To help you better understand the Form 990, and as a follow-up to last month’s Nonprofit Advisor article on marketing considerations, we’ve prepared this Part 2 article that takes an in-depth look into what you should know when it comes to complying with the Form 990.
1. Review the Form 990 Carefully: An organization is not required by federal tax law to provide a copy of the Form 990 to its board or governing body, or to have them review the form before it is filed. However, the IRS believes board review is a fiduciary duty and encourages board members and executives of nonprofits to review and understand what is being filed each year. All organizations must provide information on Form 990 about the process, if any, the organization used to review the Form 990.
2. Not All Tax-Exempt Organizations are Charities: There are more than 50 different 501(c) classifications, depending on an organization’s purpose and activities. For example, business leagues receive a 501(c)(6) designation, while social clubs receive a 501(c)(7) designation. 501(c)(3) organizations are exempt from federal income tax as charitable organizations. The major difference between charities and other tax-exempt organizations is that contributions made to charitable organizations by individuals and corporations are tax deductible. In addition, public charities may not be subject to some state and local sales taxes. It is important to identify the type of tax-exempt organization, since the requirements on Form 990 differ for each type of organization.
3. Not All Income Earned by Nonprofits is Tax-Exempt: Even though an organization is recognized as tax exempt, it still may be liable for tax. The organization may be subject to unrelated business income tax (UBIT) on activities regularly carried on and not substantially related to the entity’s exempt purpose. The primary purpose of UBIT is to put tax-exempt entities and “for profit” enterprises on equal footing with respect to their trade or business activities. Before entering into new business ventures, investments, and other activities, it is important to consult with your tax advisor. In addition to UBIT, an organization may be subject to the following taxes:
- State income tax;
- Local business taxes (i.e., Philadelphia, New York City taxes)
- Payroll tax;
- Sales tax.
4. Lobbying vs. Political Activities: Given the many crucial issues facing non-profit organizations and the people they serve, it is more important than ever that charities have a voice in public policy debates. Many non-profit organizations mistakenly assume it is illegal for non-profits to lobby. To the contrary, federal laws actually exist to encourage charities to lobby within certain specified limits. Knowing what constitutes lobbying under the law, and what the limits are, is the key to being able to lobby legally and safely. On the other hand, Section 501(c)(3) organizations are prohibited from participating in political campaigns. Schedule C provides the IRS with information concerning political campaign activities and/or lobbying activities of Section 501(c)(3) organizations.
5. Unreasonable Compensation: Organizations seeking tax-exemption must be organized and operated so that no part of their net earnings inure (i.e., accrue) to the benefit of any private stakeholder or individual. Therefore, any inurement (regardless of the amount) could endanger an organization’s exempt status. Organizations have lost their exempt status because of private inurement related to unreasonable compensation. Unreasonable compensation is one of the IRS’s most active areas of inquiry and enforcement. The detailed compensation reporting requirements in Form 990 require accurate and complete reporting. To avoid loss of tax-exempt status and/or intermediate sanctions, the organization should use a process for determining compensation which includes the following:
- Review and approval by a governing body or compensation committee;
- Use of data as to comparable compensation for similarly qualified persons in functionally comparable positions at similarly situated organizations;
- Contemporaneous documentation and recordkeeping for the deliberations and decisions regarding the compensation arrangement for senior management as well as staff.
6. State Requirements: Most states require nonprofit organizations to file one or more documents to obtain permission to operate and solicit contributions in that state. Each state has its own requirements; therefore it is important to consult with your tax or legal advisor. These filing requirements generally fall within the following areas:
- Annual Reports - To keep track of corporations registered in that state;
- Annual Financial Returns – Often means filing of the Form 990 with the attorney general or other state agencies that regulate charitable organizations;
- Tax Status – Periodic renewal of the state’s recognition of a nonprofit’s tax-exempt status. For example, tax-exempt certificates for sales and use tax;
- Charitable Solicitation Registration – If a charity is engaged in fundraising activities in a state, it is likely that the organization will be required to complete a registration with various attachments and a registration fee. It is highly recommended you do not solicit (e.g., through mailings) until you fulfill the necessary registration requirements, if any. There could be significant penalties for not complying;
- Some states also regulate professional fundraisers.
To learn more about the Form 990, please feel free to contact me at RCitino@friedmanllp.com. I am happy to answer any questions you may have.