1. Good Governance: The IRS’s goals for Form 990 are increased transparency, good governance and increased accountability for filing organizations. Form 990 requests information regarding an organization’s governing body and management, governance policies and disclosure practices.
Although federal tax law does not mandate these policies and practices, every organization is required to answer each question. Answering these questions “No” may be perceived negatively by the public because of an expectation that a prudently managed organization would have the following specified policies:
• Conflict of interest policy;
• Whistleblower policy;
• Document retention policy;
• Process for determining compensation;
• Joint venture policy.
Organizations that do not have these policies and procedures in place may want to implement them, even though they are not required by the IRS, to avoid potential public and potential donor misperception about their stewardship.
2. Review of the Form 990: An organization is not required by federal tax law to provide a copy of the Form 990 to its board or governing body, or to have them review the form before it is filed. However, the IRS believes board review is a fiduciary duty and encourages board members and executives of nonprofits to review and understand what is being filed each year. All organizations must answer on Form 990 about the organization’s process, if any, that it used to review the Form 990.
3. Not All Tax-Exempt Organizations are Charities: There are more than 50 different 501(c) classifications that organizations can be, depending on its purpose and activities. For example, business leagues receive a 501(c)(6) designation, while social clubs receive a 501(c)(7) designation. 501(c)(3) organizations are exempt from federal income tax as charitable organizations. The major difference between charities and other tax-exempt organizations is that contributions made to charitable organizations by individuals and corporations are tax deductible.
In addition, public charities may not be subject to some state and local sales tax. It is important to identify the type of tax-exempt organization, since the requirements on Form 990 differ for each type of organization.
4. Not All Income Earned by Nonprofits is Tax-Exempt: Even though an organization is recognized as tax exempt, it still may be liable for tax. The organization may be subject to unrelated business income tax (UBIT) if the activity is regularly carried on and is not substantially related to the entity’s exempt purpose. The primary purpose of UBIT is to put tax-exempt entities and “for profit” enterprises on equal footing with respect to their trade or business activities.
Before entering into new business ventures, investments and other activities, it is important to consult with your tax advisor. In addition to UBIT, an organization may be subject to the following taxes:
• State income tax;
• Local business taxes (i.e. Philadelphia, New York City taxes)
• Payroll tax;
• Sales tax.
5. Functional Expense Allocation: Form 990 Part IX reports expenses in three categories:
• Program service;
• Management and general;
Some costs incurred by an organization clearly relate to a specific program or function and should be charged directly to that function. The function of other costs may not be readily identifiable (e.g., rent or telephone). An organization is allowed to use any reasonable method to allocate these expenses. Proper allocation of expenses between these functions is very important. The amount of funds spent on program services (when compared to total expenses) is a measurement of the organization’s effective stewardship of its assets. Donors want to know the extent to which their contributions are used primarily for charitable purposes. Likewise, the IRS, state governments and watchdog agencies examine expense classifications to verify that the organization is operating within certain guidelines.
6. Public Support Test: Schedule A is used to provide required information regarding an organization’s public charity status and financial support. Part I, Schedule A, requires an organization to indicate why it is not a private foundation by checking the box for one of 11 categories of public charities. Many publicly supported organizations must describe their revenue in either Part II or III. This information allows the IRS to determine whether an entity meets the applicable public support test. An organization is not required to use the same public support test specified in its determination letter from the IRS. It can annually use the support test that best reflects its sources of support and that enables it to retain public charity status. For those organizations whose exemption category requires performing the support tests in parts II or III of Schedule A, failure to pass both of these tests may result in their loss of public charity status and being characterized as a private foundation.
7. Lobbying vs. Political Activities: Given the many crucial issues facing nonprofit organizations and the people they serve, it is more important than ever when those charities become involved in the public policy debate. Many nonprofit organizations mistakenly assume that it is illegal for nonprofits to lobby. To the contrary, federal laws actually exist to encourage charities to lobby within certain specified limits. Knowing what constitutes lobbying under the law, and what the limits are, is the key to being able to lobby legally and safely. Unlike lobbying, Section 501(c)(3) organizations are prohibited from participating in a political campaign. Schedule C, provides the IRS with information concerning political campaign activities and/or lobbying activities of Section 501(c)(3) organizations.
8. Unreasonable Compensation: Organizations seeking a tax exemption must be organized and operated so that no part of their net earnings inure (i.e., accrue) to the benefit of any private stakeholder or individual. Therefore any inurement (regardless of the amount) could endanger an organization’s exempt status. Organizations have lost their exempt status because of private inurement related to unreasonable compensation. Unreasonable compensation is one of the IRS’s most active areas of inquiry and enforcement. The detailed compensation reporting requirements in Form 990 facilitate accurate and more complete compensation reporting. To avoid loss of tax-exempt status and/or intermediate sanctions, the organization should use a process for determining compensation. The process should include the following:
• Review and approval by a governing body or compensation committee;
• Use of data as to comparable compensation for similarly qualified persons in functionally comparable positions at similarly situated organizations;
• Contemporaneous documentation and recordkeeping for the deliberations and decisions regarding the compensation arrangement for senior management as well as staff.
9. State Requirements: Most states require nonprofit organizations to file one or more documents to give them permission to operate and solicit contributions in that state. Each state has different requirements; therefore it is important to consult with your tax or legal advisor. These filing requirements generally fall in these areas:
• Annual Reports: To keep track of corporations registered in that state.
• Annual Financial Returns: Often means filing of the Form 990 with the attorney general or other state agencies that regulates charitable organizations.
• Tax Status: Periodic renewal of the state’s recognition of your nonprofit’s tax-exempt status. For example, tax-exempt certificates for sales and use tax.
• Charitable Solicitation Registration: If a charity is engaged in fundraising activities in a state, it is likely that the organization will be required to complete a registration with various attachments and a registration fee. It is highly recommended you do not solicit (e.g. mailings) until you fulfill the necessary registration requirements, if any. There could be significant penalties for not complying.
Some states also regulate professional fundraisers.
10. The Form 990 is a Marketing Tool: The Form 990 can be a valuable marketing and development tool. Once the Form 990 is filed with the IRS, it becomes a public document that potential donors, sponsors and grant recipients can use to obtain information about the organization. Information can also be accessed by state regulators and the media.
The organization should consider Form 990 disclosure as an opportunity rather than a burden. Use the Form 990 as an opportunity to tell the organization’s story by effectively stating its mission and program service accomplishments. Careful consideration should be given to all of the information presented. The IRS and various watchdog agencies encourage the public to review organizations’ Form 990 tax returns.