If you are a board member or volunteer for a local non-profit, you should be aware of Form 990 Return of Organization Exempt from Income Tax. IRS regulations require exempt organizations to make its three most recently filed Form 990 returns available for public inspection. Once filed with the IRS, the Form 990 becomes a public document that potential donors, sponsors, grantors can use to obtain information about the organization. Nonprofit watchdogs like Guidestar, Charity Navigator, or Charity Watch gather and disseminate information about every exempt organization registered with the IRS. They provide information about each nonprofit’s mission, legitimacy, impact, reputation, finances, programs, transparency, governance, and much more.
Here are 10 things that you should know about the Form 990.
1) Tax Status
There are many different kinds of nonprofit organizations that are exempt under section 501 of the Internal Revenue Code. Item I on page one of the Form 990 shows what paragraph of section 501(c) the filer is exempt under. You may believe that the organization is exempt under section 501(c)(3) (which exempts charitable, educational and religious organizations) when in fact it may be exempt under some other paragraph, such as section 501(c)(4) (which social welfare organizations and civic leagues) or 501(c)(6) (which exempts trade associations). There are 27 paragraphs under subsection section 501(c), all indicating different types of organizations that are exempt from federal income taxes.
2) Program Service Accomplishments
Part III provides the opportunity for the organization to describe the organization’s missions and accomplishments. A program service is an activity of an organization that accomplishes its exempt purpose. An organization must report new, significant program services, or significant changes in how it conducts program services on its Form 990, Part III, rather than in a letter to the IRS Exempt Organization Determinations. The IRS no longer issues letters confirming the tax-exempt status of organizations that report such new services or significant changes.
Part III gives the exempt organization the space to tout its accomplishments and state the case why donors should be contributing to the organization. Be sure that your organization is promoting your top three accomplishments and how you benefit the community.
3) Political Campaign and Lobbying Activities
Part IV, questions whether the organization engaged in political campaign activities or lobbying activities. If yes, the organization must complete Schedule and provide more information about those political campaign and or lobbying activities.
501(c)(3) organizations are absolutely prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of or in opposition to any candidate for elective public office. Contributions to political campaign funds or public statements of position made on behalf of the organization in favor of or in opposition to any candidate for public office clearly violate the prohibition against political campaign activity
Political Campaign Activities include any activity that supports or opposes a candidate for elective federal, state, or local public office. Whether the candidate is elected or defeated is immaterial.
In general, no organization may qualify for section 501(c)(3) status if a substantial part of its activity is attempting to influence legislation also known as lobbying. An organization may engage in some lobbying, but too much lobbying activity risks loss of tax-exempt status. Organizations may, however, involve themselves in issues of public policy without the activity being considered as lobbying. For example, organizations may conduct educational meetings, prepare and distribute educational materials, or otherwise consider public policy issues in an educational manner without jeopardizing their tax-exempt status.
Public Charities are prohibited from influencing political activities. Knowing what constitutes lobbying under the law, and what the limits are, is the key to being able to lobby legally and safely.
4) Donor Advised Funds
Did the organization maintain any donor advised funds or accounts which donors have the right to provide advice on the distribution or investment of amounts in such funds or accounts? If so, the nonprofit needs to complete Schedule D, Part I to provide information about the number of donor advised funds, the aggregate value of contributions received during the year, aggregate value of grants from during the year, and the aggregate value at the end of the year.
Generally, a donor advised fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, like a Community Foundation. Each account is composed of contributions made by individual donors. Once the donor makes the contributions, the organization has legal control over it. However, the donor or representative retains advisory privileges with respect to the distribution of the funds and the investment of assets in the account.
The IRS is leery of donor advised funds because of the potential for abuse that they pose. The organization is required to inform all donors in writing that the assets held in donor advised funds are the organization’s property, subject to its exclusive legal control. Grant funds from donor advised funds can only be used for charitable purposes and not for the benefit of the original contributor to the donor advised funds.
5) Professional Fundraising Expenses
If the organization paid more than $15,000 in expenses for professional fundraising services, Schedule G should be completed. Schedule G requires information about the name and address of the fundraising entity, the type of fundraising activities performed, whether the fundraiser had custody of the contributions, the gross receipts from the activity, and the amounts paid to the fundraiser versus the amounts paid to the nonprofit organization.
This information can be telling to the donor whether their contributions are being efficiently raised by the nonprofit.
6) Governance
The IRS expects that proper governance of a tax-exempt organization would include oversight of the Form 990 by the governing board of directors. Part VI, Section B, Question 11a and b questions whether a complete copy of the Form 990 was provided to all members of the governing body before filing the form. Federal tax law does not require the board to review the Form 990, but the IRS requires organizations to describe the process, if any, used by the organization to review the Form 990.
The IRS has limited resources which are stretched thin addressing all of its responsibilities for the Department of The Treasury. The IRS views non-profit organization as having less risk and has allocated fewer resources to over-sight of tax-exempt organizations. As such, the Form 990 is more an informational document for public scrutiny than a tax return. The Form 990 has several questions that each tax-exempt organization is required to answer regarding their governance. Part VI, Section B requests a tax-exempt organization must indicate whether or not they have the following:
- – Conflict of interest policy
- – Whistleblower policy
- – Document retention policy
- – Process for determining compensation
- – Joint venture policy
– Federal tax law does not mandate that a nonprofit have these policies and procedures, but an organization should consider adopting them to avoid public misperception about their stewardship.
7) Unreasonable Compensation
Part VII, Compensation of Officers, Directors, Trustees, Key Employees, Highest Compensated Employees, and Independent Contractors, requires the organization to list all current key employees and the top 5 highly compensated who received more than $100,000 of reportable compensation from the organization or any related organizations. Part VII also requires reporting of any compensation to any current officer, directors or trustees regardless of amount, and any former directors or trustees more than $10,000.
An exempt organization must be organized and operated so that earnings do not accrue to the benefit of any private stakeholder or individual. Organizations have lost their exempt status due 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 help the IRS monitor unreasonable compensation. To avoid complications related to unreasonable compensation, the organization should use a process for determining compensation which should include:
Review and approval by a governing body or committee;
Have date from similar organizations to compare;
Documentation and recordkeeping of the deliberations and decision making process regarding compensation arrangements for senior management.
8) Functional Expense Allocation
Part IX Statement of Functional Expenses reports expenses in three categories:
- – Program Service
- – Management and General
- – Fundraising
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. 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 service 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. The IRS, state governments, and watchdog agencies examine expense classifications to verify that the organization is operating within certain guidelines.
The Program Service Ratio, the percentage of an organization’s program service expenses in relation to total expenditures, becomes a valuable ratio for evaluating whether a charity is using their funds appropriately. When comparing program service ratios between nonprofits keep in mind not all organizations are the same. A number of things, such as size, age, and location, affect a nonprofit’s expenses. A nonprofit in an area with a high cost of living will need to pay more for office space, supplies, and salaries than a comparable organization in a less costly area. Younger organizations might have lower program ratios than more mature organizations as they set about building the infrastructure to support their mission. Also, some types of services simply require more overhead than others. Over time, organizations should strive to achieve ever-higher programs ratios, devoting as many of their resources to program service as possible.
9) Public Charity Status and Public Support
A 501(c)(3) organization or section 4947(a)(1) nonexempt charitable trust is required to complete Schedule A of Form 990 to document the reason for its public charity status. Failure to maintain its public charity status will result in the organization becoming a private foundation which is required to file Form 990-PF and subject to a 2% excise tax on net investment income.
There are eleven different reasons on Schedule A for a 501(c)(3) organization to qualify for public charity status such as at church or religious organization, a school, college, or university, a hospital, a medical research organization, a federal, state, or local government or government unit, among others.
Many 501(c)(3) organizations qualify for public charity status because of the more than 1/3 of their support is from public sources. When calculating the more than 1/3 support test, contributions from a disqualified person must be excluded. A disqualified person is a person who is in a position to exercise substantial influence over the affairs of the organization, including:
- – A disqualified person’s family member.
- – A 35% controlled entity of a (1) disqualified person and/or (2) family members of the disqualified person,
- – A donor or donor advisor to a donor advised fund, or
- – An investment advisor of a sponsoring organization.
10) Unrelated Business Income Tax
Part VIII Statement of Revenue of the Form 990 requires an exempt organization to report all of its revenue categories and whether the revenue is related to its exempt function, unrelated business revenue, or excluded from tax under sections 512-514.
Not all income earned by nonprofits is exempt from federal income taxes. An organization may be subject to unrelated business income tax (UBIT) if the activity is regularly carried out and is not substantially related to the entity’s exempt purpose. Furthermore, Section 514(a)(1) requires an exempt organization UBIT include a percentage of the income it derives from “debt-finance property.” That percentage is equal to the property’s average acquisition indebtedness for the tax year over the property’s average adjusted basis.
The primary purpose of UBIT is to put tax-exempt entities and for-profit entities on equal footing with respect to their trade and business activities. If an exempt organization has UBIT or debt-financed income, it is required to file Form 990-T Exempt Organization Business Income Tax Return, in addition to the Form 990.
A Nonprofit should consider its Form 990 as a valuable marketing and fundraising tool rather than a burden. Use the Form 990 to tell the organization’s story by effectively communicating its mission and program service accomplishments. Careful consideration should be given to all of the information presented on Form 990 because of the scrutiny the return will be under. The Form 990 is a great opportunity for a nonprofit to promote its story and recruit donors to its cause.
