Editor: Anthony S. Bakale, CPA, M. Tax.
The revised Form 990, Return of Organization Exempt from Income Tax, incorporates many of the same governance principles and transparency best practices introduced to the for-profit world through the Sarbanes-Oxley Act, P.L. 107-204, in the aftermath of the Enron scandal. This is the latest attempt by the federal government to restore public confidence in the governance of the exempt organization sector, particularly charities. Practitioners must ask their exempt organization clients if they are ready for changes in how they govern themselves from the board level down.
Overview of Redesigned Form 990
In an effort to recognize the growing size, diversity, and complexity of taxexempt organizations, the Service has revised the Form 990 for the first time since 1979. This newly revised form is required for all organizations whose tax year began during 2008 and whose gross receipts and assets were over $1 million and $2.5 million, respectively. The thresholds are lowered for organizations whose tax year began in 2009 to $500,000 and $1.25 million, respectively. For tax years beginning in 2010 or later, these thresholds will again be lowered, and filing will be required if receipts and assets are over $200,000 and $500,000, respectively.
Organizations that are below the thresholds generally may file Form 990- EZ, Short Form Return of Organization Exempt from Income Tax. Small nonprofits will be required to file an electronic postcard, Form 990-N, Electronic Notice (e-Postcard). The e-postcard is required for organizations with gross receipts under $25,000 for tax years 2008 and 2009 and $50,000 for 2010 and later. The low threshold shows that the IRS is determined to have a large majority of nonprofit organizations filing the new Form 990.
The IRS’s “Background Paper: Redesigned Draft Form 990” highlights the Service’s reasons for developing the new form: “The Form 990 is a public document that is made available by filing organizations, the IRS, and others. It is the key transparency tool relied on by the public, state regulators, the media, researchers, and policymakers to obtain information about the tax exempt sector and individual organizations.”
One section of the form drawing much scrutiny from tax advisers, management, and board members alike is Part VI, “Governance, Management, and Disclosure.” To increase transparency, the new Form 990 is asking new questions and requiring schedules that were never required in the past. These new questions and schedules are forcing all organizations to examine their practices and policies and in some cases to make drastic cultural changes in order to comply:
Because the reporting requirements of Form 990 have increased substantially, organizations such as ours are focused on enhancing accounting systems and practices to gather the necessary information. Increased scrutiny by the IRS in the interest of creating more transparency has led to the need for more detailed information in a variety of areas, including compensation and governance, and also comprehensive explanations of existing plans and policies. [Judee M. Bavaria, NHA, president and CEO, Presby’s Inspired Life, personal communication, May 8, 2009]
The remainder of this item discusses Part VI of the core form, which covers the organization’s governance, management, and disclosure, and the effects they may have on an organization. For an overview of all the revisions to Form 990, see Caplan, “IRS Releases Redesigned Form 990,” 40 The Tax Adviser 254 (April 2009).
Focus on Governance and Transparency
Highlighting the need for this revision, on May 29, 2007, Chairman Max Baucus (D-MT) wrote a letter on behalf of the Senate Finance Committee to then–Treasury Secretary Henry Paulson regarding the issue of charities and transparency. The main concern—stated as the catalyst for writing the letter—was that Form 990 had not kept up with modern practices in the charitable sector and needed significant updating. The letter specifically identified the issue of governance as a major item that would need to be addressed in order for any revised Form 990 to be appropriate in scope. Baucus went so far as to state, “Time and time again we have seen poor governance at the core of problems at charities.” Less than a month later, on June 14, the IRS released a draft of the redesigned Form 990 for public comment. A year and a half later, in December 2008, the Service released the final revised form and instructions, including a section (Part VI) with 30 new questions relating to governance.
Part VI: Governance, Management, and Disclosure
Form 990, Part VI, requires information on certain written policies, the internal governance of the organization (including the role the governing body plays in the organization), and the interaction between the board and the officers and directors. Among the new questions focusing on governance, policies, and disclosures are the following key inquiries:
- Does the organization have written policies on conflicts of interest, whistleblowers, and document retention?
- How are these policies enforced and disclosed to the public?
- How independent are the voting members of the board?
- Are minutes taken at board and committee meetings documenting actions taken?
- Will the board review the Form 990 before it is signed and submitted to the IRS?
- What is the process for reviewing and approving executive compensation?
The IRS, with the backing of Congress, has determined that all the questions must be addressed in order to effectively determine how well nonprofit organizations are being run. It also serves to restore public confidence through increasing transparency about organizations’ policies and procedures while emphasizing the importance of documenting those policies.
Part VI, question 2—“Did any officer, director, trustee, or key employee have a family relationship or a business relationship with any other officer, director, trustee, or key employee?”—is controversial. The Service’s goal is to identify relationships that could create a bias in the organization’s decision-making process. The Form 990 instructions provide proposed definitions of business relationships and family relationships. However, organizations will be required to obtain this information each year from board members and other key players.
There are ownership thresholds of 35% and 10%, which include both direct and indirect relationships. Ownership is measured by stock ownership (either voting or value). There is also a dollar threshold for business relationship transactions in excess of $10,000 in the aggregate. Indirect relationships can be particularly troublesome because such relationships include relationships through multiple or tiered entities. The instructions describe a process of reasonable efforts that the organization may rely on to determine the family and business relationships that may help lift some of the reporting burden. Not many conflict of interest policies sufficiently address this question; as a result, most organizations will need to revise their conflict policies and statements to elicit this information.
Part VI, question 5—“Did the organization become aware during the year of a material diversion of the organization’s assets?”—is based on the IRS’s unease about fraud against exempt organizations. A diversion is considered material if the gross dollar amount exceeds the lesser of $250,000 or 5% of the organization’s gross receipts for its tax year or total assets as of the end of the tax year. The materiality threshold will eliminate the burden of reporting smaller misappropriations.
Congress’s enactment of the Sarbanes- Oxley Act in July 2002 expanded the federal government’s reach into the private sector and was the first major law to recognize the importance of federal regulation of internal controls and governance. Prior to this act, corporate governance was under the control of state law, and the federal government had no authority in setting nationwide standards. While this act and its regulations do not apply to the nonprofit sector directly, its reach and focus on governance, transparency, and disclosure of these policies and procedures to the public are still concerns of both Congress and the IRS—concerns that are addressed by the new Form 990.
The Enron scandal and other unethical behavior in public companies brought about Sarbanes-Oxley. Similarly, scandals in the nonprofit sector involving large exempt organizations are probably the most significant catalyst for the drastic changes to the 990 and the IRS’s concern over proper governance in general. Organizations making news have included United Way, the Smithsonian Institution, and the American Red Cross; with such high-profile organizations allegedly involved in unethical behavior, a response was determined necessary and the new form (including Part VI) was developed.
Is this revised 990, especially Part VI, the first in a series of steps that will eventually lead to the creation of something similar to Sarbanes-Oxley for nonprofits? Or is it really just a single tool designed by the IRS to increase transparency of organizations’ policies in light of the recent problems in the nonprofit world? It will probably be years before the answers to these questions will be known. As described above and evidenced by the letter from the Senate Finance Committee chair, there has been considerable pressure from Congress for these stricter policy guidelines, and governance in the nonprofit world and throughout all business is being scrutinized more than ever before. An article on the IRS website regarding the new governance schedule states that “well-governed and wellmanaged organizations are more likely to be transparent with regard to their operations, finances, fundraising practices, and use of assets for exempt and unrelated purposes” (www.irs.gov/charities/article/0,,id=176674,00.html). It is clear that the IRS believes these policies are necessary in order to operate an organization effectively and efficiently and that not having these policies in place reflects poorly on the organization’s governance from top to bottom.
While the IRS has not specifically stated what the penalties are (if any) for noncompliance with the policies and practices described in the Form 990, it appears at the very minimum that noncompliance would flag an organization as risky and therefore more susceptible to audit risk. Currently, federal law does not give the IRS authority to mandate any particular management structure or policy; organizations have the right to say no to any question and explain their reasons for not having a particular policy in place. However, filers of this new form must answer each and every question to the extent applicable to them.
At this time, Congress, through the revised Form 990 and collection of the data that it will provide, is allowing the IRS to handle these issues without legally designating this authority to the IRS. The IRS is effectively engaging in a form of behavior modification by suggesting, through the questions and disclosures in the new form, what effective governance policies and practices look like—at least in its own view. If these measures prove ineffective in changing the culture in which many organizations operate, it is conceivable that Congress will pass legislation similar to the Sarbanes-Oxley Act requiring these policies to be adopted by the entire exempt-organization sector. Congress has made it clear that it will act to increase the assurance for donors (and others) that rely on and benefit from these organizations that their money is being used as it was intended.
Steps to Take
Organizations can take several steps to prepare for the redesigned Form 990 and to ensure that they have the proper policies and procedures in place to comply with the new stricter guidelines. First and foremost, all organizations should move quickly to educate their boards and key employees about the new requirements. Second, organizations must engage their in-house counsel and/or tax advisers to review, revise, and adopt policies that are consistent with the suggested policies outlined in the questions on Part VI of the redesigned 990.
The new 990 impacts nonprofit higher education at nearly the same time as the Higher Education Opportunity Act. Both have designs to bring about greater transparency, but both, unfortunately, require more resources to be expended in an era when the economy is suppressed. We forge ahead thoughtful of the burden, but considerate of the realities. As General Counsel, it is important to realize early the intent behind the Form 990, such as increased accountability, and to prepare your organization accordingly. Education for the Board and review and revision of certain related policies, as well as developing new policies aimed at compliance is absolutely prudent. [Jonathan Peri, vice president and general counsel, Neumann University, personal communication, May 8, 2009]Organizations should send out questionnaires to determine the independence of all their board members under the new stricter independence standards. Policies should also be put in place to ensure that contemporaneous minutes for all committee meetings are taken so that all actions are well documented. Finally, all organizations should periodically engage in a robust review of policies and procedures that have been adopted to comply with the new questions and ensure that documentation is kept up to date.
With this level of scrutiny, organizations will no longer be able to go through the motions in running their organizations or in completing the annual Form 990 filings. The IRS is attempting to modify behavior with the release of this new form in order to restore public confidence, and Congress appears ready to provide whatever support is needed to that end. By engaging in an active review of internal policies, processes, and practices, including many of the steps suggested here, organizations can ensure that there is a smooth transition and can do their part to operate in a transparent, responsible, businesslike manner while continuing the important mission that they carry out on a daily basis.
Anthony Bakale is with Cohen & Company, Ltd., Baker Tilly International, Cleveland, OH.
Unless otherwise noted, contributors are members of or associated with Baker Tilly International.
For additional information about these items, contact Mr. Bakale at (216) 579-1040 or email@example.com.