April 11, 2008
Author: , Jr.
Once thought of as primarily limited to charitable and religious groups, tax-exempt organizations have been an ever-growing sector of our national economy for a number of years.
There are experts, however, who believe some organizations with less than charitable motives are abusing the tax-exempt organization structure. In response to the evolving complexity and increased prevalence of these organizations, the Internal Revenue Service has redesigned its Form 990, the annual information return required to be filed by tax-exempt organizations. The redesigned Form 990 reorganizes many of the elements of the old form, so tax-exempt organizations will have to orient themselves with the new layout.
But more importantly, the IRS has greatly increased the number of schedules to Form 990. The purpose of the new and expanded schedules is to gather increased amounts of information. Moreover, because these schedules will be open to the public, the government is seeking to cast sunshine on areas that have been the focus of recent IRS and public attention. Many of the schedules require more detailed information on topics that the old form dealt with by means of a few yes or no questions.
The IRS proclaimed that its revisions to the Form 990 increase transparency in the tax-exempt arena, promote compliance and accountability, and minimize the burden on filers. The new form consists of a core, where the organization’s basic information is disclosed, and many schedules, each focusing on a different area of interest. The new Form 990 will be phased in over a three-year period by increasing the filing thresholds for the Form 990-EZ, allowing smaller organizations the option to file either the new Form 990 or the Form 990-EZ.
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Tax Aspects of Operating a Partnership-Taxed Organization
Presented by Langdon T. Owen Jr.
Among the most notable areas of scrutiny reflected in the new Form 990 are the following:
Executive Compensation. In order to buttress efforts to prevent excess benefit transactions and stop the perceived trend of paying executives more than reasonable compensation, the revised form requires greater detail regarding executive compensation. An organization must now separately disclose various types of fringe benefits, deferred compensation, bonuses, health plan contributions and retirement contributions, instead of including these benefits in base salary amounts. At the same time, the revised Form 990 also requires a side-by-side comparison of the compensation paid in the prior year. In addition, organizations must disclose how compensations paid to officers and key employees are initially established, as well as how and if the compensations are reviewed and approved.
Governance. Detailed information regarding an organization’s policies and management practices, including the existence and utilization of a conflict-of-interest policy, is now required by the IRS. The government is concerned that conflicts are going unchecked, allowing questionable flows of funds to private individuals. As evidence of this concern, several organizations have received audit letters based solely on the absence of a conflict-of-interest policy. An organization is now also required to disclose the existence or nonexistence of other policies, such as those pertaining to whistleblowers and document retention, and any changes to the control of the organization, its organizational documents or flow of funds.
Financial Information. The IRS now requests various information related to the organization’s financials, including detailed questions on (i) expenses and revenues; (ii) investments; (iii) assets; (iv) endowments and (v) the reconciliation of financial information on the return and audited financial statements. A series of questions related to organizations engaging professional fundraisers is aimed at exposing the flow of funds for the benefit of private fundraisers. In a move that will clearly attract the interest of state enforcement agencies, it also requests information regarding the states in which charitable organizations have registered to solicit contributions.
Related Persons and Transactions. Tax-exempt organizations must now disclose the details of a broad range of family and business relationships between individuals and other organizations. New questions target transactions, such as loans and grants, between the organization and related individuals. The focus of these inquiries is to expose potentially improper dealing between the exempt organization and related persons.
Hospitals. For tax year 2008, organizations must report identifying information for any related hospitals and medical care facilities such organizations may operate. Beginning in tax year 2009, however, hospitals must disclose certain information related to charity care, community benefit and bad debt expense. This is a clear reflection of the questions raised in recent years (including by a number of legislators) as to what is, and what should be, the basis upon which a hospital is granted exempt status.
Tax-Exempt Bonds. For tax year 2008, tax-exempt organizations must report identifying information for outstanding tax-exempt bonds. Beginning in tax year 2009, an organization must report information surrounding the use of bond proceeds, the private use of the financed property, the existence of certain agreements related to the financed property, the engagement of bond counsel or underwriters, and any hedge set up against the bonds. The questions make information previously only disclosed to the IRS available to the public.
Foreign Countries. Organizations must now report donations on a country-by-country basis. The information required to be disclosed includes the purpose and amounts of the grants, along with information about the organization’s procedures to monitor the use of funds. This added scrutiny is a clear reflection of IRS concerns as to whether foreign activities by exempt organizations are truly in furtherance of tax-exempt purposes. The new reporting requirements are also an indication of the IRS’s increased focus on the anti-terrorism and other concerns reflected in guidelines Treasury has issued in recent years regarding best practices in making grants to foreign organizations.
Noncash Contributions. Recently, the IRS has focused on the overvaluation of noncash donations to charities. There have been numerous stories in the media on such issues that have attracted significant congressional attention. Reflecting these concerns, an organization must now disclose different items of tangible contributions, the revenues from each type of contribution, and how the values were determined. It is particularly noteworthy that organizations must now also disclose any conservation easements, artworks or treasures they accepted during the year. This presumably reflects enhanced IRS concerns regarding the valuation of such contributions.
What Can a Tax-Exempt Organization Do Now?
While the new Form 990 is not effective until the 2008 tax year, the IRS is beginning to scrutinize tax-exempt organizations based on the areas of concern targeted by the new Form 990. Tax-exempt organizations should begin now to protect themselves from becoming the center of an IRS inquiry by familiarizing themselves with the information required for disclosure. Organizations should also begin evaluating whether and to what extent they should adjust their practices and policies to more closely conform to expected norms. Such an evaluation is especially important given the fact that the information now being demanded by the IRS will also be available to the public. Although many of the questions on the new Form 990 ask for information on topics for which there is no legally required standard of behavior, such as the existence of a formal conflict of interest policy, it is clear that many of those questions have an implied correct answer which both the IRS and the public will consider when evaluating the organization, particularly with respect to good governance matters. One relatively simple step an organization can take is to adopt an appropriate conflict of interest policy. This simple notion can separate the organization from the many other organizations that do not have such policies and which, as a result, may become targeted by the IRS.