The IRS retains the names of more than 1.3 million nonprofit entities in its master files. In 2004, the most recent year for which data is available, the IRS received 364,601 Forms 990 and 142,269 Forms 990-EZ. And yet the Form 990 - the principal channel of communication between nonprofit organizations and the federal government - has not been revised in any significant way for nearly 30 years.
After months of deliberation and public comment, guided by the principles of "transparency, compliance, and burden minimization," the IRS released the long-awaited final draft of the 2008 Form 990 in December of last year.1 In its new configuration, the 2008 Form 990 replaces the old 9-page form and its 2 schedules with an 11-page "Core Form" and 16 schedules, each one keyed to a specific type of nonprofit activity. In August 2008, after reviewing more than 600 pages of detailed public comment, the IRS published the final version of instructions to accompany the new Form 990. Organizations that operate on a January 1 fiscal year will file their first redesigned Form 990 by May 15, 2009.2
Although the 2008 Form 990 allows tax-exempt organizations to better describe their activities and contributions to the community, it also requires organizations to provide significantly more information than in previous years. The organizations best positioned to tell their own story in an effective manner -- and least likely to be lost in the transition to a new reporting regime -- will be those that educate themselves on the new requirements, implement policies and procedures that respond to the constraints of the new form, and plan to track information not previously required by the IRS.
Core Form. Every organization filing a Form 990 must complete the 11-page Core Form, which has been radically redesigned for use in 2008. Filers will find a summary of key information on the very first page, designed to capture a "snapshot" of the organization’s basic financial, governance, and operational structure. The IRS also has moved the "Statement of Program Service Accomplishments" up to the second page of the form, bolstering claims that the new Form 990 allows a filing organization to explain what it does before accounting for how it does it.
For example, both Part I and Part III of the new Core Form ask a filing organization to state its mission and list its most significant activities. Prior to the release of the instructions, it seemed the IRS might be satisfied with a simple restatement of the purposes recited in an organization’s articles of incorporation. However, the instructions suggest that more specific information will be necessary. According to both the instructions and its accompanying glossary, the organization’s reported "mission statement" should establish "why the organization exists, what it hopes to accomplish, who it intends to serve, and what activities it will undertake and where." The IRS has indicated that it may list examples of program service accomplishments for particular sectors of the nonprofit community or develop "service activity codes" to ease reporting burden, but adopted neither idea in the final release of the 2008 instructions.
In Part VI, a new section entitled, "Statements Regarding Governance, Management, and Financial Reporting," an organization must now describe the composition of its board of directors, its governance and management structure, and its policies for promoting transparency and accountability to members and beneficiaries. For example, Part VI asks the filing organization to disclose the size of its board of directors, the proportion of the board that is independent, and whether or not its directors or officers have family ties or business relationships with each other or with key employees.
"Independent board member" is one of the more complicated terms outlined in the final instructions, and the test for "independence" has changed since the first draft of the instructions was released in April. A "member of the governing body" of an organization is "independent" if three conditions are met at all times during the taxable year: (1) the member "was not compensated as an officer or other employee of the organization or of a related organization"; (2) the member "did not receive total compensation or other payments exceeding $10,000" from the organization, except as reimbursement for expenses or reasonable compensation for "services provided in the capacity as a member of the governing body"; and (3) neither the member, nor any family member of the member, "was involved in a transaction with the organization (whether directly or indirectly through affiliation with another organization) that is required to be reported in Schedule L for the organization’s tax year." Board members do not lose their independence simply because they are major donors to the organization, or because they receive certain benefits as general members of the organization. An organization need not engage in more than a "reasonable effort" to obtain the information required to determine the independence of its leadership, and may rely on the information provided by its directors and officers.
Part VI of the Core Form also requires a filing organization to report any delegation of responsibilities to a "management company." There has been some initial concern about the scope of this disclosure. The final instructions to Part VI direct the filing organization to report use of a management company or any other person that performs "management duties customarily performed by or under the direct supervision of officers, directors, trustees, or key employees." These management duties may include "hiring, firing, and supervising personnel, planning or executing budgets or financial operations, or supervising exempt operations or unrelated trades or businesses of the organization." The final instructions clarify that "management duties" do not include basic administrative services, such as payroll processing, "that do not involve significant decision making." An organization need not report the use of an investment management company, unless the organization itself provides such services to others.
Finally, if an organization has local chapters, branches or affiliates, it must now use Part VI to report whether it has written policies and procedures in place to ensure that the chapters are operated in a manner consistent with the filing organization’s tax-exempt purpose.
Part VII, regarding "Compensation of Officers, Directors, Trustees, Key Employees, and Five Highest Compensated Employees," has changed in more subtle ways. All tax-exempt entities -- not simply 501(c)(3) organizations -- are now required to report the five highest employee salaries. The threshold for that reporting requirement has been raised from $50,000 to $100,000. When accounting for executive compensation, filers will now use Form W-2 and Form 1099 information as a starting point, but must also report "other" compensation, such as retirement plan contributions, deferred compensation, and health and welfare benefits in order to allow for a more complete picture of the compensation package. Organizations may provide a reasonable estimate of nontaxable fringe benefits when an actual dollar amount is unavailable. According to the final instructions, Part VII does not require filers to list any item of compensation that does not exceed $10,000 in value - although Schedule J may still require these items to be reported, as described below.
Although the current Form 990 also calls for information about "key employees," many in the tax-exempt community have called for a more specific explanation of the term. According to a recent press release, the IRS "really struggled" with an appropriate description. The final definition of "key employee" differs significantly from the test provided in the April draft instructions: a key employee (1) "had reportable compensation exceeding $150,000 for the year (the '$150,000 Test')"; (2) "had or shared organization-wide control or influence similar to that of an officer, director, or trustee, or managed or had authority or control over at least 10% of the organzation’s activities (the 'Responsibility Test')"; and (3) was "within that group of the organization’s top twenty highest paid employees for the year (the 'Top 20 Test')."
One of the most popular and least complicated additions to the 2008 form is Part IV, "Checklist of Required Schedules," designed to provide the IRS with a broad overview of an organization’s activities and to assist organizations with completing the proper sections. By answering this series of questions, a tax-exempt organization verifies which of the 16 Form 990 schedules it is required to submit.
Public Charity Status and Public Support. Prior to the release of the 2008 form, Schedule A - which must be completed by all 501(c)(3) public charities - required information regarding numerous topics unrelated to the basis of the organization’s public charity status, such as information about lobbying activities and transactions with non-charitable tax-exempt organizations. The redesigned Schedule A now focuses exclusively on public charity status; questions on unrelated topics have been moved to other schedules. In addition, the public support testing period has been lengthened from four to five years (to simplify the process and allow for the eventual elimination of the advance ruling process), the public support test for 509(a)(1) organizations has been separated from the support test for 509(a)(2) organizations, and space has been added for a narrative explanation to justify the "10% facts and circumstances" test, if applicable.
Political Campaign and Lobbying Activities. Since the Form 990 was first drafted, tax-exempt organizations have grown increasingly adept at participation in lobbying and political activities. The redesigned form incorporates expanded questions about lobbying and political expenditures and activities into a new Schedule C. Of note, the IRS has added questions regarding the transfer of funds between tax-exempt organizations and so-called "527 organizations," and non-501(c)(3) tax-exempt entities will now be required to provide more extensive reporting of lobbying and political campaign activities.
Statement of Activities Outside of the United States. In order to provide a more complete picture of an organization’s international activities, Schedule F now requests information about tax-exempt organizations that raise funds, make grants, or conduct trade, business or other activities outside of the United States. Organizations with more than $10,000 of aggregate expenses or revenues from foreign activities will be required to describe their operations on a region-by-region basis, and to provide information regarding grants or assistance made to foreign governments, organizations and individuals. These reporting requirements are expected to result in new recordkeeping practices for entities with substantial overseas activities.
Hospitals. Any organization that "operates or maintains a facility to provide hospital or medical care" is required to complete a new and somewhat controversial Schedule H. The final instructions key the definition of "hospital" to state licensure requirements - i.e., a "any facility that at any time during the year was, or was required to be, licensed, registered, or similarly recognized by a state as a ‘hospital’" must disclose its charity care policy, its billing and collection practices, and any outstanding joint venture or management company agreements it may have with third party entities. Hospitals also must report aggregate amounts of bad debt expenses and Medicare reimbursements. At least in part because of the comprehensive nature of this inquiry, the IRS has decided to phase in the application of Schedule H. While a filing organization may submit as much information as it would like, only Part V of Schedule H -- detailing the scope and location of certain hospital facilities -- is due in 2008. Reporting pursuant to the full Schedule H will be required in 2009.
Executive Compensation. As discussed above, executive compensation reporting is required for two types of compensation -- "reportable compensation" and "other compensation" -- and the final instructions provide definitions, examples, and other guidance for both terms. Officers, directors and employees who earn more than $150,000 in reportable compensation (as reflected on Forms W-2 or 1099) or $250,000 in total compensation (including nontaxable fringe benefits and expense reimbursements) will trigger more detailed reporting requirements in a redesigned Schedule J, including breaking out base compensation, bonus and incentive compensation, other compensation, deferred compensation, certain nontaxable benefits, and compensation reported in prior Forms 990. While the final version of Schedule J eliminates the reporting of de minimis fringe benefit and nontaxable expense arrangement/reimbursement amounts that had been included in the draft version of the new Form 990, certain arrangements that may raise "tax compliance and transparency concerns" must now be reported, including payments for first-class or charter travel, travel for companions, tax indemnification and gross-up payments, discretionary spending accounts, housing allowances and payments for the business use of a personal residence, health or social club dues or fees, and personal services (such as those of a maid, chauffeur or chef). The final instructions require filers to report such arrangements even if they are subject to the "$10,000-per-item Exception" and are not listed in Part VII of the Core Form.
The double counting of deferred compensation - requiring deferred compensation to be reported both in the year earned and the year paid - has been controversial, as it can lead to the perception that an individual’s compensation (in a single year and on a cumulative basis) is greater that it actually was. While the IRS believes that such double reporting is necessary for "transparency and compliance reasons" and is not eliminating this requirement, a new column was added to the final Schedule J to report amounts that also were reported in a prior year.
Transactions with Interested Persons. The old form required disclosure of transactions between the organization and its "insiders," including excess benefit transactions, grants and other business arrangements. Schedule L has been restructured to incorporate all such conflict-of-interest reporting in a single location. The final instructions indicate that the purpose of Schedule L is determine the independence of members of an organization’s board of directors.
Non-Cash Contributions. The old Form 990 failed to capture an accurate picture of the non-cash contributions received by exempt organizations, even when these contributions provided substantial benefit to the organization. The IRS added Schedule M to collect information about non-cash donations ranging from clothing and household goods to intellectual property, real estate, and easements. Quantity reporting is not required for some contributions; an organization need only check a box to show that it has received clothing, appliances, books, or publications. When quantity reporting is required, it should be based on the number of contributions made, as opposed to the number of items contributed.
Supplemental Information. One of the most significant criticisms of the old form was its inability to depict the full scope and impact of an organization’s activities. The new Form 990 contains a new Schedule O, allowing electronic filers up to two pages to respond to each question on the form, and an additional two pages to present any other information it might want to include in the overall report.
For example, the "Summary" portion of Part I requires the filing organization to estimate its total number of volunteers. In the new Schedule O, organizations may -- but are not required -- to explain how the number of volunteers was determined, and the types of services or benefits that such volunteers might provide. The final instructions help clarify the reporting required here by defining a "volunteer" as any individual, full-time or part-time, who provides any volunteer service to an organization during the reporting year. The instructions also note that an organization that does not keep records of volunteer activities may use any reasonable method to estimate its total number of volunteers.
Related Organizations and Unrelated Partnerships. The IRS added Schedule R to capture the increasingly complex organizational structure of many tax-exempt entities, and to improve transparency with respect to partnerships, limited liability companies, and other related organizations. The schedule is designed to add a new dimension of scrutiny in assessing an organization’s compliance with its tax-exempt purposes and, in the case of 501(c)(3) organizations, the potential for private inurement and private benefit (the ban on private inurement applies to other categories of tax-exempt organizations as well).
Schedule R also requires organizations to provide information on related organizations and on certain unrelated partnerships through which the organization conducts "significant" activities. The final instructions define "related organizations" broadly: the term includes parent organizations, subsidiaries, supporting organizations, and brother and sister organizations controlled by the same entity as the filing organization. An organization that maintains a group exemption is not required to list any of its subsidiaries; however, it is required to report any transactions with related organizations in Part II of Schedule R.
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With all of these changes now in effect, tax-exempt organizations should focus most immediately on two distinct areas - their processes for approving executive compensation and their organizational governance.
Approval of Executive Compensation. Because the 2008 Form 990 requires organizations to make the details of its compensation packages available to the public, tax-exempt entities must make it a priority to substantiate the reasonableness of executive salaries and benefits. An organization that pays what may be viewed as excessive compensation risks affecting its public image and jeopardizes future fundraising efforts and membership support.
While the Form 990 does not directly reference the "intermediate sanctions" rules applicable to 501(c)(3) and 501(c)(4) organizations, Section VI of the new form does ask if "the process for determining compensation . . . include[s] a review and approval by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision." The Treasury Regulations set out the criteria necessary to create a "rebuttable presumption of reasonableness" of compensation received by officers, directors and employees: The organization’s governing body, or a committee of the governing body free of conflicts of interest with respect to the transaction, must approve the compensation arrangement;The governing body or its committee must have obtained and relied upon appropriate comparability or benchmarking data -- such as industry surveys or compensation studies -- prior to making its decision; andThe governing body or its committee must adequately document the basis for its decision at the time it is made.
Tax-exempt organizations that meet these three factors and qualify for the rebuttable presumption of reasonableness likely create additional grounds to defend themselves against any additional scrutiny imposed by the 2008 Form 990.
Organizational Governance. The IRS maintains that no particular policy or form of governance is compelled as a matter of law, and encourages organizations to fully explain and provide the context for their preferred method of administration. Nevertheless, the 2008 Form 990 asks for detailed information about a filing organization’s leadership structure and its governance policies. As such, both the IRS and the general public will be looking to see that the boards of directors make independent judgments and exercise an undivided loyalty to the organization. Tax-exempt organizations should review their procedures for board member election and qualification to ensure, if at all possible, that the majority of the organization’s voting directors do not have relationships with the organization that might compromise their objectivity (see the definition of "independent board members," discussed above). Organizations should be prepared to explain who its board members are, how the organization selects them, and why its process for choosing them is sound.
In addition, organizations should conduct a general review of existing governance policies and practices, and consider adopting additional policies or guidelines as needed. Knowing that information disclosed in the new Form 990 sets a tone with the public, organizations may wish to adopt policies and procedures that lend increased transparency and trustworthiness to compensation decisions, conflicts of interest, whistleblower protection, document retention and destruction, chapter governance, and participation in joint venture arrangements. All policies should be in writing, and their application and enforcement should be well documented.
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Tax-exempt organizations should realize that today’s activities will be those reported on the 2008 Form 990. Therefore, organizations should take the time now to become familiar with the new form, and to review their relevant policies and procedures. Also considering conducting a "dry run" completion of the new form, to see how your organization’s profile will be reflected; this may enable you to make helpful changes before the end of the tax year. The 2008 Form 990 prompts tax-exempt entities to tell their stories in more scope and detail than ever before; those that tell their stories best will be those that become familiar with the document sooner and respond accordingly.
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