demystifying the 990: an overview of its purpose and...
TRANSCRIPT
Alexandria Small Business Development Center
The Alexandria SBDC is funded in part by a Cooperative Agreement with the U.S. Small Business Administration.
Demystifying the 990: An
Overview of Its Purpose
and Pitfalls
April 9, 2015
Sponsored By:
Or how Return of Organization Exempt from Income Tax can be your friend
Pretty much any tax exempt organization has to file some form of 990 (990-EZ, 990-N)
◦ Exceptions are churches and some political
organizations
15th Day of the 5th month after year-end
For a December 31 year-end this means May 15
Two 3 month extensions are available; the second requires an explanation
A: Nothing good
No filing for three years causes automatic loss of exemption
Gross Receipts normally < $50,000
File 990-N
Gross Receipts <$200,000 and total assets <$500,000
File Form 990-EZ
Income > $200,000 or total assets >$500,000
File Form 990
Failure to file: ◦ Small organization -$20/day up to lesser of
$10,000 or 5% of gross receipts
◦ >$1M - $100/day up to $50,000
Revocation of Exemption – for nonfiling during any three year period
Three main purposes: ◦ Compliance
◦ Justify continued exemption
◦ Governance
501-c-3 - No part of the net earnings may inure to the benefit of any private shareholder or individual
Inurement is direct benefit to disqualified persons
Private Benefit may be nonincidental, indirect benefit on disinterested persons serving private interests
Not expressly prohibited ◦ Remember private inurement or benefit
◦ Must be fully disclosed
IRS can now match more filings
Payroll/1099s
Unrelated Business Income
Foreign accounts and activity
Contributions/Donors
Name, governance docs, activity changes
Section 4,5,6 dues/lobbying filings
Form 990 (or 990-EZ) – exclude donor names
Form 990-T (only 501-c-3 organizations)
Form 1023 or 1024 Exemption application and all attachments
Does not include audit reports, internal financial statements or budgets,
Balance Sheet ◦ Liquidity, investments, debt
◦ Detail on Schd D
Revenue ◦ Line 1 – contributions
◦ Line 2 – program revenue
Expenses ◦ Functional breakdown , (c) 3 and 4
◦ Breakdown Misc. if too high
501 (c) 3 ◦ Rebuttable presumption
Box 5 – Medicare Wages
Other related organizations
Include other compensation, include perks
Services
Don’t have to be on a 1099
Size of Board
Independence (compensation driven)
Board powers, related activities
Level of involvement
Relate to the mission
Tell the story with accomplishments, metrics
Disclose (to IRS) new activities, changes in mission
Let client “tell the story”
Board: ◦ Members
How many?
How are they selected
◦ Makeup
Independent?
◦ Related party transactions
Problem or not?
◦ Balance of power with members?
Internal Control
Whistleblower
Document retention/destruction
Review of 990
Board minutes
Effective Board Review
How many of you serve on a Board? • Ever been asked to review
Form 990?
To Board Members:
From: CEO
July 16, 2014
Re: Form 990 attached
• Here is the draft 990 provided by our auditors,
• Our director of finance has reviewed it,
• It will be filed electronically one week from today,
• Please let us know your comments.
What are your thoughts?
Exercise Oversight
I’m not a CPA
I trust the preparer
Others understand
it
My name is spelled
right
Are questions welcome?
Who’s looking over your shoulder?
Attorney General
IRS Donors
Grantors Watchdogs
What’s on your mind?
Duties of Board
• Duty of care
• Informed and prudent
• Duty of loyalty
• No conflicts
• No private benefit
• Duty of obedience
• Following law, bylaws and mission
What else is on your mind?
Fundraising transparency
Tax exempt status
• Exempt purpose
Public Charity Status
• Organization test
• Support test
What else is on your mind?
Taxable activities
Reasonable compensation
Tax filing requirements
Use of resources
Financial staying power
Where’s that on the 990? • TODAY’S GOAL—a Review Roadmap:
• Link appropriate Board concerns to corresponding areas of 990,
• Make best use of Board resources,
• Support oversight and governance.
• Review Form 990 for “red flags”, and suggest proposed questions.
• Not all inclusive – top items in general.
Board Member’s Goal
• This 990 has not been reviewed by an informed committee of the Board.
• If you’re a financial Board member, this is your roadmap.
• If your Board expertise lies elsewhere,
• Recognize issues,
• Ask questions,
• Ensure that an informed review has been done by some committee of the Board.
What’s a red flag?
• Area of interest to IRS, attorney general, donor community, etc.
• Not necessarily an error,
• Area that invites scrutiny,
• 990 should present relevant information, explanations, background,
• Satisfy any potential questions.
990 Review Roadmap:
Determine context of your review
Get your bearings on page 1
Read activity descriptions, page 2
Note “interesting” areas, pages 3 and 4
Check tax filing compliance, page 5
990 Review Roadmap, continued:
Size up your governance, page 6,
Check out the Board, page 7,
Read financials, pages 9-11
Are you still a public charity?
Make notes for follow up.
The worst 990 ever prepared…
• Look it over,
• Identify your questions,
• Mark possible red flags,
• Team up,
• Teams with highest score win.
Beginning Your Review-- Find out what review has already been done: • Go straight to page 6…
• Question 11a – Has Board seen the 990?
• Question 11b – how was 990 reviewed? • Must go to Schedule O to find the description…
• Schedule O says: • Your auditors prepared, • Your CFO and CEO have reviewed. • Board member can expect basic accuracy. • Has NOT been reviewed by a finance/audit committee.
Get Your Bearings; Read and understand the front page
• Executive summary, • Conveys priority information,
• Snapshot of Organization, • Exempt status, • Mission, • Size of Board, • UBIT, • Dollar volume, • Net income, • Total assets and liabilities
• Signature block at bottom.
Any Red Flags on 990 Page 1?
• Lines 3 and 4 – Board is very small • “What do nonprofit professionals say about board size?”
• Line 6 – No volunteers • “Shouldn’t we list the unpaid Board members as volunteers?”
• Line 7b – No net income from unrelated business. • “What type of expenses do we have and • how are they documented”?
Size of Board— Best Practices:
• BBB Wise Giving Alliance says:
• “To ensure that the volunteer board is active, independent and free of self-dealing…the organization shall have…
• A board of directors with a minimum of five voting members…”
• Not more than one compensated member.
Touring the 990; page 2 – Do activities support mission?
• Activities are described on page 2, part III, lines 4a – c,
• Descriptions should demonstrate how activity furthers mission,
• Include measurables,
• Take opportunity to promote your good work.
Any Red Flags on 990 Page 2? • Descriptions of activity
in 4a-c:
• 4a Looks like entertainment,
• 4b Doesn’t tie to mission,
• 4c Not a program activity.
• “Could we take this opportunity to provide a fuller description?”
990 part IV, pages 3-4 – Are your activities “interesting”? • Purpose of pages 3-4 is to identify required
schedules based on your activities,
• These activities have schedules because they are of interest to IRS,
• Read the questions and drill down on YES answers.
• YES answers on pages 3 and 4 indicate additional information is needed,
• YES answers on pages 3 and 4 may lead to further scrutiny.
990 part IV, pages 3-4 – YES answers can lead to further scrutiny:
• Question 3 – partisan political activity • If YES, public charities could lose exempt
status.
• Question 4 – lobbying • If YES, public charities could lose exempt
status.
• Question 5 – dues • If YES, associations may owe proxy tax.
990 part IV, pages 3-4 – YES answers can lead to further scrutiny:
• Board members can skim lines 6 through12, • Numbers questions,
• Not board-level.
990 part IV, pages 3-4 – more YES answers that can lead to further scrutiny:
• Question 14 – foreign activities or accounts, • Foreign bank account form required for Org, • Form may also be required on signor’s 1040! • “When is it due, have we filed it?”
• Drill down on that YES answer, • Read schedule F,
• “ It appears that Schedule F is missing from my copy…”
Back to 990 part IV, page 3 – more YES answers that can lead to further scrutiny:
• Question 17 – use of professional fundraising services, • Fundraising transparency
• Drill down on that YES answer: Read Schedule G.
Read Schedule G:
• Note dollars disclosed,
• “Who is evaluating Mr. Williams’ performance?”
• Note there are no charitable registrations filed. • “Are we required to file any state charitable
registrations?”
Back to 990 part IV, pages 3-4 – more YES answers that can lead to further scrutiny:
• Question 19 – gaming, • Are you complying with law and filing
requirements? • Raffles are gaming.
Back to 990 part IV, pages 3-4 – more YES answers that can lead to further scrutiny:
• Question 23 – compensation of officers, directors, key and highest compensated employees, • Private inurement • Payroll compliance.
• Drill down on that YES answer, read Schedule J.
Compensation Information – Schedule J
• Read Schedule J: • 1a - “Interesting” types of compensation,
Compensation Info; Schedule J, continued
• 1b and 2 - Lack of documentation, • 3 - Salary not approved using safe harbor
methods.
Schedule J page 2:
• Read schedule J page 2.
• “what documentation do we have that Ms. Williams compensation is reasonable?”
Back to 990 part IV page 4 – questions looking for private benefit:
• Could lead to loss of exempt status,
• Question 25 – self identified transactions,
• Question 26 loans to/from officers,
• Drill down on that YES answer • Read schedule L,
• Second mortgage for executive director,
• “Tell us more about this loan. When will it be repaid?”
Back to 990 part IV page 4 – questions looking for private benefit:
• Question 27 grants to officers, key employees or family members,
• Question 28 related party business transactions. • (Is everyone OK that this has been answered
NO).
Back to 990 part IV page 4 – more YES answers you should know about:
• Question 31 – liquidation • How were assets disposed?
• Question 32 – transfer of more than 25% of net assets.
• In Summary: pages 3 and 4 are more than a checklist,
• Pages 3 and 4 are a road map to areas of scrutiny,
• Understand any YES answers and read the follow-up form,
• Ask questions,
• Response will involve adding additional explanations to satisfy questions.
Read 990 part V, page 5 – Red Flag questions about IRS filing requirements
• Question 1a – did you file any 1099s? • No 1099s - Really?
• Question 2a – did you file any W-2s? • If no W-2s – Really?
Read 990 part V, page 5 – Red Flag questions about IRS filing requirements
• Question 4a and b – foreign bank account, • (Already discussed)
• Questions 6a-b and 7a-b – Solicitation of contributions, • Did you make required disclosures?
990 part VI, page 6 – Sizing up Your Governance • Question 1a - number of voting Board members,
• Question 1b – number who are independent. • Small number of independent Board members viewed
as an indicator of risk of conflict of interest or concentration of control.
• Board members who receive compensation are NOT independent.
990 part VI, page 6 – Sizing up Your Governance
• Question 2 – are there any family relationships? • Must look at page 7 to answer, • Really?
• Question 5 – any significant fraud discovered?
990 part VI page 6 – Evaluating Your Policies
• Question 12 – Written conflict of interest policy? • If no – viewed as indicator of risk of conflict of interest,
private benefit.
Conflict of Interest—Best Practices • BBB Wise Giving Alliance says: • “To ensure that the volunteer board is
active, independent and free of self-dealing…
• The organization shall have…no transactions in which any board or staff membesr have material conflicting interests with the charity resulting from any relationship or business affiliation.”
• (the organization shall eliminate material conflicts of interest rather than just disclose them).
990 part VI page 6 – Evaluating Your Policies • Questions 13 and 14 – whistleblower
and document policies, • Written policies are required by law for all
corporations,
• NO answers reflect on Board’s exercise of duties.
990 part VI page 6 – Evaluating Your Policies • Question 15 – process for determining compensation
for highly compensated, • NO answers viewed as indicator of risk of private inurement,
• (As previously discussed).
Red Flags Add Up:
Risk of Private Benefit
Lack of conflict
policy & backup
Little independ
ent governan
ce
Highly paid
related parties
• Page 4, question 23, • Highly
compensated individual
• Page 4, question 26, • Loan to
officer • Page 4, question
28, • Vendor is
family member
• Page 6, question 1a-b • Few
independent Board members
Red Flags Add Up:
Risk of Private Benefit
Lack of conflict
policy & backup
Little independ
ent governan
ce
Highly paid
related parties
• Page 6, question 2 • Two of three
independent Board members are family,
• Highly compensated officer is family member
More Red Flags Add Up:
Risk of Private Benefit
Lack of conflict
policy & backup
Little independ
ent governan
ce
Highly paid
related parties
• Page 6, question 12a • No conflict
of interest policy
• Schedule J—few salary policies
• Schedule L—transactions with officer
• Schedule G—vendor is family member, performance questionable
Read the Financials, pages 9 - 11
• Numbers should already be accurate,
• Page 9, Revenue--Scan sources of income,
• Page 10, Expenses--Scan expenses—what does everyone look at on this page?
• Only 50% of expenses spent on program.
• “Are expenses allocated properly?”
• Our cost to raise a dollar is 77 cents.
• “Who is evaluating our fundraising efficiency?”
Use of Resources— Best Practices
• BBB Wise Giving Alliance recommends:
• “To ensure that the charity spends its funds honestly, prudently and in accordance with statements made in fund raising appeals…the charitable organization shall…
• Spend at least 65% of its total expenses on program activities…
• (Spend no more than 35 cents to raise a dollar.)”
Read the Financials, pages 9-11
• Page 11, Balance Sheet—Do we have staying power?
• What is our reaction time? • We have 4 months of expenses in cash and
investments—without cutting anything.
• “Who has studied our operating reserve in case of unexpected events?”
Common Reserve Goals– Best Practices
• Most common Association reserve goal is 6 months of operating expenses. • ASAE operating ratios report.
• Charity rating organizations prefer reserves of 1-3 years of operating expenses. • American Institute of
Philanthropy.
Are you still a public charity?
• Organization and operation • We have reviewed
• Support test—33% is the magic number • Public charity status
requires a broad base of public support
• More than 33% of your total support should be from public support.
Are you still a public charity?
• Go to Schedule A page 2 or 3 • Whichever is filled out.
• Percent in section C should be way more than 33%.
• “Who is reviewing our support ratio for future action.
Red Flag Remedies
• Ensure answers are consistent and accurate,
• Explain circumstances in Schedule O,
• Answer as of last day of year,
• Any changes after year end can be added to Schedule O,
• Keep notes on governance items for future follow up.
Summary: 990 Review Roadmap:
Determine context of your review
• Find out what review has already been done,
• Page 6, question 11.
Get your bearings
• Read and understand page 1.
Read activity descriptions, page 2
• Do they support mission?
Note “interesting” areas, pages 3 and 4
• Drill down on YES answers.
Check tax filing compliance, page 5
Renner and Company, CPA, P.C.; www.rennercpa.com
Page 1
Summary: 990 Review Roadmap, continued:
Size up your governance, page 6,
Check out the Board, page 7,
Read financials, pages 9-11
• Staying power?
• Use of resources?
Are you still a public charity?
• Support % Schedule A
Make notes for follow up.
Renner and Company, CPA, P.C. www.rennercpa.com
Page 2
How many red flags?
aka UBI
Gross income of an exempt organization derived from an unrelated trade or business regularly
carried on
Any trade or business the conduct of which is not substantially related to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501-c-….
Trade or business
Regularly carried on
Not substantially related
Not defined by IRS
Generally considered to be an activity carried on to produce income
A profit motive is key
Frequency
Continuity
Compared with similar for-profit enterprises
Causal relationship to achievement of exempt purpose
Relationship must be substantial and contribute importantly
Volunteer exception
Convenience exception
Contributed merchandise
Some Bingo games
Low cost articles
Sale of membership lists
Certain investment income
Qualified sponsorships, etc.
All of the profits are used to support our exempt purpose!
UBI is taxed
Deductions are allowed
Too much is a bad thing
Income retains its character as it passes to the exempt organization
Specified payments of rents, annuity, royalties, interest from a Controlled organization are taxable
Advertising
Debt financed rental income
NMFTA owns an office condo. They have too much space and rent out 12% of it under a 5 year lease. Is it taxable?
Benefits Bethany House for abused women ◦ Sells variety of donated merchandise
◦ Has paid managers and lots of volunteers
◦ Is it taxable?
◦ What if it was a consignment shop?
AWPA holds a meeting in the spring and sells sponsorships. Each sponsor gets recognition as a sponsor, two registered attendees, and an ad in the program.
Is there any UBI?
Hopewell House needs cash and has more farm than it needs for its exempt purpose. They already have livestock; how about ramping up production and selling to people on Food Stamps under a USDA program to get more fresh produce to the poor. Does this create UBI?
What if they do it through a single member LLC?
What if the work is done by volunteers?
Three scenarios ◦ They have a store selling art supplies
◦ They have soda machines in the classroom areas and in the back foyer of the Torpedo Factory
◦ They have an art gallery in the Torpedo Factory
501-C-7 Social club – organized for pleasure, recreation of members.
Needs more $; has slack times in late morning
Solution: allow nearby summer camps to use the pool for a fee
Stores sell: t-shirts, astronaut food, toy dinosaurs, First Lady paper doll books, miniature White House pencil sharpeners, drinks and snacks, rain ponchos, cherry tree seeds, dvds of museum tours
501-c-6 Business League – association of persons with common business interest to promote such interest not engaged in a regular business of a kind normally carried on for profit
Incorporate as a traffic bureau for members and nonmembers
Provides service in shipment of goods
Rates, rules and practices, claims investigation, representation before regulatory boards
Promote common interests
Not engage in a business normally carried on for profit
For improvement of business conditions of one or more lines of business
Three levels of membership: Industry, Associate Silver and Associate Gold
Associate members get 2 or 4 admissions to events, access to Industry members, newsletters & other info, ¼ or ½ page in industry guide
Problem: small traders (odd lot amounts) had no easy, inexpensive way to settle out at the end of each month
Solution: ITFA created online method for settling that involved lower fees that major services. Generated large fees for IFTA.
Is this too much UBI?
Don’t turn your back on profitable options
How can they make this work?
Revenue from an activity, even one substantially related to the exempt purpose, cannot be exempt income if the activity is conducted in a commercial manner ◦ Based on competition with for-profits
Operating Manner
Pricing
Existence and amount of current or accumulated profit
Commercial promotion methods
Receipt of charitable contributions
Taxable and/or loss of exemption
UBI can be many things
Think thoughtfully about your FIN 48 revenue reviews
Remember your exemptions: volunteer labor, donated goods/services, convenience, not regularly carried on
Catherine Pennington, CPA, CGMA www.rennercpa.com [email protected]
Related articles on our website: ◦ Charity scorecard, ◦ Operating reserve ◦ Nonprofit compensation ◦ Board member review of 990 ◦ Raffles, the right way, ◦ Lobbying by 501(c)(3) organizations.
Alexandria Small Business Development Center
The Alexandria SBDC is funded in part by a Cooperative Agreement with the U.S. Small Business Administration.
Follow Us on Social Media!
www.facebook.com/alexandriasbdc
@AlexVASBDC
Alexandria Small Business Development Center
The Alexandria SBDC is funded in part by a Cooperative Agreement with the U.S. Small Business Administration.
Upcoming Events
Tuesday, April 14th: “Securing Your Small Business – Cyber & Physical Challenges" Workshop. 9:00 am - 12:00 pm.
This two-part session covers how you can help prevent, protect, and recover from electronic and physical property theft in your business. For more
information, visit http://alexandriasbdc.org/event/securing-your-small-business/
Tuesday, April 21st: “Do You Really Know Your Target Market?" Business Development Roundtable. 12:00 - 1:00 pm.
No registration is required for this event. This is a facilitated discussion with other small business owners. For more information, e-mail
Tuesday, April 21st and Wednesday, April 22nd: Social Media Counseling
45-minute sessions for City of Alexandria businesses with Ray Sidney-Smith of W3 Consulting. E-mail Gloria Flanagan for availability
Wednesday, April 22nd: HR Counseling
50-minute sessions for City of Alexandria businesses with Patricia Frame of Strategies for Human Resources. E-mail Gloria Flanagan for
participation information at [email protected]
Friday, May 1st: Nonprofit Consulting and Health Department Consulting
50-minute sessions for City of Alexandria businesses. E-mail Gloria Flanagan for participation information at [email protected]
Save the Date!
Thursday, May 14th: “Commercial Leasing 101" Workshop. 9:00 am - 11:00 am.
Thursday, May 28th: “Government Contracting" Workshop. 9:00 am - 12:00 pm.