New Form 990 Makes a Point of Governance

Transparency Wins 28-12
Thomas A. McLaughlin
This article provided by the Engstrom Institute

Seldom does a bureaucratic blank form foretell the future. But when the Internal Revenue Service (IRS) released its new Form 990 this past summer, it sent an unmistakable message about what it considers most important for nonprofit public charities. That message can be summed up in three words: leadership, governance, and purpose.

This is a departure from the past for the IRS. To understand why, one need only put the old Form 990 side-by-side against the new one and analyze the differences.

The old form was truly a tax form, exactly as its lineage implied. Up-front information included numbers that would have been drawn directly from the audited financial statement, such as types of revenue, total expenses, and net assets (or fund balance, as it used to be called). On the second page came the call for expenses and a thumbnail sketch of what the programs and services were all about. The balance sheet came next, and then some largely non-financial questions about an eclectic mix of subjects.

In effect, the first three pages were a re-arranging and selective use of data from the audited financial statements. The underlying message was subtle but strong: Give us the numbers first and the soft stuff second, if at all.

The priorities are now different, starting with the first line. In the old form the first numbered line asks for total contributions. The new draft's first line asks for the mission. Although it's probably accidental, this change is a good test for any street-smart manager. If you can't describe your organization's mission in the two lines provided, it's time to create a new mission statement. And in case you miss the point, the heading of the first 10 lines is "Activities and Governance."

Sweeping Change

The magnitude of the change is sweeping. To get an idea of why, use a measurement that media types call "column inches."This is simply a linear measurement of each column of text. The new Form 990 has only one "column," so the maximum number of column inches per page is about nine. The old form asked for 12 column inches worth of information about leadership, governance, and purpose, with the rest being devoted to straight financial data, factual things such as corporate name and address, and miscellaneous information. The new form asks for 28 inches of leadership, governance, and purpose. Transparency wins, 28-12.

Those accustomed to the old form and its subtle messages ("tell us about the money!" the first page used to scream) will need to do some adjusting. By the time you've answered 10 questions, the subjects have ranged from mission to activities to unrelated business operations to executive and trustee compensation and total numbers (including 'independent' trustees, a term more familiar to the for-profit sector).

These first questions are just a hint of what's to come. The second page is devoted entirely to compensation received by executives, board members, and independent contractors. Alumni of these ranks get drawn in as well, since the questions specifically ask for the data about people formerly in one of these positions.

Smartly, the IRS also asks for background information on the same topic from related entities. Then it goes on to ask Sarbanes-Oxley-inspired questions about whistleblower and records retention policies, board minutes, audit policies, collections of artwork, sponsorship

of donor advised funds, and a whole range of other questions. Not until page 5 does it get around to asking the old front page questions about revenue.

You get the picture. If this form is finalized to look anything like this draft, it will dramatically alter what nonprofits report and the way they report it. To describe the changes succinctly, street-smart CEOs will be paying a lot more attention to their organization's Form 990 than in the past. The relatively innocuous end-of-the-year ritual in financial reporting will become a whole-agency undertaking.

What To Do

As a first step, every nonprofit organization should look at the redesigned form. It can be found at: http://www.irs.gov/pub/irs-tege/form990coreform.pdf

IRS press material suggests that the new form should not cause most organizations to experience a "change in burden." This might well be true, especially after a few filings. But, the nature of the existing burden will change for all. The IRS acknowledges that the burden might increase for those with complicated compensation practices and related corporate structures. The IRS intends to begin using the new form in FY 2008.

For small and/or relatively uncomplicated entities with modest financial operations, the change might not be troublesome. For example, the compensation disclosures generally apply only to levels exceeding $100,000. The current cut-off is $50,000.

It is hard to imagine the actual act of data collection will be difficult for large and complex organizations. Many of the requirements embody best practices that have been informally adopted anyway. The real issue is not how easy or hard it will be to collect the data. The real issue will be the reaction to what is disclosed, and what the streetsmart manager can do about it in advance. Happily, following good practices will usually steer you clear of the potential gotchas.

For example, there is a simmering tension about executive pay in all corporations, nonprofits included, and this will fan those embers. Several areas deal with executive compensation, but Part II asks "did the process for determining compensation include a review and approval by independent members of the governing body, comparability data, and contemporaneous substantiation of the deliberation and decision?"

This is like a heavy-handed middle school test, with the "correct" answer embedded in the question. The message is, do your homework on executive compensation. In practice that will probably mean a salary benchmark study by an independent party, along with appropriate documentation of board deliberations on the matter.

Similarly, many of the mission, governance, and activity questions can be answered effectively if the organization has done some reasonably good thinking about its strategy. Other questions about making certain documents and records available to the public can be answered simply by making them available on your Web site.

Enforcement is a lurking question in this form. The Form 990 was and is an informational return. There are no explicit financial stakes the way there are with a personal tax return. So if your mission statement is ill-conceived and poorly written, or if you don't have a written whistleblower policy, will the IRS do anything about it?

The answer has to be, probably not. It is inconceivable that the IRS would use its limited resources to pursue, say, a nonprofit that admits it doesn't have a written conflict of interest policy. More likely is that the form is meant as a quiet lesson in current thinking about nonprofit accountability, and that the real enforcers will be the outsiders who decide not to donate to you until you adopt these good practices.

Also, it cannot have escaped the IRS' attention that the new form provides a handy road map for data gathering by enterprising reporters who already have their suspicions about a particular nonprofit in their media market.

In the end, this is one of those situations where the inconvenience, extra work, and maybe even embarrassment for a few is the price that will be paid for strengthening the sector. Virtually every kind of institution in the U.S. economy gets publicly knocked down and dirtied every now and then, including nonprofits. A decline in reputation and financial well-being can come from this ritual roughing-up.

The oil industry and the pharmaceuticals can absorb the blows well enough. Nonprofits usually can't, and if the increased disclosures mandated here can head off some public unpleasantness for some organizations and strengthen the rest, it should be a tradeoff worth making.

The NonProfit Times September 1, 2007. Used by permission

Thomas A. McLaughlin is a national nonprofit management consultant with Grant Thornton in Boston. He is the author of the book Nonprofit Strategic Positioning (John Wiley and Sons, 2006). His email address is thomas.mclaughlin@gt.com