Not-For-Profit/Exempt Organizations Blog : Non-Profit Lawyers & Attorneys : Proskauer Rose Law Firm : Tax & Corporate Law for 501(c), 501(3) Organizations

  The final regulations: 

• allow for new threshold amounts for reporting compensation; 
• require reporting on a calendar year basis; 
• modify the scope of organizations subject to reporting upon a substantial contraction;  
• eliminate the advance ruling process; 
• change the public support computation to five year; and 
• clarify that support must be reported using the organization's overall method of accounting. 

   

Both small businesses and tax-exempt organizations will use the form to calculate the credit.  Instead of claiming the credit on an income tax return, however, exempt organizations will instead claim the small business health care tax credit on a revised Form 990-T.  The Form 990-T is currently used by exempt organizations to report and pay the tax on unrelated business income.  Form 990-T will be revised for the 2011 filing season to enable eligible exempt organizations to also claim the small business health care tax credit.  These organizations will not have to owe unrelated business income tax to be able to file a Form 990-T and claim the tax credit.

The draft Form 8941 is available on the IRS website.  The IRS states that the final Form will be available later this year.

For additional information on the health care tax credit, please visit the IRS page on this topic or review our April 7, 2010 blog entry.

Two types of relief are available for small exempt organizations — a filing extension for the smallest organizations required to file Form 990-N and a voluntary compliance program ("VCP") for small organizations eligible to file Form 990-EZ. 

To become compliant, small organizations required to file Form 990-N can go to the IRS website, supply the eight information items called for on the form, and electronically file it by October 15.  On the other hand, under the VCP, tax-exempt organizations eligible to file Form 990-EZ must not only file their delinquent information returns by October 15, but must also pay a compliance fee. 

Importantly, the relief announced by the IRS is not available to larger organizations required to file the Form 990 or to private foundations that file the Form 990-PF.

Organizations that have not filed the required information returns by October 15 will have their tax-exempt status revoked, and the IRS will publish a list of these revoked organizations in early 2011. Donors who contribute to at-risk organizations are protected until the IRS publishes the final revocation list.  At that point, donations to these organizations will no longer be tax deductible.

This one-time relief is extremely helpful to many small organizations that are at risk of automatic revocation.  As IRS Commissioner Douglas Shulman stated, "...[I]f you do not have your filings up to date, now’s the time to take action and get back on track."

For additional information about losing tax exemption because of failure to file, please see our April 5, 2010 blog entry.  For additional information about the VCP, please visit the IRS website and frequently asked questions about the VCP.

Certain activities are completely off-limits to non-profits, while others must be undertaken after research and sometimes consultation with business or legal advisors.  The following list contains rules with which public charities must comply in order to maintain their tax exempt status:

1. No Private Benefit and Inurement.  Individuals and organizations may not obtain more than an incidental benefit from a public charity.  Additionally, any person with a private or personal interest in the activities of an organization may not be compensated unreasonably by the organization.  If any person in a position to exercise substantial influence over the affairs of an organization receives an economic benefit from it (in excess of the goods or services that the person has provided), the charity must report the transaction to the IRS as an “excess benefit transaction.”  
2. Political Campaign Intervention.  Public charities may not directly or indirectly participate or intervene in any political campaign – whether on behalf of or in opposition to any candidate for public office.  Public charities may engage in general “get out the vote” drives, as long as they are non-partisan.  Organization leaders can make political comments only if they clearly indicate they are speaking in a non-official capacity.  This absolute bar on political activity extends to issue advocacy as well – public charities cannot advocate for any issue that essentially functions as political campaign intervention.  The IRS has also issued detailed guidelines about when it is appropriate for candidates to speak at functions sponsored by a public charity.  Ultimately, failure to heed the restrictions against engaging in political activity can have severe effects on a public charity, ranging from the imposition of an excise tax to loss of tax-exempt status.
3. Lobbying.  Public charities may not try to influence legislation through substantial lobbying activities.  Whether an organization’s legislative activity is considered substantial enough to risk loss of tax-exempt status or imposition of an excise tax is determined by one of two tests.  The substantial part test looks at a number of factors to determine whether lobbying activity is substantial, while the expenditure test looks at how much an organization spent on lobbying activities compared to a set amount specified in the Internal Revenue Code.
4. Form 990.  Annually, public charities must file some version of the IRS Form 990 (Form 990-EZ, Form 990-N).  The penalties for failure to file or late filings vary, and are based on an organization’s annual gross receipts (but may range from $20 per day to $100 per day).  An organization that is delinquent in filing the appropriate form for three consecutive years may have its tax-exempt status revoked.
5. Employment Tax Returns.  All public charities that pay wages to employees must withhold, deposit, and pay employment tax (including federal income tax withholding, Social Security and Medicare taxes).  Public charities should have a Form W-4 on file for each of their employees to determine how much income tax to withhold.  Public charities must also report employment taxes on Form 941 (quarterly) or Form 944 (annually).
6. Recordkeeping.  Public charities should maintain books and records to demonstrate that they are in compliance with tax rules, and keep all documents that indicate the sources of their receipts and expenditures reported on the Form 990.  Generally, charities should keep records that support an item of income or deduction on a return until the statute of limitations for that return runs.  Failure to provide back-up documentation when requested by the IRS may result in a loss of tax-exempt status.  Additionally, charities should maintain records generally as a means to evaluate their programming, identify their donors over time, and monitor their financial health.  In addition, charities sometimes must prepare accurate and timely annual financial statements (per state law) and maintain adequate records and case summaries of grant-making activities.  An organization’s record-keeping system should include a summary of transactions (including gross receipts, purchases, other expenses, employment taxes, and assets) and all documentation supporting these entries (such as grant applications and awards, donor correspondence, sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks).
7. Governance.  As we have mentioned in previous blog posts, public charities should develop and adopt sound governance policies and practices.  At a minimum, public charities should adopt a mission statement, establish an active and engaged governing board, and implement policies relating to executive compensation, conflicts of interest, investments, fundraising, document retention, and whistleblower claims.  Also, a charity should document important governance decisions made by the board or other governing body. 

For additional issues that exempt organizations should consider in this new regulatory environment, please see our May 19, 2010 entry.

Churches and integrated auxiliaries of Churches are not required to file Form 990.

Starting this year, organizations that fail to file these information returns for three consecutive years will automatically lose their exempt organization status.

A list of the revoked organizations will be publicly available on the IRS website.

If an exempt organization fails to file and loses its exempt organization status, it will have to reapply for tax-exempt status.  Moreover, any income that it incurs after it loses its exempt status, but before the application is approved may be taxable.

Form 990 (all series) is due on the 15th day of the 5th month after the organization's taxable year ends.

For more information, please visit the IRS page on this topic.

Below are some important drafting tips for governance policies to help a not-for-profit organization survive and thrive in this new regulatory environment.

1.)                Introduce Your Organization

            Governance policies are the face of the board to the CEO, staff, and the general public.  From the outset, before addressing the substance of the policies, governance policies should contain introductions that address an organization’s vision, mission, desired outcomes, and internal and external values that define its character.  This introduction should also address an organization’s functions, the percentage of its time devoted to each function, its strategies, and its goals. 

2.)                Describe the Role of the Board

            The most important part of governance policies deals with board structure and policies; specifically, these provisions address the “job description” of the board; disciplinary action against board members; accountability, self-monitoring, and evaluation; and how policy changes may be initiated. The board’s responsibilities should include:

§ Maintaining, reviewing, and updating the governance policies as times change;

§ Ensuring the financial solvency and integrity of the organization, which requires regular external audits and internal checks and balances; and

§  Selecting the CEO and reviewing his or her performance. 

3.)                Who Is Responsible for CEO Oversight?

            Board policies should address the selection and evaluation process and compensation of a CEO (whether the CEO is to be compensated and, if so, how compensation levels are determined).  The board should provide regular performance reviews and an annual performance report to the CEO based on his or her performance, and the governance policies should address precisely how such evaluation is carried out and delivered.

4.)                What Every Candidate Should Know Before Joining Your Board

            Governance policies should detail what can be expected of board members – including the criteria to become a member of the board and training for new and seasoned members.  These provisions should provide enough information to serve as a self-explanatory “orientation” for new board members who inquire about their responsibilities. The role of the chairman of the board should also be detailed, as should meeting rules, agenda-setting, and the evaluation process for determining if meetings are actually effective. The policies should outline a code of conduct so that board members are fully aware of what is expected of them, and what kind of behavior warrants discipline.  Included in a code of conduct should be a comprehensive conflict of interest policy.

5.)                How All the Moving Pieces Fit Together

            Policies should also address how the board, the CEO, and staff – and their varying responsibilities – are interrelated.  To avoid confusion, duplication of efforts, and finger-pointing, responsibilities should be clearly assigned among the various parties.  Policies should also include the CEO’s job description and how the CEO and the board should communicate with each other.  Staff hiring, termination, treatment, and compensation should be documented, and a whistleblower policy should also be adopted.  Including a whistleblower policy indicates that an organization is committed to complying with the law, and encourages a culture of transparency.

6.)                Establish Standing Committees

            Governance policies should provide for subgroups of the board, which are tasked with more specific agendas, depending on an organization’s needs.  The typical standing committees include committees focused on governance, finance, audit and compliance, advancement, programming, and executive responsibilities.  Advisory groups and task forces, consisting of both board members and outsiders, may be created to assist with particular projects that require more specialized knowledge and expertise.

7.)                Budgeting and Finances

            Policies should address budgeting and financial controls, as well as asset protection and investment principles, since every organization that plans to be fiscally healthy must develop a comprehensive, long-term plan to achieve and maintain good fiscal health. 

8.)                Programming and Fundraising

            A comprehensive policy includes a description of the programs an organization will offer, and how new programs will be developed.  It should also include advancement parameters, such as fundraising principles and a donor bill of rights, which ensure prospective donors that an organization is trustworthy, and that donors can have full confidence in the organization and the causes it asks donors to support. 

9.)                Handling the Media

            A provision should be included detailing how public affairs and communications will be managed, as well as the role and responsibilities of spokespersons.

10.)                        Develop a Theme

            Overarching themes in any well-respected governance document should be transparency and accountability.  Accordingly, provisions should be included which specifically address audit and compliance parameters and document retention.  Most importantly, information about operations and methods of self and outside evaluation should be widely available to the public.  

Developing effective governance policies will take time and require full commitment at the highest level of an organization.  A coordinator should be assigned to oversee the adopting and implementation of the various policies.  Many governance policy models are available, and can be tailored for each organization.  And they can implemented after a vote by the board.  In most cases, the board should seek legal review of these policies to ensure that they are both sound in their governance structure and tax compliant.  Because a governance policy is meant to be the voice of the board, it must reflect the board members’ vast differences in experience and perspectives and help make the organization's infrastructure stronger. 

The IRS has compiled a table of significant changes, as well as in the beginning of the Form 990 instructions.  A few changes that may be of interest to many organizations are:

·         Related organizations may include governmental entities as well as private entities.

·         The instructions clarify that foreign investments are included among foreign activities that must be reported on Schedule F (Statement of Activities Outside the United States).

·         The instructions to Schedule K (Supplemental Information on Tax-Exempt Bonds) address how bonds should be reported when multiple organizations (for example, a parent and subsidiary) use bond proceeds. The reporting organizations can choose whether to report all bonds at the borrower (e.g., parent) level or to allocate reporting among all related organizations, but reporting must be consistent within the group.

·         Tax-exempt organizations could in the past notify the IRS by letter of changes in their activities.  The Form 990 instructions articulate the current IRS practice, which is that it will not respond to such letters with a letter stating that the change in activities doesn’t affect exempt status.  All changes should simply be reported on the Form 990.

·         The instructions clarify how leased employees, employees on common paymaster arrangements, and employees paid through payroll agents are to be counted and reported.

This list of changes is not an exhaustive or complete list.

In preparation for filing the 2009 Form 990, exempt organizations should make sure their systems can capture any additional needed information. 

Disclosure forms and practices should be reviewed to confirm that the organization will get all the information it needs to make all disclosures of interested persons and transactions under the revised instructions. 

Portions of some schedules did not have to be completed in the 2008 Form 990, like portions of the schedules for hospitals and tax-exempt bonds, because the requested information was difficult to obtain or was not maintained in that form. 

Organizations that must complete these schedules for the first time should take advantage of this delay so that accurate information can be gathered. 

Finally, organizations that have not yet filed  the 2008 Form 990 – for example, organizations with a tax year ending in June or September who are on extension – may in some cases be able to get clarification from the new instructions in completing last year’s form.

Questions about board members’ and key employees’ family and business relationships with each other have been on the Form 990 in one guise or another in recent years.  Section 501(c)(3) organizations have also had to answer generally worded questions about board members’ relationships with the reporting organization.  However, on the new Form 990, the questions have become more specifically defined and the detail required to answer them has increased.  In addition, for the first time, Form 990 asks about the number of independent board members – with a very specific definition of “independent.”  The information needed to determine independence overlaps with, but is not identical to, the information needed to answer the questions about family and business relationships.

What this means is that the reporting organization must seek more personal information than ever before from its board members and other individuals connected with the organization in order to accurately complete the Form 990.  Moreover, the current focus of the IRS and the public on tax-exempt organization abuses, and the publicity surrounding the issuance of the new Form 990, will cast a spotlight on organizations’ responses to this form.

The information exempt organizations must now obtain from their board members, officers, and key employees includes:

·        Whether they or any of their family members engaged in any business transactions with the organization;

·        Whether entities of which they or their families owned more than 35 percent engaged in any business transactions with the organization;

·        Whether they do business, other than as a member of the general public, with another board member, officer, or key employee, or with an entity of which another board member, officer, or key employee is a director, officer, or more than 35 percent owner;

·        Whether they have a family relationship with any other director, officer, or key employee of the organization; and

·        Whether they are a director, officer, or greater than 10 percent owner of an entity of which another of the organization’s directors, officers, or key employees is a director, officer, or greater than 10 percent owner.

A complete list of the required information would run several pages.  Also, in some cases, questions must be asked of former board members and officers who are compensated by the organization.

The IRS dictates in the Form 990 instructions and materials posted on the IRS web site that the reporting organization must make a reasonable effort to obtain the information needed to answer these questions.  The instructions specify that distributing a questionnaire asking about these matters is sufficient; in other words, the organization need not require documentation, search records, or hire private detectives.  Although many organizations already have conflict of interest policies in place, not all organizations currently circulate annual disclosure questionnaires.  Of those who do, very few will have existing questionnaires that ask the specific questions needed to elicit the required information.  Also, many organizations do not circulate the questionnaire to all the groups (board members, officers, and key employees) that must complete it.

Consequently, many organizations are instituting new procedures to meet this requirement.  New questionnaires will need to be prepared and circulated, along with an explanation of why this information is being requested.  Persons about whom information will be disclosed on the Form 990 when completed may appreciate knowing, before the Form 990 is filed, what will be disclosed about them.  Finally, because some reporting individuals may be unaware of existing, reportable, indirect relationships, the organization should be diligent in review of questionnaires to catch anything that is an indirect business relationship that would otherwise go unreported.

The new Form 990 undoubtedly requires additional effort and intrusive questions to ensure compliance with reporting requirements.  On the plus side, much of the information that is gathered can be useful in avoiding the appearance of a conflict of interest in the organization’s decision-making.  Respondents should know that the new Form 990 requirements are moving their organization toward best governance practices.

The Governance Check Sheet is a two page document (IRS Form 14114), which is to be used by IRS exempt organization revenue agents in their examination of public charities.  The Check Sheet provides questions to be considered by the agent concerning six specific aspects of the organization’s corporate governance structure: (a) “Governing Body and Governance Topics;” (b) “Compensation;” (c) “Organizational Control;” (d) “Conflict of Interest;” (e) “Financial Oversight;” and (f) “Document Retention.”  The Check Sheet is designed to be completed by the agent on-line, with drop-down menus of possible responses and very little opportunity for narrative or description. 

In addition to the governance questions included in the revised Form 990, the Check Sheet addresses the following points:

·         certain organizational document issues (e.g., whether they include an articulation of a charitable purpose, and information about the composition, duties, qualifications and voting rights of board members);

·         whether board members have received copies of the organization’s articles and bylaws;

·         whether the organization’s articles and bylaws are available to the public, and if so, whether they are generally available or only on request;

·         the frequency of board meetings as compared to bylaw requirements;

·         whether there is a single individual or small group of individuals to whom the board typically defers;

·         the frequency with which the conflicts of interest policy is actually adhered to (e.g., how often have conflicted members actually recused themselves from the corresponding decision making process?);

·         the extent to which board members are provided with information concerning the organization’s financial condition and discusses those reports and related financial activities; and

·         whether the Revenue Agent’s examination was hindered by a lack of necessary documentation.

Ultimately, the Check Sheet data will be included in a long-term study the IRS is undertaking to set forth a greaterunderstanding of the connection between charities’ tax compliance and corporate governance practices.

At this point, the IRS is not expected to make poor governance practices alone an exemption level issue, but it is conceivable that evidence of problematic governance may contribute to the consideration of penalties where evidence of more severe organizational abuse exists.