Impact of the New Form 990

Dan Busby
This article provided by the Engstrom Institute

There was a day when charities significantly controlled the disclosure of an organization's financial data. There was also a day when the governance of charities was conducted below the radar of the media and the public.

Those days were before issues at the American Red Cross, The Nature Conservancy, American University and the Smithsonian became media fodder. Those days were before Senator Charles Grassley and the Internal Revenue Service became intensely interested in governance issues and greater transparency of charities. Those days are over for most charities!

Yes, there is a select group of 501(c)(3) charities that are exempt from the disclosure and governance limelight. They are religious orders, integrated auxiliaries of churches, "steeple" churches and those "non-steeple" charities that are organized as churches—televangelists and a surprising number of other charities you would not imagine are organized as churches. But most nonprofits are Form 990 filers and subject to the new disclosures.

The new Form 990 significantly expands the reporting requirements. The form continues to offer public relations opportunities for organizations that use it well, but the greater specificity of the form increases the traps for the unwary.

The IRS is seeking more information to reflect the inner works of nonprofits in order to provide better information to the public. "The new Form 990 instructions bring tax compliance in general, and the Form 990, in particular, into the boardroom more than ever before. It requires nonprofits to confront potentially sensitive issues relating to board structure, conflicts management, and disclosure of compensation, as well as business and financial relationships between board members," according to Michael W. Peregrine of McDermott Will & Emery LLP, Chicago.

The governance section of the new form increases the level of due diligence from board members, which ultimately places a larger workload on board members who are typically uncompensated volunteers.

Attorney Chip Watkins with Webster, Chamberlain, and Bean, Washington, D.C., says, "In the wake of many charity scandals, often traceable to failures of governance, the IRS has added a series of 'governance' questions to Form 990 because it rightly believes that a well-governed organization is less likely to have tax or other compliance problems. Nonprofits that demonstrate that they are well-governed, as evidenced by board attention to corporate policies, compensation of key executives, and stewardship of ministry assets, are less likely to be audited."

He continues, "Because the new Form 990 requires disclosure of whether the nonprofit has adopted various corporate policies, boards should give attention to these issues before the new form is filed. The fact that the board has thought through an issue and thoughtfully adopted or reviewed a policy is more important than the specific provisions of the policy, though the specifics are not unimportant."

The IRS has drawn criticism for the expansion of the Form 990 questions into the board governance area. They defend the expansion on the basis of discretion provided them through the Internal Revenue Code.[1] Stephen Miller, Commissioner of the Tax-Exempt & Government Entities division of the IRS, classifies these areas as "implicit jurisdiction." He states, "These are areas where the Code does not clearly set forth a standard, but where we need to involve ourselves to assure the integrity and compliance of the sector, and the public's confidence in it." He goes on to discuss that the IRS must educate organizations as to "promote principles of good governance."[2]

In part this education is being distributed through the new form's instructions. Specifically, Part VI of the revised core form instructions discusses the rationale of governance behind the various questions as well as policies the IRS is looking examining. It is likely that further resources will become available as the IRS continues to emphasize the importance of governance practices, something the private sector has been discussing for years.

If an organization does not have the policies and procedures referenced in the new Form 990, what are the options? Desiring to demonstrate excellence, the organization could adopt the policies—even those policies they may believe are inapplicable. Or, they can check a "No" box and wonder how the response will play with the IRS, the media and the public.

One thing we can be certain of is that these changes will have an impact for years to come. The last major redesign of Form 990 was nearly 30 years ago and the information age has greatly improved its distribution to the public through the Internet since then. Therefore, this new form will most assuredly play a part in how organizations are perceived as well as affect the decision processes that donors and grantmakers use.

Knowledge is power. With that in mind, organizations will be more proactive in safeguarding their public image through the Form 990. While some of the impact may not be apparent for several years, in the near-term, organizations are likely to make governance modifications in the near future to formally adopt written policies concerning some of the new questions.

Policies and procedures. The policies and procedures of interest to the IRS include:

• Whistleblower policy. The Form 990 asks whether the organization has a written whistleblower policy. Such a policy is important to prevent retaliation against employees who report suspected illegal activities. Retaliation could violate both federal and state law.
  
  
• Document retention and destruction. The Form 990 asks whether an organization has a written document retention and destruction policy. This, too, is important because federal and state laws prohibit the destruction of documents under certain circumstances, particularly if they are relevant to a pending investigation or lawsuit. Establishment and compliance with a written document retention and destruction policy minimizes the likelihood that documents will be destroyed in violation of law and may protect a ministry from sanctions for destruction of documents in accordance with its policy.
  
  
• Approval of compensation. The Form 990 requires the description of the process that the organization uses to approve compensation of its CEO and other officers and key employees; and whether the organization is following the "safe harbor" procedure of the Internal Revenue Code for approving compensation of "disqualified persons." This procedure includes approval by independent directors or committee members, review of comparable data, and contemporaneous substantiation of the deliberation and decision by the board or committee.
  
  
• Reimbursement policy. For key employees, disclosures must be provided relating first class and charter travel, travel for companions, personal services provided, spending accounts, housing allowances, and health and social club dues and fees. Confirmation is required whether the organization followed a written policy regarding reimbursement of any of these expenses.
  
  
• Disclosure of joint venture investments. The Form 990 requires organizations that participate in joint ventures to indicate whether they have a written procedure ensuring evaluation of the joint venture in light of the requirements for income tax exemption.
  
  
• Grant substantiation. While somewhat more indirect than some of the other policy questions, the Form 990, Schedules I and F inquire whether the organization maintains records to substantiate the amount of the grants, the grantee's eligibility, and criteria used to evaluate eligibility. Additionally, both Schedules require a narrative of the procedures the organization has to monitor the use of the funds both domestically and abroad respectively.
  
  
• Non-discrimination policy. The Form 990, Schedule E requires schools to declare if they have a nondiscriminatory policy in key documents and if there is any discrimination by race in aspects such as admissions, scholarships, use of the facilities or sports programs and other extracurricular activities.
  
  
• Disclosure of key documents. Form 990 requires the organization to indicate how it makes its application for exemption, Forms 990, and Forms 990-T available for public inspection. Organizations must also describe whether, and if so, how, they make their articles of incorporation, bylaws, conflict of interest policy, and financial statements available to the public. The tax code does not require this second group of documents to be published by the organization. However, articles of incorporation and amendments are public record documents, and most large ministries are required to file their articles of incorporation, bylaws, and audited financial statements with some state offices that regulate charitable solicitations.
  
  
• Gift acceptance policy. The Form 990, Schedule M (non-cash gifts) asks organizations that must file Schedule M if they have a gift acceptance policy that requires the review of any "non-standard contributions." A "non-standard contribution" is a non-cash gift that is not used in the organization's activities, for which there is no market in which the gift can be readily liquidated, and whose value is "highly speculative or difficult to ascertain."
  
  Although the definition of a "non-standard contribution" is narrow, organizations should have gift acceptance policies that guide executives regarding the circumstances under which the organization will accept non-cash gifts. This is particularly important with respect to gifts of real estate (which may hold environmental cleanup liabilities), and of securities and other business interests that are not publicly traded.
  
  
• Documentation of minutes. The form asks about the contemporaneous documentation of the governing body meeting and each committee with authority to act on behalf of the governing body. While most board minutes are timely recorded, the same is often not true of committee minutes.
  
  
• Form 990 to the board. A question is asked whether a copy of Form 990 provided to the governing board before it was filed and the process used to review the Form 990. This question does not ask if the form was reviewed by the board prior to filing only if the form was provided to the board.
  
  
• Form 990 filed on the nonprofit's website, another website or available upon request. This question deals with the issue of how the nonprofit complies with the public disclosure rules.
  
  
• Governing documents, conflict of interest policy, and financial statements to the public. Few nonprofits make the governing documents (undefined in the draft of the instructions, but presumably articles of incorporation and bylaws or constitution), conflict of interest policy, and financial statements (whether or not they are audited) available to the public. Except for ECFA members who are required to provide copies of the audit upon request, few nonprofits post their governing documents, conflict of interest policy and financial statements on their websites.

The IRS is not requiring nonprofits to adopt all these policies and procedures. But it is using the Form 990 to ask whether nonprofits are using these tools.

Expanded reporting. In addition to the new governance questions, the new Form 990 expands information reporting in a number of other areas. Here are just a few:

• International activities.
• Gifts-in-kind
• Political activity
• Financial statement and compensation disclosure
• Certain functional expense classifications
• Fund-raising activities
• Grants and benevolence
• Related party transactions and related organizations
• Special schedules for schools and hospitals

While the IRS has expanded the scope of questions asked, it has also provided an avenue (Schedule O) for organizations to explain or supplement responses which otherwise may be misleading if taken out of context.

Even for small nonprofits, completing the Form 990 has never been enjoyable for financial managers. Now, with a core form and up to16 schedules, the process is much more formidable! In fact, many large organizations will need to complete at least 10 of the new schedules.

Particularly for larger organizations, responsibility for collecting the data should be assigned to a particular staff member. With the old form, collecting the data often began after year-end. With all the additional questions on the new form, data collection activities should occur throughout the year, and designation of a "point person" for this process will be helpful. For some organizations this could require the modification of information systems, databases and programs to ensure accurate information is available to complete the 990.

Who this affects. Organizations under $25,000 in gross receipts will file the 990-N. Organizations with over $25,000 in gross receipts must either file Form 990-EZ or Form 990. For the 2008 returns (usually filed in 2009), organizations with more than $25,000 but less than $1 million in gross receipts can elect to file the less rigorous Form 990-EZ. For 2009 and 2010, these threshold amounts are reduced to $500,000 and $200,000 respectively.

Electronic filing. While the process of requiring more organizations to file their 990 electronically is separate from the redesign process, it is an additional issue that leadership should consider to streamline the reporting process as much as possible. The goal of the e-file and redesign process is to provide the most current and transparent information to the public. Generally speaking, most organizations with over $10 million in total assets or who file over 250 returns a year including the 990, W-2's, and 941's must file electronically.

The bottom line. The stated goals of the IRS for the new Form 990 focus on transparency, tax compliance, and burden minimization. Many nonprofits will struggle to accept the phrase "burden minimization" as an accurate reflection of the new Form 990! Even if the new form is prepared internally, staff time (and therefore costs) will increase. If outside professionals are used, the costs will undoubtedly increase significantly. And the additional cost for this "burden minimization" is primarily overhead expense, not program!

Looming larger than the cost of preparing the form is the potential impact of the media and the public ferreting through the expanded information provided on the new Form 990. Accurate preparation of the form is vital. Whether you prepare the form internally, or you ask an external professional to handle the preparation, the complexity of the new form begs for a review by a nonprofit tax attorney.

[1] See Internal Revenue Code (IRC) §§ 6033(a)(1) and (b)(14)

[2] Georgetown Law Center Seminar, "Nonprofit Governance, and Effectiveness and Efficiency of Operations" April 24, 2008.