lead to better quality information. Requiring applicants to (1) report annually on their organization's compliance with the Section 501(c)(3) qualification mandates; and (2) to address how potentially sensitive operations are conducted or implemented will result in increased education of the charitable sector as well as the public-at-large's confidence in its integrity. In addition, ongoing reporting will result in continued education of organizations and their founders, officers, directors and trustees. It will also provide the public with additional specific, current information with which to scrutinize exempt organizations.

     

     

     

    We believe it would be a dramatic improvement to the Determinations process if close-to-contemporaneous detailing of actual operations to further evaluate an organization's qualification were used. We believe this process would not only better serve applicants and the public-at-large, but it would also overcome the issue of unreliable reporting of operational information based upon planned rather than actual operations.

     

     

     

    We appreciate your consideration of our comments and urge you to redesign the determination process as soon as practicable. If we can be of further assistance please contact Mary Rauschenberg, AICPA Panel member and Chair of the Form 1023 Task Force, at (312) 242-9544, or mrauschenberg@deloitte.com; Lisa A. Winton, AICPA Technical Manager, at (202) 434-9234, or lwinton@aicpa.org; or the undersigned at (713) 523-5767, or jody@bvcpa.com.

     

     

     

    Sincerely,

     

     

     

    Jody Blazek

    Chair

    AICPA Tax Exempt Organization Taxation Technical Resource Panel

     

     

     

    Task Force Members

     

     

     

    Jody Blazek

    Eve Borenstein

    Diane Cornwell

    Sandy Deja

    Trisha Goeke

    Mary Rauschenberg, Task Force Chair

     

     

     

    cc: Cindy Westcott, IRS-TE/GE (Exempt Organizations Division), Former Leader, Cincinnati Determinations Customer Satisfaction Team

    Lois Lerner, IRS-TE/GE (Exempt Organizations Division), Director, Rulings and Agreements

    Victoria Bjorklund, Chair, American Bar Association Section of Taxation Exempt Organizations Committee; Member, IRS' Advisory Committee TE/GE

    Betsy Buchalter Adler, Vice-Chair, American Bar Association Section of Taxation Exempt Organizations Committee

     

     

     

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