Form 990 disclosure requirements
Tip of the iceberg?

On October 26 2013 the Washington Post released an insightful investigative report on disclosures of exempt organisations with a "significant diversion" of their assets. The report highlights the range of problems – including embezzlement, theft, fraud and misuse – that can afflict exempt organisations of all types and sizes. Accompanying the report, the Post also published a new searchable online database, created in cooperation with GuideStar, which lists every exempt organisation since 2008 that has reported a significant diversion of assets on its Form 990. The report serves as a reminder – just in time for Form 990 filing season – that exempt organisations must be vigilant in safeguarding their assets.

Form 990 disclosure requirements

Since the last major revision of the form in 2008, the Form 990 has explicitly asked organisations to report if they became aware, during the tax year, of any "significant diversion" of assets. For 990 reporting purposes, a 'diversion' occurs when there is any unauthorised use of the organisation's assets for non-charitable purposes. A diversion is 'significant' if the gross value of the diversion exceeds the lesser of:

  • 5% of the organisation's gross receipts for its tax year;
  • 5% of the organisation's total assets as of the end of its tax year; or
  • $250,000.

Importantly, organisations should be aware that the dollar thresholds are cumulative; thus, several small, unrelated diversions could trigger the reporting requirement. If a significant diversion has come to light during the reporting year, even if the diversion occurred in any earlier year, the filing organisation must check "yes" on line 5 of Part VI and:

"explain the nature of the diversion, amounts or property involved, corrective actions taken to address the matter, and pertinent circumstances on Schedule O … although the person or persons who diverted the assets should not be identified by name."

The same diversion of assets may need to be reported in multiple places on Form 990. For example, if the diversion gives rise to an excess benefit transaction under Section 4958 of the Internal Revenue Code, the organisation should disclose the discovery in Part IV, line 25, and the relevant facts should be reported on Schedule L (Interested Party Transactions). In addition to federal tax reporting, there may be analogous state tax reporting obligations to consider. Organisations should also carefully discuss the relevant facts with their independent auditors in connection with the preparation of annual financial statements.

Non-profit managers who discover significant diversions should take a deliberative approach and bear in mind that they and the organisation's governing board are stewards of the organisation's assets in the eyes of the public, as well as those of state and federal regulators. They should remember that some of these filings and documents will find their way into the public domain – if not because of a statutory mandate, as with the Form 990, perhaps because the organisation chooses voluntarily to share the information with donors and regulators, or because a disgruntled employee leaks the story. This reality makes it all the more important to take a thorough and strategic approach to both the investigation and the disclosure of any diversions. The public – both donors and regulators – will expect the organisation's stewards to take timely and decisive action to remedy the situation.

Tip of the iceberg?

Although tax and financial disclosure deadlines are often the initial triggers for important conversations with internal stakeholders (eg, relevant officers, members of the board, counsel, financial advisers), for many organisations this is just the first step in the process of detecting and curing any failures in internal controls. Even in the most straightforward cases, non-profit managers would be wise to seize the moment to review the organisation's internal policies and procedures to prevent future lapses. Because the very fact of a significant diversion calls into question the effectiveness of an entity's internal controls, organisations may wish to consider engaging independent experts to assist in conducting an internal investigation to determine the full scope of the diversion of assets and whether it resulted from ineffective procedures, lax oversight or both, and to make recommendations regarding appropriate remedies. Corrective actions might include termination of employment, cancellation of grant agreements or contracts with third parties, and changes in internal control systems and procedures. In some cases, the organisation may wish (or be required) to disclose the matter to the relevant authorities for possible criminal prosecution.

Non-profit organisations and their managers will be judged by how well they handle the situation and what they do with the information once they discover a diversion of charitable assets.


This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.