As anticipated, the Internal Revenue Service announced a streamlined, much simpler and shorter version of Form 1023, the Application for Recognition of Tax Exempt Status.
Standard Form 1023
The standard Form 1023 is 26 pages long, not counting a 38-page instruction booklet, 3 additional pages of instructions the IRS has added to the front of the form making changes to the form and the instructions, and a 2-page checklist to make sure the entire submission package is complete and compiled in the correct order. But that’s not all — one of the most important sections of the form, Part IV, is only about a quarter-page long but it calls for the applicant to attach a detailed narrative description of the organization’s activities explaining how each of them supports the organization’s charitable purpose, and several other sections leave so little room to include all the necessary information that most applicants find it necessary to attach addtional pages. With all that, and with the other information that must be submitted, such as articles of incorporation and bylaws, Form 1023 submission packages can easily reach 50, 60, or 70 pages.
The IRS says that they currently have a nine-month backlog of Form 1023 applications, and it is possible that number is actually an understatement. Once received by the IRS, Form 1023 applications go through a sort of triage process. Applications that are complete and do not appear to pose significant obstacles to approval are directed into a queue to be processed more quickly than applications that will require the IRS to request significantly more information. Just this week our office received a determination letter for a Form 1023 that had been pending for more than seven months, and that application was, presumably, directed through the quicker process.
In contrast, Form 1023-EZ is less than three pages long, although that is a little misleading because it still requires an instruction booklet with 10 pages of instructions to explain how to complete the form, a 7-page worksheet that must be completed in order to determine if the organization is eligible to use the streamlined form, and a 3-page list of National Taxonomy of Exempt Entities (NTEE) Codes from which the applicant must select the code that best fits the organization. Nonetheless, Form 1023-EZ should be considerably less burdensome than the standard form.
After completing the worksheet, the applicant must file the form online at www.pay.gov, which requires a username and password obtained through free registration. Any applications submitted on paper are automatically deemed incomplete.
Most organizations with annual revenues less than $50,000 for the current year, each of the previous three years, and the next two projected years are eligible to submit Form 1023-EZ. However, some types of organizations must submit the standard Form 1023 regardless of revenues. Here is a partial list of organizations that are ineligible for Form 1023-EZ:
- Those organized as limited liability companies.
- Churches and associations or conventions of churches. (Note: Churches are not required to submit an application for recognition of tax exempt status, but if they do not, they will not have a determination letter from the IRS, which can be useful for various reasons. Those that wish to receive a determination letter will continue to submit Form 1023 rather than 1023-EZ.)Schools, colleges, and universities.
- Hospitals, medical research organizations, and hospital organizations.
- Health maintenance organizations (HMOs).
- Accountable care organizations (ACOs).
- Supporting organizations (i.e., charitable organizations that are derive their status as public charities from their supporting relationship to another charitable organization that is a public charity).
- Credit counseling organizations.
- Organizations that have previously had their tax exempt status revoked except organizations that have had their tax exempt status revoked for failing to file Form 990 (or 990-EZ or 990-N) for three consecutive years.
That last part is significant because many smaller organizations have lost their tax exempt status for failure to file Form 990, and Form 1023-EZ will be available to those wishing to have their tax exempt status reinstated.
I just read a report by the Small Business Administation that includes a wealth of statistics and other information about small businesses in the United States. As useful as the report is, it contains a mistake that, although commonly made, one would not expect from the SBA. The last item in the report asks the question, “What legal form are small businesses?” That’s a good question, but the SBA didn’t answer it. Instead, it answered another question, “What is the tax status of small business?” Even though the two questions are related, they are nonetheless distinct, and answering the second question does not answer the first.
Legal Form of a Business or Nonprofit
As we’ve discussed before, businesses are commonly organized according to one of a handful of legal forms: sole proprietorships, general partnerships, corporations, and limited liability companies. There are a few others used less frequently, including limited partnerships, limited liability partnerships, and professional corporations. Tax exempt organizations are commonly organized as nonprofit corporations, but they can also be organized as unincorporated associations, charitable trusts, and sometimes limited liability companies.
The legal form of a business or tax exempt organization is primarily related to two fundamental attributes: who controls the organization, and who is liable for the organization’s obligations. For example, if a business is structured as a general partnership, the partners collectively control the business and the partners are individually liable for the obligations of the partnership. In contrast, if a business is structured as a corporation, it is probably controlled by a board of directors, elected by the shareholders and acting through the officers. As long as things are done properly, neither the shareholders, the directors, nor the officers are liable for the corporaton’s obligations.
Although selecting the legal form of an organization determines the attributes of control and liability, it does not determine how much income tax the organization must pay. That is determined by the particular subchapter of Chapter 1 of Subtitle A of Title 26 of the United States Code (also known as the Internal Revenue Code) that applies to a particular business or nonprofit. There are four common possibilities: Subchapter C (the default provisions for corporations), Subchapter S (which is an alternative to Subchapter C that can be elected by small business corporations that meet the eligibility criteria), Subchapter K (for partnerships), and Subchapter F (for tax exempt organizations). There is actually a fifth possibility because some types of legal forms that have a single owner, such as sole proprietorships, are diregarded for income tax purposes, with their income reported on the owner’s income tax return. Those businesses or nonprofit organizations are known as, appropriately enough, “disregarded entities.”
A common source of confusion is that there is not a one-to-one correspondence between the type of entity and the tax status, and you may have noticed that there is no tax status called “LLC.” Depending on the number of members in the LLC and some other factors, LLCs may be taxed as disregarded entities, as partnerships under Subchapter K, as corporations under Subchapter C, or as small business corporations under Subchapter S. In fact, most forms of organization have more than one choice for tax category, as shown in the chart below. (We’ve indicated that a sole proprietorship is taxed as a disregarded entity, which is technically not correct because there’s no entity to disregard. But for practical purposes a sole proprietorship is the treated the same way as a disregarded entity owned by an individual.) Even nonprofit corporations have more than one possibility; while most nonprofit corporations are organized with the intent of qualifying for Subchapter F (exempt organizations), if a nonprofit corporation fails to meet the criteria for tax exemption, it will be subject to taxation under Subchapter C.
Now you won’t make the same mistake that the SBA made.
[Note: The above table was corrected on May 7, 2015 to include all the possibilities for the tax status of partnerships.]
The Internal Revenue Service’s application for an employer identification number (or EIN) requires the applicant to submit the name and tax identification number (usually a social security number) of the applicant’s “responsible party.” That is true whether the application, Form SS-4, is submitted on paper or online, and it is true for any type of organization applying for an EIN, including corporations, limited liability companies, partnerships, trusts, and tax exempt organizations. That is the last time most organizations ever think about the “responsible party.” Until now.
On May 6, 2013, the Internal Revenue Service published a final rule that requires any business, nonprofit organization, trust, or other entity with an EIN to report any change in the entity’s responsible party. Here are the answers to some questions that essentially every business and tax exempt organization should know.
Who is a “responsible party”?
The answer differs a bit for various types of organizations. For companies with shares traded on a public exchange or securities registered with the U.S. Securities Exchange Commission, the responsible party is defined fairly unambiguously:
For corporations, the responsible party is the principal officer.
For partnerships, the responsible party is a general partner.
For trusts, the responsible part is the trustee, grantor, or owner.
For disregarded entities, the responsible party is the owner.
For other entities, the definition is more ambiguous:
The responsible party is “the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets.”
For business corporations, the responsible party may be the president or chairman of the board; for LLCs, a member; for partnerships (including limited partnerships, such as family limited partnerships), a general partner.
The issue of identifying a responsible party for a nonprofit organization may be particularly problematic because, in many organizations, no single person who has the authority to control, manage, or direct the organization and — in particular — to control the disposition of its funds and assets. In fact, we often tell the boards of directors of our nonprofit clients that, collectively, they have full authority to control the organization but, individually, they have no authority at all. Even so, the IRS requires the designation of a responsible party, and the organization must decide who best fits the definition. For some organizations, that may be the executive director or CEO; for others, it may be the president or chairman of the board.
Our LLC has three members, all with the same rights and authority. Who is the responsible party?
If more than one person qualifies as a responsible party, the entity must select one of them by whatever criteria the entity chooses.
When and how must changes be reported?
As of January 1, 2014, any change in an entity’s responsible party must be reported on IRS Form 8822-B within 60 days after the change takes effect. Changes made prior to January 1, 2014 must be reported before March 1, 2014.
Our organization obtained an EIN years ago, and we have no idea who was listed as the responsible party. But Form 8822-B requires us to list not only the new responsible party, but also the old one. What do we do with that?
The best course is probably to submit Form 8822-B without the information about the old responsible party and attach a statement explaining what you have done to locate the information and why it is unavailable despite those efforts. [Revised February 21, 2014, to include the idea of attaching a statement — a suggestion from James W. Foltz, Attorney at Law, of Indianapolis, Indiana.]
Our nonprofit has filed Form 990 (or 990-EZ or 990-N) every year, and we always have to list the organization’s principal officer. Isn’t that good enough?
From what we know at the moment, probably not. Even if the responsible party and the principal officer are the same person, Form 8822-B calls for the responsible party’s social security number, but Form 990 does not. The same thing is true for the tax matters partner identified on Form 1065 filed by partnerships and by LLCs taxed as partnerships.
I called the IRS and tried to get some more specific information about the new reporting requirement, and the person I spoke with had never heard of this new requirement. Are you sure about it?
We had the same experience, but, yes, we’re sure. We hope the IRS will issue guidance that clarifies some of the details, but we’re sure the rule is in effect.
What happens if we do not file Form 8822-B or file it late?
That’s the good news. As far as we can tell, there is no penalty for failing to file or for filing late. Even so, everyone with an EIN, including small businesses and tax exempt organizations, should comply with the rule using the best understanding of the requirement and the best information available.
If you use a vehicle for business, medical, or moving purposes, or in providing volunteer services to a charitable organization, you may be able to deduct at least a portion of the cost on your income tax return. There are two alternatives for calculating the amount of the deduction, but the simplest is to keep track of the number of miles driven and multiply by the appropriate standard IRS mileage rate.
The standard mileage rates are based on an annual study of the costs of operating a motor vehicle, conducted by the IRS and an independent contractor. The information used in deriving the standard rate for business purposes include both fixed and variable automobile costs, such as insurance, fuel, maintenance, and repair costs. Only variable costs are considered in calculating the standard rate for medical and moving purposes. The charitable rate is fixed by statute.
What are the rates?
Businesses and nonprofit organizations that have recently hired unemployed veterans and those that do so before 2013 may be eligible for a tax credit of as much as $9,600 for each unemployed veteran hired by a business or as much as $6,240 for each unemployed veteran hired by a qualified tax exempt organization. Qualifying businesses will receive a credit against income tax, and qualifying tax exempt organizations will receive a credit against the employer’s share of Social Security tax.
The tax credit is a result of the bipartisan VOW to Hire Heroes Act of 2011, unanimously passed by both houses of Congress and signed by the President on November 21, 2011, which expanded the Work Opportunity Tax Credit (or “WOTC”) to include certain classes of unemployed veterans. The amount of credit available depends on the length of time the veteran was unemployed before being hired, the number of hours the veteran works, the amount the veteran is paid in the first year of employment, and whether the veteran has a service-related disability.
Businesses and tax exempt organizations that wish to take advantage of the tax credit need to be aware of two critical deadlines. You will not get the tax credit if you fail to meet either one:
- First, the expanded tax credit expires at the end of the year. The veteran must start work on or before December 31, 2012.
- Second, the employer must file certain forms within 28 days after the veteran starts work. (Other rules were in place for veterans hired before May 22, 2012.) Different forms are required for businesses and for tax exempt organizations. The process of for claiming the credit, including a list of the required forms, is summarized here.
The IRS has provided several other sources of information on the WOTC for veterans, including a list of frequently asked questions and a detailed description of the WOTC. You should also consult your tax advisor.
The Internal Revenue Service has announced the following standard mileage rates used to calculate income tax deductions for business travel expenses and for travel expenses incurred while serving charitable organizations.
- Business, $0.565 per mile
- Charitable service, $0.14 per mile
Last November I wrote about a new law that expanded the requirement to issue Form 1099 to include reporting of payments made to corporations and to suppliers of goods. The law was set to go into effect for payments made in 2012. In January I wrote that Representative Dan Lungren (R. California) had introduced a bill to repeal the new requirement. On April 14, President Obama signed Congressman Lungren’s bill into law, eliminating the expansion of the reporting requirements.
[This is the last of a seven-part series of posts discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here’s the entire list.
Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company’s owners are not liable for the LLC’s obligations.
Part 6. Options for an LLC’s management structure.
Part 7. Options for an LLC’s tax treatment.]
In prior posts, I’ve discussed several characteristics of LLCs. First, like corporations, LLCs are entities separate from their owners. Second, also like corporations, the owners are not liable for the obliigations of the LLC. Third, they offer choices of management structures: They can be managed directly by the owners, like sole proprietorships and many partnerships, or they can be managed by others who are selected by the owners, in much the same way that shareholders of a corporation elect directors to run the business. This last post of the series looks at the tax characteristics of LLCs.
Interestingly, LLCs do not have a specific category in the Internal Revenue Code or the Tax Regulations. Instead, their tax treatment is governed by the so-called “check-the-box regulation.” It provides that the LLC may elect to be treated in one of several ways, and the choices depend on whether the LLC has one member or more than one member.
The default status for a single-member LLC is that it is a “disregarded entity” in that all the income and expenses go directly on the member’s personal tax return, just like a sole proprietorship. The LLC itself doesn’t even have to file a tax return. The default status for a multi-member LLC is to be taxed as if it were a partnership. Alternatively, either a single-member LLC or a multi-member LLC can elect to be taxed as if it were a corporation, either as a Subchapter C corporation or, if the LLC meets certain criteria, as a Subchapter S corporation. To decide which is the best tax strategy for your LLC, you should consult both your lawyer and your accountant.
As discussed in my post of November 24, businesses and nonprofit organizations face a significant increase in the requirements to issue 1099 forms beginning with payments made after December 31, 2011. However, a lot could change between now and then. Several legislators introduced bills during the previous session of Congress that would have dramatically reduced the new reporting requirements or even repealed them altogether. Although none of them passed, similar bills are being introduced again in the new session.
Representative Dan Lungren (R. California) originally introduced a repeal measure last April, just one month after the original legislation was passed, but was unable to obtain the signatures necessary for a vote on the matter. Rep. Lungren re-introduced his bill to repeal the 1099 tax provision earlier this week and plans to continue fighting against the new tax provisions. The bill, referred to as “The Small Business Paperwork Mandate Elimination Act,” has 180 co-sponsors and was one of the first bills to be introduced during the 112th Congressional Session.
Other members of Congress have sought to lighten the impact of the reporting changes without repealing them altogether. Senator Mary Landrieu (D. Louisiana) introduced a bill last September that would increase the reporting threshold from $600 to $5,000. Senator Landrieu has yet to re-introduce the bill, but it is likely that similar efforts will begin to surface in the new Congress.
Many organizations representing small business owners have also shown great concern about these changes, which increases the possibility of amendments or a total repeal before next year. Continue checking back here for updates on the 1099 reporting requirements and how they will affect your small business or non-profit organization.