The new Form 990, introduced for the 2008 tax year, was the first major change in the Form since 1979. The change highlights the issues that the Internal Revenue Service ("IRS") currently cares most about and, accordingly, those to which tax-exempt organizations should pay close attention. Consisting of an 11-page core form and 16 schedules, the new Form 990 is also a very public window on the inner workings of each reporting organization. For example, the redesigned first page of the return gives potential donors a bird's eye view of what the organization does and how efficiently it does it. It is important that nonprofit staff and board members be aware of the strategic implications of the key changes, several of which are highlighted in this article.
I. Summary Statement (Page 1)
The new Form 990 includes a redesigned first page. The information now presented on page 1 includes a statement of the organization's mission or most significant activities, the number of directors and how many of them are independent, the number of employees and volunteers, and a comparison of summary financial information for the current and prior year.
II. Governance and Management (Form 990, Part VI)
1. Governance. One of the new governance items required to be reported is the number of Board members who are considered independent. This item is deemed so important that it is also included in the first page summary of the Form 990. The instructions provide that a Board member is considered independent only if all three of the following circumstances applied at all times during the organization's tax year:
A. The member was not compensated as an officer or other employee of the organization or of a related organization.
B. The member did not receive total compensation or other payments exceeding $10,000 during the organization's tax year from the organization or from related organizations as an independent contractor, other than (1) reimbursement of expenses under an "accountable plan" as defined in IRS regulations [explaining this would be the subject of a separate article] or (2) reasonable compensation for services provided in the capacity as a member of the governing body.
C. Neither the member, nor any family member of the member, was involved in a transaction with the organization (whether directly or indirectly through affiliation with another organization) that is required to be reported on Schedule L (discussed below) for the organization's tax year, or in a transaction with a related organization of a type and amount that would be reportable on Schedule L if required to be filed by the related organization. Schedule L deals with reporting of loan transactions, excess benefit transactions, grants, and other business transactions between the organization and insiders.
2. Policies. For several years, primarily because of a requirement in Form 1023 that organizations adopt a conflict-of-interest policy or explain how they deal with such issues in lieu of adopting a policy, most tax-exempt organizations have implemented conflicts-of-interest policies. With the introduction of the new Form 990, reporting organizations may now effectively be required to have several, additional policies in place. Included are the following:
A. Whistleblower Policy. A whistleblower policy encourages staff and volunteers to come forward with credible information on illegal practices or violations of adopted policies of the organization, specifies that the organization will protect such individuals from retaliation, and identifies those staff or board members or outside parties to whom such information can be reported.
B. Document Retention and Destruction Policy. A document retention and destruction policy identifies the record retention responsibilities of staff, volunteers, board members, and outsiders for maintaining and documenting the storage and destruction of the organization's documents and records.
C. Joint Venture Policy. A joint venture policy should require the organization to negotiate, in its transactions and arrangements with other members of the venture or arrangement, such terms and safeguards as are adequate to ensure that the organization's exempt status is protected, and take steps to safeguard the organization's exempt status with respect to the venture or arrangement.
D. Non-Standard Gift Acceptance Policy. In Schedule M (Non-Cash Contributions), the new Form 990 asks whether the organization has adopted a gift acceptance policy that requires the review of any non-standard contributions. A non-standard contribution includes a contribution of an item that is not reasonably expected to be used to satisfy or further the organization's exempt purpose (aside from the need of such organization for income or funds) and for which (a) there is no ready market to which the organization may go to liquidate the contribution and convert it to cash, and (b) the value of the item is highly speculative or difficult to ascertain.
Time will tell whether or not the IRS uses reporting items like an organization's number of "independent" directors or its failure to adopt some of the policies listed in Part VI of Form 990 as a trigger for an audit or to increase scrutiny of an organization otherwise selected for audit. In the meantime, many organizations are adopting all of the policies listed in Part VI as a safety measure.
III. Transactions with Interested Persons (Schedule L)
Schedule L requires reporting of loan transactions, excess benefit transactions, grants, and other business transactions between the organization and insiders, consolidating reporting of most relationships and transactions involving insiders in a single schedule. Related-party transfers have been a significant concern of the IRS for many years, but the prior Form 990 had only requested some of the relevant information requested on the new Form 990. The intermediate sanctions (i.e., excess benefit transactions) law, Internal Revenue Code Section 4958, which was enacted in 1996, had not been effectively incorporated into Form 990 until the 2008 changes. The changes provide a significant enforcement tool for the IRS in this regard. What would previously have been uncovered only through investigation during an audit, are now questions on the return that could in themselves trigger an audit.
The intermediate sanction rules of Section 4958 and the Treasury regulations thereunder apply to all forms of "excess benefit transactions" engaged in by "applicable tax-exempt organizations" and "disqualified persons," including compensation, loans and other transactions in which the economic benefit paid by the applicable tax-exempt organization to the disqualified person exceeds the fair market value of the consideration received by the disqualified person. An "applicable tax-exempt organization" for this purpose is an organization that would be described in Section 501(c)(3) charitable organizations (other than Section 509(a) private foundations) and Section 501(c)(4) social welfare organizations. IRC Section 4958(e)(1) and Reg. Section 53.4958-2(a)(1). A "disqualified person" is any person (including an organization or entity) who, during the five year period ending on the date of the transaction, was in a position to exercise substantial influence over the affairs of the organization, any family member related to such person or any business in which such person or a family member of such person owns more than a 35% share. Treasury Regulation section 53.4958-3 provides further guidance on what constitutes a person in such a position.
IV. Compensation (Schedule J)
Schedule J is used by an organization that files Form 990 to report compensation information for certain officers, directors, individual trustees, key employees, and "highest compensated employees." It requires a break down of compensation for these individuals as follows: base salary, bonuses, other reportable compensation, deferred compensation and non-taxable benefits. Each of these categories of compensation is required for the organization filing Form 990 and any related organizations.
The category of "key employees" will be of particular interest to some filers. The instructions provide that for purposes of Form 990, a key employee is an employee of the organization (other than an officer, director or trustee) who meets all three of the following tests, applied in the following order:
1. The $150,000 Test: The individual receives reportable compensation from the organization and all related organizations in excess of $150,000 for the calendar year ending with or within the organization's tax year.
2. The Responsibility Test: The individual:
a. has responsibilities, powers, or influence over the organization as a whole that is similar to those of officers, directors, or trustees;
b. manages a discrete segment or activity of the organization that represents 10% or more of the activities, assets, income, or expenses of the organization; or
c. has or shares authority to control or determine 10% or more of the organization's capital expenditures, operating budget or compensation for employees.
3. Top 20 Test: The individual is one of the 20 employees (that satisfy the $150,000 Test and Responsibility Test) with the highest reportable compensation from the organization and related organizations for the calendar year ending with or within the organization's tax year.
V. Non-Cash Contributions (Schedule M)
The old Form 990 did not capture information about an organization's non-cash contributions, other than for certain contributions required to be reported on Schedule B. The IRS believed that significant tax compliance problems existed with respect to non-cash charitable contributions. In order to collect information regarding those organizations receiving significant amounts of non-cash contributions, and specific types of such items, the new Form 990 includes Schedule M to collect aggregate annual information on the types of non-cash property an organization receives. The threshold for completing the schedule is $25,000 of revenues reported from non-cash contributions.
VI. Related Organizations (Schedule R)
Schedule R was added to the new Form 990 to capture the increasingly complex organizational structures of tax-exempt organizations and improve transparency with respect to such structures. It requires the filing entity to list "related organizations" which include joint ventures. It contains separate parts for reporting the various types of tax entities (disregarded, exempt, tax partnership, tax corporation, or trust) so that information specific to relationships with each type of tax entity could be reported in an organized manner. Required information for Schedule R generally includes the name of the related organization, a description of its primary activity, the state or country of domicile, certain ownership and financial information, and in the case of partnerships, disproportionate allocations of tax items and unrelated business income allocations.
Joint ventures come in the following varieties:
1. Exempt-Function Joint Ventures. In this type of joint venture, the principal activity that serves as the basis for the tax-exempt status of the organization is transferred to or is being developed by the joint venture. Examples include, whole hospital joint ventures and low-income housing projects.
2. Ancillary Joint Ventures. This type of joint venture involves the operation or development of services or facilities that are ancillary to the primary operations of the tax-exempt organization, but are directly related to the organizations exempt purpose (e.g., health care or education). Examples include hospital joint ventures involving surgery centers and dialysis centers and educational joint ventures involving extension programs or distance learning.
3. Support Services Joint Ventures. This type of joint venture involves the facilities or services that provide support functions to the tax-exempt organization (and thus indirectly supports the exempt purpose by increasing efficiency). Examples include joint venture medical office buildings or billing and collection businesses, joint venture laundry or laboratory activities with other exempt or non-exempt organizations.
4. Pure Investment Joint Ventures. This type of joint venture is formed to exploit specific assets or operations, typically for the primary purpose of generating income. Examples include partnerships formed to make venture capital investments or exploit valuable assets of the tax-exempt organization, such as information systems and other valuable intellectual property rights (including patents).
5. Capital Financing Joint Ventures. This type of joint venture is formed to raise capital for facilities and equipment construction, acquisition or renovation that are then leased to the tax-exempt organization. Examples include joint ventures that allow tax benefits to flow to non-exempt investors without materially increasing the cost of the capital to the tax-exempt organization (e.g., low-income housing tax credits or rehabilitation tax credits).
In summary, not for profits must be aware of the enhanced visibility the revised Form 990 brings to their organizations. In addition, the IRS appears to be putting greater focus on the independence of Board members, officers and donors by requiring disclosure of governance practices and policies which prevent financial abuses and promote the organization's mission and by requiring more comprehensive disclosure of transactions with interested persons, compensation practices, non-cash contributions and relationships with related organizations. Tangentially, by instituting a more comprehensive Form 990, the IRS is also encouraging increased Board oversight of all these issues to provide yet an additional check on possible abuses and continued advancement of mission.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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