Form 990: Five Common Mistakes and How to Avoid Them
By Sara Smith, Manager, Nonprofit Tax Services
The Form 990 is one of the most important documents for nonprofit organizations in the United States. It serves as the primary tool for the IRS to gather information about an organization’s finances, activities, and governance. In addition, because the Form 990 is publicly available, it is also a communication tool that speaks to an organization’s current and potential donors, as well as other interested parties. Filing errors or mistakes on the form can result in penalties, reputational damage, and even risk to the filing organization’s tax-exempt status. To avoid these potentially costly mistakes, get familiar with the following common errors or omissions seen on the Form 990 and do your utmost to avoid them.
1. Failure to (Timely) File
The biggest mistake that can be made regarding the Form 990 is the failure to file and/or failure to timely file. The Form 990 is originally due on the 15th day of the fifth month after the organization’s tax year end (that’s May 15th for calendar year filers). A six-month automatic extension can be requested by filing Form 8868. Organizations that fail to timely file their Form 990 are subject to daily late-filing penalties, which can accrue up to a maximum of $56,000 for any one return. Organizations are considered non-filers if they are required to file electronically but fail to do so—even if a paper return was filed. In addition, submitting an incomplete return can result in being deemed a non-filer or late filer. Not only can failure to file or late filing result in penalties, but it can also jeopardize the organization’s tax-exempt status. The IRS will automatically revoke tax-exempt status for organizations that fail to file their 990-series form for three consecutive years.
To avoid penalties associated with late filing, make sure that you know the due date of the Form 990 and ensure the form is filed completely, on time, and in compliance with electronic filing requirements.
2. Inexact or Inapplicable Narratives
Another common mistake on the Form 990 is narrative responses that do not fully address the details or clarification required by the IRS. Many Parts and Schedules of the Form 990 request narrative responses to further explain the organization’s activities and processes. These narratives are often carried forward from the previous year without much thought or consideration. In these cases, the narratives can become outdated or fail to fully satisfy the scope of the requested response.
Take a close look at each year’s Form 990 submission to ensure you fully understand the issue(s) the IRS wants addressed. Then review all narrative responses included in the Form 990 filing and update the response so it is accurate and relevant to the underlying inquiry.
3. Not Properly Reporting Unrelated Business Income (“UBI”)
Many nonprofit organizations believe they are exempt from paying taxes on all sources of income due to their tax-exempt status. However, organizations recognized as tax-exempt by the IRS may still need to pay taxes on income that is considered Unrelated Business Income (UBI). Income that meets all three of the following criteria qualifies as UBI:
- It must be from a trade or business.
- It must be regularly carried on.
- It must not be substantially related to the performance of the organization’s exempt purposes or functions.
There are many different ways that nonprofits can generate UBI. One common type is advertising revenue—arising from paid ad placements that might be featured in an organization’s periodicals, event-specific publications, or websites. The rules surrounding the taxation of UBI can be complex, and there are a number of exceptions and qualifiers. If you believe your organization may have unrelated business income that is not being reported properly, your first step should be reaching out to your tax team to discuss.
Don’t assume your organization is exempt from tax liabilities on all forms of income. When preparing the Form 990, carefully investigate all funding sources with an eye toward properly handling the tax aspects of any UBI.
4. Incomplete Reporting of Board Members
Nonprofit organizations are required to provide details relating to those serving on their governing body, including titles and average hours of work per week benefitting the organization. However, this requirement is frequently missed or misunderstood. Part VII-A of the Form 990 should include any and all voting board members who served during the organization’s tax year—even if just for a day. Unless your organization’s board term coincides exactly with your tax year, you are likely to have two distinct board cohorts serving your organization during any given tax year. For example, if your organization has a December tax year-end, and your board terms run July-June, you should be including both the board serving January 1-June 30 and the board serving July 1-December 31 on your Form 990. If the same individual serves in multiple capacities during the tax year, they should only be listed once on Part VII-A, with their titles conveying the change in duties.
Keep a thorough record of when board members rotate on or off the board throughout your tax year. This will be a valuable resource when completing your Form 990, especially if your board regularly features new faces.
5. Misclassification of Expenses by Function
Certain nonprofit organizations are required on the Form 990 to provide their statement of expenses broken down not only by type of expense but also by functional category (program, general and administrative, fundraising, etc.). The importance of proper classification of expenses by functional category can often go underappreciated, leading to imprecise or erroneous totals. Accurate classification of expenses allows nonprofits to provide interested parties, such as potential donors and grantors, a clear understanding of how the organization utilizes the funding it receives—how much goes towards programmatic activities versus administrative or developmental activities. In addition, with the Form 990 being required as part of some charitable solicitation filings, state-level authorities are increasingly scrutinizing the proportion of expenses used for program activities versus supportive activities.
Establish practices that ensure expenses are properly associated with functional categories. That way, you’ll be able to avoid any headaches when categorizing your spending for the Form 990 filing.
Although the issues addressed here are by no means comprehensive, it should be clear that there are a number of ways that an organization can run into issues when preparing and filing the Form 990. These can lead to processing delays, costly corrections, and even penalties. Organizations should take the time to prepare for and carefully review their Form 990, seeking assistance from a tax professional as needed. By doing so, nonprofits can ensure that they comply with tax regulations and better focus their efforts on their core mission and programs.