Every year, Tax Exempt Organizations go through the frustrating task of filing their annual Organization Exempt from Income Tax Return (Form 990). Below is some useful information for organization executives and board members to consider carefully before filing their next Form 990 so the organization can benefit from this public record of disclosure.
- The Form 990 is a marketing 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 to highlight its accomplishments, rather than a burden. Use it as an opportunity to tell the organization's story by effectively stating its mission and program service accomplishments.
- Functional expense allocation: Form 990 Part IX reports expenses in three categories: program service; management and general; and fundraising. Proper allocation of expenses between these functions is very important. The amount of funds spent on program services (when compared to total expenses) is viewed by many donors as a measurement of the organization's effective stewardship of its assets.
- Public support test: 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 of Schedule A. This information allows the IRS to determine whether an entity meets the applicable public support test. For those organizations whose exemption category requires performing the support tests, failure to pass these tests may result in their loss of public charity status and being characterized as a private foundation.
- Lobbying vs. political activity: 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.
- Unreasonable compensation: Unreasonable compensation is one of the IRS's most active areas of inquiry and enforcement. To avoid loss of tax-exempt status and/or intermediate sanctions, the organization should use a process for determining compensation that includes review and approval by a governing body or compensation committee, data-based salary comparisons, and careful documentation and record-keeping of compensation-related deliberations and decisions.
- Not all tax-exempt organizations are charities: There are more than 50 different 501(c) classifications that organizations can be, depending on their purpose and activities, from business leagues to social clubs. 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.
- 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. Tax exempt organization may be subject to tax on income, considered as unrelated business income, if the income is from an activity which is regularly carried on and not substantially related to the entity's exempt purpose.
- Good Governance: 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, there is an expectation that a prudently managed organization would have specified policies around conflicts of interest, whistleblowing, document retention, determining compensation and joint ventures. If the questions are not answered, the IRS return may be considered incomplete.
- Review of the Form 990: An organization is not required by federal tax law to provide a copy of the form 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.
- 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 a tax or legal advisor. Filing requirements may include annual reports, annual financial returns, periodic renewal of state nonprofit tax-exempt status, and registration as a fundraiser. There also may be filing requirements resulting from activity considered Unrelated Business Income conducted in a State.
If you have any questions regarding Form 990, or would like to discuss this information in greater detail please contact one of a Marcum Tax Advisor who specializes in Form 990s listed to the right.