Form 990: More Than  Just a Tax Return

No longer the mundane tax return of the past, Form 990, Return of Organization Exempt From Income Tax, has evolved into one of the most important marketing and public relations documents for tax-exempt organizations. Not only are the Forms 990 for Sec. 501(c)(3) organizations posted on the Internet at the Guidestar site (www.guidestar.org), but also, rating services analyze these organizations operations and report ratings to potential donors.

Form 990 provides the information for the ratings systems and for much of the content of media reports. Exempt entities must recognize this new focus when preparing and filing their annual returns. The following are suggestions and strategies to maximize the effectiveness of presenting information on Form 990.

Statement of Functional Expenses

Part II of Form 990 requires a filer to list its expenses and allocate them to the following three categories: Program services, Management and general, and Fundraising. The overall goal is to allocate as many expenses to Program services as is reasonably possible, to demonstrate that the organization expends substantial resources to further its exempt purposes.

The Management and general category can be a trap, because the media and the uninformed public may view these expenses negatively. Statements such as 38 cents of every dollar given to XYZ Charity goes toward administrative charges, rather than XYZs programs are not uncommon.

Frequently, many organizations do not allocate any expenses to the Fundraising category, even when they have raised a substantial amount of donations. The Service has publicly questioned this practice and informed exempt organizations that it expects fundraising expenses to be properly categorized on Form 990.

How should an organization allocate its expenses? The filer should consider using documented methods, such as time studies (for personnel expenses) and square footage (for allocating occupancy expenses by function). This data may be difficult to collect, especially for organizations that are understaffed. However, the potential repercussions of a negative news story or a low score from a rating organization such as Charity Navigator (www.charitynavigator.org) often outweigh the costs of developing reasonable and accurate allocation methods.

Statement of Program Service Accomplishments

For marketing purposes, Part III is the most important part of Form 990. This section allows an organization to provide concrete details about its mission and accomplishments.

In the past, filers often used one-sentence descriptions of their programs, a practice that no longer suffices. The more detail (descriptions of programs, statistics, etc.) that an organization can offer, the better informed the public and the media will be of its efforts. Descriptions should not be limited to the space provided in Part III; instead, the organization should consider attaching statements that adequately summarize all of the accomplishments it has attained over the past year (even if several pages long). If a nonprofit entity uses an outside firm to prepare its Form 990, it must make sure the preparer has all of the details needed to be included in Part III.

Compensation Disclosure

Because it contains compensation information for an organizations officers, directors, trustees and key employees, Part V is one of the most scrutinized sections of Form 990. Compensation must be divided into three categories: wages, contributions to employee benefit plans and expense accounts.

The most frequent error in Part V is not disclosing all of the components of employee benefit plan contributions. Such contributions include not only the employees contribution to a qualified retirement plan (e.g., Sec. 401(k) or 403(b) plan), but also the employers contribution. Additionally, the organization must report deferred compensation, even if the employee is not yet vested. Further, both the employees and the employers contributions to welfare plans (e.g., health, dental and life and disability insurance) should be included.

The totals of each of these categories can be sizeable. In certain cases, it may make sense to attach a statement that lists each component of the Contributions to employee benefit plans and deferred compensation category, rather than just reporting one large number.

Other Information

Part VI of Form 990 requires organizations to answer several compliance questions. A wrong answer in this section can invite IRS inquiry and further scrutiny. For example, Item 83a asks if the organization has complied with the public inspection requirements for returns and exemption applications. A negative answer could result in the IRS imposing penalties against responsible persons in the organization for failing to comply.

Part VI also asks important questions about unrelated business income, excess-benefit transactions, required state filings and the identity of the person who keeps the organizations books and records. An organization should carefully answer each question to demonstrate that its operations are within the confines of the Code.

Analysis of Income-Producing Activities

Part VII requires organizations to categorize the revenue sources they listed in Part I (Revenue, Expenses, and Changes in Net Assets or Fund Balances) into one of three categories: exempt-function income, income excluded from taxation under Secs. 512514 and unrelated business income.

This part is particularly enlightening, because it requires organizations to disclose income from unrelated activities. Form 990-T, Exempt Organization Business Income Tax Return, which is used to report and pay taxes on income from activities that do not qualify for exemption, is not open to public inspection. However, the disclosure in Form 990, Part VII, makes some of this information publicly available, thus allowing informed readers to ascertain the nature and gross revenue of an organizations unrelated activity.

Schedule A

Sec. 501(c)(3) organizations must also file annually Schedule A, Organization Exempt Under Section 501(c)(3), to furnish additional information not required of certain other types of organizations that file Form 990. In particular, Schedule A, Part III, requires information about certain specific activities and transactions during the year between the entity (directly and indirectly) and:

1. Its trustees, directors, officers, key employees, etc. or

2. Any taxable organization with which the persons specified in (1) above are affiliated.

This part is intended to determine whether there is any private inurement during the tax year.

Conclusion

In this new era of public scrutiny, exempt organizations must recognize the vital role that Form 990 plays in providing information to interested parties. Organizations should adopt a new focus by using Form 990 to demonstrate to the public that they are worthy of exempt status.

From Christopher B. Anderson, CPA, Cleveland, OH