Nonprofit Tax Compliance

California CPA magazine: August 2008

IRS Raises the Governance Bar with the Revised Form 990

The IRS has raised the governance bar for public charities. It has issued a revised Form 990, the annual information return filed by most nonprofits based on the premise that good governance produces better tax compliance (see Sidebar 1). The form includes an entirely new governance part, which, in effect, increases scrutiny of the management policies and practices of nonprofit organizations in matters directly and indirectly related to the organization’s tax law compliance. Careful responses to the substantial issues raised by these new governance questions will require advance review and planning by the charity, its CPAs and legal advisers.

The revised Form 990 will be effective for tax years beginning after January 1, 2008. Now is the time to encourage your nonprofit clients to review their organizations’ policies so that they are fully prepared to demonstrate compliance with both tax laws and “best practices” of nonprofit governance.

IRS Form 990 Revision
In June 2007, the IRS proposed substantial changes to its Form 990. It explained that the existing form, last revised in 1979, “failed to keep pace with changes in the law and with the increasing size, diversity, and complexity of the exempt sector,” and “fail[ed] to meet the Service’s tax compliance interests or the transparency and accountability needs of the states, the public, and local communities served by the organization.”

More than 700 public comments (3,000 pages) were filed in response to the proposed revisions, prompting the IRS to make additional changes. The final version was published December 20, 2007, and draft instructions were published for comment on April 7, 2008. The IRS expects to finalize the instructions by the end of the year.

The revised Form 990 expands the “core” form from nine to 11 pages, and increases the number of potential schedules to 15. Organizations will determine which schedules they need to file by completing a new, 37-question checklist. The revised core form, schedules, draft instructions and IRS background explanations can be found on the IRS’ website (see Sidebar 2).

An entirely new part entitled, “Governance, Management and Disclosure” (GMD) is particularly important to nonprofit directors, officers and managers. It seeks information on governance and management, the process for determining executive compensation, policies regarding conflicts of interest, whistleblower encouragement and protection, document retention, and public disclosure of tax returns and other governance and financial information.

Opponents of GMD argued that the information it sought is not required by law, and that the inclusion of questions on such topics might make them de facto legal requirements. Although the IRS admitted that much of the requested information was not required, it insisted “the existence of an independent governing body and well-defined governance and management policies and practices increases the likelihood that an organization is operating in compliance with federal tax law.”
Besides the IRS, donors and grantors will likely be very interested in a nonprofit’s responses to the new governance questions and may use the questions as additional criteria for their donations and grants.

For example, Line 10 asks whether a copy of Form 990 was provided to the directors before filing with the IRS. The form’s follow-up question underscores the point: it requires a description of the process by which directors, officers or other management, if any, reviewed the Form 990, including by whom and when the review was conducted, and the extent of the review. Both the IRS and the nonprofit’s funding sources seek assurances that the directors are properly supervising tax law compliance.

Key Governance Questions
The new Part VI of the revised Form 990, GMD, is divided into three sections: Governing Body and Management, Policies, and Disclosures. Below is a discussion of some of the information it seeks.

A. Governing Body and Management
• Existence of Independent Directors: The total number of voting members of the governing board and the number that are “independent.” From a risk perspective, the IRS may use the response to this question regarding “independent” directors to indirectly discover potential “excess benefit” transactions subject to excise taxes. Also, a response that indicates that more than 49 percent of the directors of a California nonprofit public benefit corporation are “interested” highlight the nonprofit’s noncompliance with California Corp. C. § 5227, which reflects a standard more stringent than the IRS.

• Got Minutes? On the surface, the question simply reflects good management practice (recording board meeting minutes) to keep timely, accurate, records of actions taken by board and board committees. However, a negative response potentially precludes reliance upon the executive compensation “safe harbor” provisions of federal “excess benefit” prohibitions which, inter alia, require contemporaneous recording of the board’s deliberations and decision (Treas. Reg. § 53.4958-6).

B. Policies
• Existence of a Conflict of Interest Policy. Are officers, directors, trustees or key employees required to make annual disclosures of potentially conflicting interests? How does the organization monitor and enforce compliance with the policy? However, even if there is no written policy, it may be prudent to attach an explanation how the nonprofit, in practice, assures that conflicts are disclosed and addressed.

• Joint Ventures Policy. The new form asks, with little subtlety (raising the specter of loss of exemption), “[H]as the organization adopted a written policy or procedure requiring the organization to evaluate its participation in joint venture arrangements under applicable Federal tax law, and taken steps to safeguard the organization’s exempt status with respect to such arrangements?” Some suggested safeguards identified in the instructions include control over the venture to ensure it furthers the exempt purpose of the organization and gives priority to the exempt purpose over profits for other participants.

C. Disclosures
• Public Disclosures. In addition to confirming that the nonprofit’s Form 1023 (or Form 1024 if applicable), Form 990 and 990-T are available for public inspection as required by IRC § 6104 (with names and addresses of contributors redacted), the IRS is now interested in how that disclosure occurs: on the nonprofit’s website, another person’s website, or upon request. If any of these documents are not made available upon request (as required by statute), the instructions request an explanation for the reason.

Conclusion
If public charities are to properly meet the IRS’ foray into governance policies and practices reflected in the revised Form 990, CPAs and other advisers need to pay prompt attention to governance issues involving independence of board members, identification and resolution of conflicts of interest, determination of reasonable executive compensation, and means to improve financial transparency. If the increased demands of the revised Form 990 are addressed early with the encouragement of their accountants, charities will be able to use their responses to the new governance questions to their advantage. On the other hand, if the governance questions are not given careful attention, the IRS and the Franchise Tax Board may give the charities more attention than
they desire.

Sidebar
1. The IRS has not revised the tax information Form 990-PF filed by private foundations to include the questions added to the Form 990. However, many of the governance policies reflected in the revised Form 990 are viewed as “best practices” in a major policy paper, “Principles for Good Governance and Ethical Practice” by the Panel on the Nonprofit Sector (October 2007). The paper may be downloaded without charge from their website, www.nonprofitpanel.org.
2. The revised Form 990 and explanations can be downloaded from www.irs.gov/pub/irs-tege/990_whatsnew_purpose.pdf, and the draft instructions may be downloaded from www.irs.gov/pub/irs-tege/990ez_instructions.pdf. Further information is available on the IRS website.

Marty Trupiano owns and operates the Law Offices of Martin J. Trupiano. He can be reached at (818) 783-5151 or marty@mtrupianolaw.com.