Is it too easy for a small group to become a 501(c)(3)?
For personal reasons, part of me wants the process to form a 501(c)(3) as simple as possible. I volunteer with the local high school’s parent-teacher organization (PTO), and by this time next year the organization must secure its tax-exempt status as a nonprofit public charity advancing education.
That’s because our school district will no longer manage the financial assets of our PTO or those of the 9 other PTOs and booster organizations that serve district families and students. It has advised the organizations to seek special tax status to (1) pay no income, employment, or sales tax, and (2) receive charitable contributions that an individual or corporate donor can deduct from their income taxes.
Some of my volunteer colleagues are confident that establishing and running a tax-exempt organization is “easy” and the application process is straightforward. Since organizations in our district all have annual income under $50,000, subsequent annual reporting would be very simple.
But if we care about who pays—or doesn’t pay—taxes and why, should becoming a tax-exempt organization be easy? Or should it be a bigger deal?
Why 501(c)(3) status is available, and who might apply
Our tax system has long favored the idea of “charity,” with roots in the Elizabethan Statute of Charitable Uses, enacted in England in 1601 to protect and prevent the misuse of funds used to help those in need. Flash forward a few centuries. The Tariff Act of 1894, the Revenue Acts of 1917, 1936, and 1954, and other legislation established the many types of organizations that can secure nonprofit, tax-exempt status under Section 501(c)(3), including the status our PTO seeks as a public charity.
Our PTO collects donations from members of the community to support the education of schoolchildren. In general, tax-exempt purposes, according to the IRS, can include (emphasis added): “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”
Volunteers serving our PTO do not benefit personally from the PTO’s operations, nor does our PTO seek to influence legislation or any political campaign. Plus, our revenue—though a small amount—largely exceeds our expenses. Seeking tax-exempt status under Section 501(c)(3) seems to make sense.
The IRS explains how to apply here as a “parent and teacher group” with the standard Form 1023, a 26-page form with a 40-page instruction manual. The application fee is $600. But for a small organization like ours that expects less than $50,000 in annual gross receipts over each of the next three years, we can instead apply online using the three-page Form 1023-EZ and pay a $275 application fee. Form 1023-EZ has been available since 2014, released as a solution to the IRS processing backlog of Forms 1023.
Did that solution create another problem?
The simpler option sounds like a good deal. But in October, 2022, the Treasury Inspector General for Tax Administration (TIGTA) determined that the IRS needs more information to make informed decisions about streamlined applications for tax exemption.
TIGTA found that the IRS was approving organizations for tax-exempt status that may not qualify, in part because Form 1023-EZ allows for a 250-character description of an organization’s mission and most significant activities. For some context, this paragraph contains about 250 characters.
TIGTA also noted, “Form 1023-Z requires applicants to attest, rather than demonstrate, that they meet the requirements for IRC § 501(c)(3) status.” In other words, our PTO would simply have to say that we have bylaws. We wouldn’t have to submit supporting documentation. We don’t have to submit such proof to our home state of Michigan, either.
TIGTA also reported that the IRS examines the compliance of only 1 percent of tax-exempt organizations each year, so the agency has little assurance that it did not approve tax exemptions for fraudulent organizations or those involved in illegal activities.
In response, the IRS said it would assess the feasibility of requiring applicants to submit organizational documents but concluded detailed activity descriptions are unnecessary to make determination decisions.
Where does that leave small groups like our PTO?
While I can’t say for certain, I’m fairly confident the IRS would approve our PTO’s application for tax-exempt status as a 501(c)(3) organization. Indeed, the IRS would probably approve the applications submitted by the other PTOs and booster organizations in our school district.
But then what? For starters, every year, the organizations will submit an annual information return with the IRS. The information return is the IRS’s primary way to collect data about tax-exempt organizations, educate organizations about tax law requirements, and promote compliance.
On the bright side, the organizations in our community likely would not need to file the longer information return known as IRS Form 990. Instead, they could file IRS Form 990-N, given future modest gross receipts (it’s just an ePostcard). And of course, the organizations would be exempt from taxes. Since they have no employees, the benefit of tax exemption would apply only to Michigan’s 6 percent sales tax.
But, beyond the TIGTA’s concerns, there’s a downside to easily securing and maintaining 501(c)(3) status: competition. Our high school’s PTO will, as an independent organization with its own tax status, compete against other district PTOs for tax-deductible donations from charitable-minded individuals and corporations. I’ve been a volunteer for parent-teacher organizations for about 15 years. I’m certain that won’t be easy.
The Tax Hound, publishing once a month, helps make sense of tax policy for those outside the tax world by connecting tax issues to everyday concerns. Have a question or an idea? Send Renu an email.
