With the November 15th due date for not-for-profits (original due date for 6/30 year-ends, extended due date for12/31’s) just around the corner, it’s a good time to take a look at what message your organization’s tax return is sending. In years past, Form 990 was considered no more than a compliance task; an annual filing requirement to keep the IRS at bay. After all, there is no tax due, so what’s the big deal? The big deal is, people are watching.
For as long as most can remember, there have been public disclosure requirements for Form 990. Internal Revenue Code §6104 requires exempt organizations to make the prior three years of tax returns, Form 1023 and IRS Determination Letter available to the public. However, what used to be a request made by mail or in person with charities charging for each page is now instantly available with the click of a mouse. IRS Info Release 2016-87 guaranteed that 100% of filed Form 990’s would be downloadable and searchable by the public through Amazon Web Services. In addition to the public, media, and federal and state regulators, watchdog sites like GuideStar, Charity Navigator, Better Business Bureau Wise Giving Alliance, and Charity Watch analyze thousands of 990’s with the goal of helping donors make informed giving decisions. These organizations post return copies, ratings, rankings, evaluations, financial metrics and comparative analytics.
So if people are watching, what are they looking for? While financial statements focus on the numbers, Form 990 digs much deeper. The tax return uncovers details on your mission, program service accomplishments, governance, management practices, compensation, political activities, related organizations, transactions with insiders, percentage of G&A costs, fundraising dollars spent, unrelated business income amounts and much more.
Let’s look more closely at a handful of areas on Form 990 along with compliance tips that can help make sure you are optimizing the message it sends to its readers:
Part I – Summary
- Develop an attention grabbing, heartstring tugging, succinct description of your mission that shouts your purpose to the world (and fits on line 1).
- Make sure to accurately reflect the independence of your board members. If they are not independent your return should contain additional disclosures such as Schedule L and/or R.
Part III – Statement of Program Service Accomplishments
- This page should be one of your primary marketing tools. Go into great detail on your vision, mission, programs and accomplishments. Make the reader want to join your cause and donate.
- Answer yes to questions 2 and/or 3 if you had new or changed program service accomplishments. Use schedule O to describe them and why the revenue generated is not UBI. This is a way to inform the IRS of smaller shifts in purpose without requesting a new determination letter.
Part IV – Checklist of Required Schedules
- Although tempting, don’t just answer all the questions the same as last year. Read through them carefully.
- Pay special attention to questions concerning related/controlled entities, excess benefit transactions, political activities, special events and professional fundraising.
- For any yes responses make sure to complete the associated schedule for additional disclosures.
Part V – Statements Regarding Other IRS Filings and Tax Compliance
- The number of employees should include those paid by the organization as well as payroll agents and common paymasters.
- If Line 3a is checked yes, file Form 990-T even if the activities do not result in taxable income.
Part VI – Governance, Management and Disclosure
- The public and watchdog groups will look here to make sure you have good policies, procedures and controls in place.
- Know the rules for whether or not a board member is independent. Additional disclosures will likely be required for any that are not.
- Take advantage of Schedule O to highlight the details of your policies and how they are enforced and describe how your top management’s salaries are determined.
Part VII – Compensation of Officers, Directors, Trustees, Key Employees, Highest Compensated Employees and Independent Contractors
- Be aware of the rules and salary thresholds around who is and who is not required to be listed here.
- Check the appropriate position for each employee even if it doesn’t match how the organization views them. The top management official (CEO, executive director) and top financial officer (CFO, treasurer) are officers for 990 purposes.
- Report numbers consistently with related organizations and on Schedule J.
- Note that reporting on Part VII is based on the calendar year end that falls within your tax year even if you are a fiscal year filer, so there can be discrepancies between wage amounts here and on Part IX.
PART VIII – Statement of Revenue
- Categorize your contributions correctly among lines 1a-1f, then note any non-cash amount included on any of those line items on line 1g. Schedule G will be required if this number is >$25,000.
- Report all revenue sources in the proper columns between related/exempt function, UBI, and excluded.
- Capture the contribution portion of revenue received at fundraising events on line 1c instead of including on line 8a.
- Verify all UBI assumptions annually and make sure Column (C) matches your 990-T.
- Do not blindly follow the financial statements, but be able to reconcile between the two (Schedule D).
- Avoid placing significant amounts in “miscellaneous revenue;” categorize it on other line items as appropriate.
Part IX – Statement of Functional Expenses
- Correctly capture officer, director, trustee and key employee compensation on line 5. This should be based on the organization’s tax year and include amounts received for pension plans, 401(k) match and other benefits received.
- Avoid placing significant amounts in “other expenses;” categorize it on other line items as appropriate.
- Regularly evaluate the allocation of expenses between program, management & general, and fundraising. Donors and others are extremely interested in the percentage of their dollar that funds the mission rather than “overhead.”
Part XI – Reconciliation of Net Assets
- This is where you can show the value of donated services and use of facilities that are not included on the 990.
- Unrealized gain/loss on investments is reflected here, but not included in net income for tax purposes.
- Organizations can complete either Part II or Part III each year if one provides a higher public percentage.
- Carefully monitor substantial contributors and the impact on public support percentage.
- Consider whether any large amounts qualify as unusual grants if applicable.
- Amounts received from donor advised funds qualify as public support even if the underlying individuals would otherwise be disqualified persons.
- Ensure that everything from Part VIII is properly reflected, or excluded, from Schedule A.
- Remember that names and addresses of your contributors can (and should) be redacted on your public inspection copy of the return.
- Contributions from donor advised funds should be treated as coming from the sponsoring organization, not the underlying individuals.
- If the organization meets the Schedule A, Part II public support test (regardless of its primary category of exemption), it qualifies for the “special rule” to only include those donors > 2% of Part VIII line 1h on Schedule B.
- If a “substantial part” of a 501(c)(3) organization’s activities involve efforts to influence legislation, it is at risk for loss of tax-exempt status. Be familiar with the definitions of lobbying and what activities are permitted.
- 501(c)(4), (5), and (6) organizations can engage in lobbying, however if expenses exceed $2,000, they must pay a proxy tax or inform members that a percentage of their dues is non-deductible.
- This schedule is often helpful for board members and management as it highlights the reconciling items between the financial statements and tax return.
- If there are significant amounts of alternative investments (futures, commodities, hedge funds, derivatives, etc.), there may be UBI.
- If the organization engages in foreign activity or it or its employees have signature authority over foreign bank accounts, it may be required to file Form 114 (FBAR). Penalties for missing these filings start at $10,000.
- IRS exemption does not necessarily apply in foreign jurisdictions. Offices, employees or activities abroad can result in income, VAT or other unexpected taxes.
- Maintain proper documentation of all fundraising activities to allow for the separation of the contribution portion of the revenue. This is equal to the excess of the money given over the fair market value of any goods and services received by the donor.
- Development personnel and others are sometimes confused by apparent “losses” from fundraising events showing up on Schedule G. However, adding in the contribution piece shows a more complete picture.
- Do not include salaries or other compensation paid to employees or independent contractors.
- Grants to affiliated disregarded entities should not be listed.
- Assistance to individuals paid through another organization should be included in Part II rather than Part III unless the grants are earmarked for specific individuals.
- Officer compensation levels are very important to the public and watchdog groups who may perceive that too much is going to salary instead of programs.
- Make sure to report deferred compensation, severance benefits, fringe benefits, and compensation from related organizations where applicable.
- Incentive compensation arrangements must be disclosed here, which are often looked at unfavorably by donors.
- This schedule is based on calendar year numbers. Reported W-2 compensation should equal the sum of column (B) (i), (ii) and (iii). Columns (C) and (D) should equal Part VII, column (F).
- If the organization has any outstanding liabilities associated with tax-exempt bond issues, complete and accurate reporting is required especially around use of bond proceeds, private business use and arbitrage compliance.
- It is a good idea to annually discuss responses with bond counsel or tax counsel before filing.
- There are four parts of Schedule L aimed at different transactions with interested persons: Part I – excess benefit transactions, Part II - loans to/from interested persons, Part III - grants or assistance to interested persons and Part IV – business transactions with interested persons. Only Part IV has a monetary threshold.
- Excess benefit transactions for first tier include anyone having substantial influence, second tier includes family members of tier 1 plus entities controlled 35% by tier 1.
- Excess benefit transactions include those with any party considered a disqualified person in the prior five years before the date of the transaction.
- A board member reported on Schedule L of the organization or a related organization is not independent.
- If an individual is included on Schedule L as a result of being a substantial contributor, their name does not need to be included, only “substantial contributor” or “related to substantial contributor” to protect their identity from public disclosure.
- The schedule is only required if non-cash contributions exceed $25,000.
- Items on Schedule M should also be included on Schedule B if reporting thresholds are met.
- The IRS is beginning to focus more on the valuation of non-cash items.
- It is good practice to have a gift acceptance policy to manage the expectation of donors and prevent gifts of items that run counter to your values or are difficult to sell, dispose of or manage.
- The form is usually only filed once in conjunction with an organization’s final Form 990 to detail the final distribution of assets upon ceasing of operations.
- It is near the back, but don’t discount its importance.
- This is your place to shine. Use it as a marketing piece for your vision, mission and accomplishments.
- Provide further explanations on issues that may be of concern to readers.
- Highlight governance with details on 990 review, conflict of interest and other policies, compensation practices and public disclosure of documents.
- Communicate any significant changes to your exempt purpose or activities.
- The purpose of the schedule is to highlight related organizations, transactions with related organizations, and identify unrelated partnerships through which the organization conducts significant activities.
- All activity of any disregarded entities owned by the organization should be included on Form 990, not just the net income.
- Related organizations to be disclosed include parent/subsidiary, brother/sister, supporting/supported, sponsoring organization/contributing employer of a VEBA.
- For control of non-stock NFPs look at who has the right to appoint or remove board members. Also look to overlap of the majority of officers, directors, or employees.
We’ve discussed what the general public is looking for, but how about the IRS? The Service has recently adopted a more data driven approach to exam selection. Each filed return is scanned and analyzed on 200 data points. Those meeting certain criteria are flagged for potential exam. The IRS 2016/2017 work plan estimates that 7,000 exempt organization returns will be examined annually. They report that over 90% of returns selected for audit based on data selection modeling result in adjustments.
Here are some examples of data points on returns that could trigger an exam:
1) Inaccurate or incomplete Form 990 – missing schedules or parts of schedules, mismatch on name/EIN/exemption type, lack of signature
2) Reporting a mortgage on Part C and rental income on Part VIII, but no 990-T to report debt financed income
3) Zero asset balance, but no Schedule N
4) Yes answer to Part VI, Line 5 indicating a significant diversion of assets (fraud/embezzlement concern)
5) Yes response to Part IV, line 3 showing prohibited political activity
6) Checked yes to Part V, line 3a for unrelated business income >$1,000, but no 990-T filed
7) Indication of lack of an independent board leading to possible private inurement or excess benefit transactions (Part VI, line 1b < 50% of line 1a, yes to Part VI, line 2, or reporting of transactions with interested persons on Schedule L, Part IV)
8) Part VI – the IRS provides a “hint” on what it considers best practices. Not having board review of your 990, a conflict of interest policy, a whistleblower policy, a document retention policy and methodology for determining compensation can be a red flag.
9) Loans to/receivables from disqualified persons on Part X, lines 5 & 6 didn’t decrease from the prior year
10) Part IV, lines 25a or 25b checked yes and incomplete detail on Schedule L, Part I and/or no related Form 4720 filed by the disqualified person self-assessing first tier excise tax.
11) Employee compensation is shown on Part VII, but there are no W-2’s listed or there are more 1099’s than W-2’s, it may signal a worker classification issue (employee vs independent contractor).
In addition to statistical selection, the other most common factors used by the IRS to select 990’s for exam include the following:
- Referrals from a current or former employee
- Referrals from a board member or manager
- Referrals from the public (donors, competitors, etc.)
- Press and social media stories and allegations
- Organization’s website/Related organizations’ websites
Despite the fact that there is often no tax due and it is sometimes seen as just a compliance exercise to meet IRS requirements, Form 990 is much more than that. It is often the first place anyone wanting to know more about your organization will turn. It is accessible at the click of a mouse and provides a significant amount of detail. Be proactive and control those details to make them depict your organization in its most positive light. Charitable contribution dollars are limited so anything you can do to stand out can have an impact. Form 990 should be a group project with the board, management and tax preparers working together to minimize exposure, present a consistent message, and market your not-for-profit to the many audiences that are reading it. CBIZ has a dedicated not-for-profit tax team who shares your passion for making a difference in the community and would welcome the chance to partner with you to make sure you are perfectly positioned to achieve your mission. Please reach out to us if we can help you with your 990 or any other tax related issue.