IRS Releases Draft Redesigned Form 990

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1 ORGANIZATION MANAGEMENT, INC. SEPTEMBER 3, 2007 A SPECIAL REPORT FROM THE NON-PROFIT LEGAL & TAX LETTER IRS Releases Draft Redesigned Form 990 by Charles M. (Chip) Watkins Webster, Chamberlain & Bean Washington, D.C. Mr. Watkins previously served as an attorney in the Office of the Associate Chief Counsel for the Internal Revenue Service (Employee Benefits and Exempt Organizations) INTRODUCTION On June 14, 2007, the Internal Revenue Service released the long-awaited initial draft of the redesigned Form 990. Form 990 and Schedule A have remained largely unchanged in format for many years. Having recognized that a one-sizefits-all Form 990 even for non- 501(c)(3) organizations does not provide adequate information about whether increasingly complex and sophisticated tax-exempt organizations (EOs) continue to qualify for exemption, the IRS has substantially redesigned the form. The redesigned form includes a core Form 990 that must be completed by all filers, and a series of schedules that require detailed information from particular types of organizations, e.g., schools and hospitals; and about particular types of activities that the IRS believes are risk factors that might indicate: 1. Non-compliance with the requirements for exemption, 2. Liability for unrelated business income tax (UBIT), or 3. Liability for any of the numerous penalties or excise taxes that may be imposed on exempt organizations or their organizations managers or disqualified persons. The redesigned Form 990 results from the confluence of several factors: Increased Congressional scrutiny of exempt organizations, especially charities, in light of numerous well-publicized scandals, many of which occurred in the Washington, D.C. area; IRS recognition of the diversity and complexity of tax-exempt organizations; IRS and state regulator interest in greater understanding and analysis of fundraising, executive compensation, and other transactions with insiders; and The trend toward electronic filing, requiring greater standardization of reporting formats for information that has, until now, been reported in non-standard statements attached to Form 990. IRS TIMETABLE The IRS has called for comments on the initial draft to be submitted by September 14, Comments submitted after that date will not be accepted because the IRS will promptly launch the effort to finalize the draft, which it plans to release in final form in time for the 2009 filing season, reporting about taxable years beginning in Thus, in the absence of a change in the IRS plan or an extension of time to file, EOs with calendar year taxable years will file the new Form 990 by May 15, This article summarizes the information required by the proposed new Form 990 and each of the proposed new schedules. Chief financial officers and others who are responsible for preparing and filing IRS Form 990 should review the proposed new form in more detail, with a particular view to determining the extent to which financial accounting and reporting systems will need to be modified for 2008 in order to ensure timely access

2 Page 2 of 8 IRS RELEASES DRAFT REDESIGNED FORM 990 to accurate information necessary to complete each new schedule. STRUCTURE The redesigned Form 990 includes the core Form 990 and a series of schedules that require more information from particular kinds of EOs, e.g., hospitals, or about particular kinds of activities, e.g., fundraising or international activities. Not all organizations will be required to complete all schedules. However, all 501(c)(3) EOs must complete Schedule A (Public Charity Status), all EOs must complete Schedule D (Supplemental Financial Statements), and many 501(c)(3) EOs must complete Schedule G (Fundraising), Schedule I (Grants Made in the U.S.), and Schedule M (Non-Cash Contributions). Many EOs will also be required to complete Schedule J (Compensation Information). IRS also released a glossary with definitions for 68 terms used in the forms and instructions. A copy of the redesigned Form 990, including all the new schedules, draft instructions, glossary, commentary, and requests for comments, can be downloaded from the IRS website at FORM 990 The core Form 990 is expanded from nine to 10 pages, and requires all EOs to report Summary information about the EO s mission, activities, and finances, including executive compensation and percentages of various kinds of revenue and expenses. Comment: Highlighting information about executive compensation, e.g., how many employees are paid more than $100,000, on page one gives undue prominence to amounts paid, without reference to experience, results obtained, geography, or quality of work. On lines 8a and 8b, 501(c)(3) and (c)(4) EOs are also required to calculate the percentage of total program service expense that is paid as compensation to officers, directors, and key employees. This hitherto unknown ratio has no clear significance. Comment: Summary information about revenue and expenses attributable to gaming, and to other kinds of fundraising, including the net percentage retained (after expenses), is highlighted. Unfortunately, the IRS is perpetuating the myth that the worth of an EO, and especially a charity, can responsibly be measured by the percentages of funds it spends each year on program services, management, and/or fund raising. While not insignificant, especially when measured over multi-year periods and compared to other, similarly situated EOs, these percentages may vary considerably from year to year, depending on numerous factors, many of which are beyond the control of the EO. Detailed information about compensation of current and former officers, directors, and key employees, and independent contractors, including the nature of each individual s position with the EO, the amount of reportable compensation, amounts owed to the EO and affiliated organizations, and business or personal relationships between or among the individuals and the EO. Information about the EO s governance, including number of directors or trustees, and how many are independent; changes in the governing documents; conflicts of interest; relationships with affiliates; preparation and review of financial statements; whether the EO has an audit committee; and the extent to which governing documents, financial statements, and Form 990 and 990-T are available to the public. Comment: Some commentators have complained that questions about an EO s governance are not relevant to its tax-exempt status. Strictly speaking this is generally true. However, the history of scandals within EOs demonstrates that most scandals are rooted in the governing board s failure to exercise sufficient oversight of the management. Thus, deficiencies in governance may well signal to the IRS that other problems, more directly relevant to tax exemption, would be uncovered in an audit. Detailed income and functional expense statements, and a balance sheet. Like Part VII of the current Form 990, the

3 IRS RELEASES DRAFT REDESIGNED FORM 990 Page 3 of 8 income statements classify revenue as related, unrelated, or excluded by 512, 513, or 514. Comment: The IRS eliminated the question, currently in Form 990, Part VIII, asking the EO to explain how the activities that generated its related revenue contribute importantly to the accomplishment of its exempt purposes. This question has often been incorrectly answered using the long-repealed destination of income test: e.g., XYZ uses the income generated by giving skydiving lessons to help children learn to read. Information about activities or transactions that might require one or more schedules to be filed. Information about activities or transactions that might require filing other returns, e.g., Form 990-T. The Statement of Program Service Accomplishments that is now Part III of Form 990. SCHEDULE A Supplementary Information for Organizations Exempt Under Section 501(c)(3) Under the redesigned Form 990, Schedule A is limited to information about a 501(c)(3) EO s status as a public charity. Supporting organizations (SOs) must list all supported organizations and identify whether they are Type I, Type II, or Type III. Type III SOs must also identify whether they are functionally integrated, i.e., they perform a function that supports the supported organization (other than grant making). Schedule B requires EOs to report gifts from large donors. In many cases the reporting threshold is a gift of at least $5,000. However, a public charity described in 170(b)(1)(A)(vi) reports only gifts that exceed the greater of $5,000 or 2 percent of its total support. Section 501(c)(7), (8), and (10) organizations report certain gifts of more than $1,000. Schedule B is unchanged, and the IRS did not release Schedule B with the redesigned Form 990 package. SCHEDULE C Political Campaigns and Lobbying Activities Schedule C is required to be filed by any EO that engaged in lobbying or political activities. Section 501(c)(3) organizations must report their lobbying activities (as they do now in Schedule A), and 501(c)(4), (5), and (6) organizations must report information pertinent to whether they may be liable for unrelated business income tax, under 162(e) and 6033(e), on their lobbying and political expenditures. SCHEDULE D Supplemental Financial Statements Schedule D requires detailed reporting by all EOs of non-financial assets, conservation easements, donor-advised funds, and endowment funds. Schedule D also includes the reconciliation of assets and liabilities with the EO s audited financial statements that is now in Form 990, Parts IV-A and IV-B. SCHEDULE E Schools Schedule E requires reporting of the information relating to documentation of compliance with racial nondiscrimination requirements, presently reported in Form 990, Schedule A, Part V. Comment: The instructions do not clearly indicate whether public charities that, as part of their activities, operate schools outside the U.S. are required to file Schedule E. Schedule A includes revised public support schedules, which are helpfully designed to eliminate the need for new publicly supported organizations to separately file Form 8734 at the end of their fifth fiscal year. SCHEDULE B Schedule of Contributors SCHEDULE F Statement of Activities Outside the U.S. New Schedule F requires all EOs to report details of their international activities if they conduct any of the following activities in a foreign country: Grant making, fund raising, or a trade or business; Exempt activity programs; Maintain an office, employees, or agents; or

4 Page 4 of 8 IRS RELEASES DRAFT REDESIGNED FORM 990 Have an interest in, or signature or other authority over a financial account. The information required includes The activities and amount spent in each country; How foreign grantees are selected; Grants to grantees related to officers, directors, key employees, or donors; and The identity of organizational and individual grantees. Comment: EOs whose personnel are working in sensitive areas of the world have reason to be concerned that publication of the detailed information required by Schedule F could endanger those personnel and the work they are engaged in. The safety and security of EO employees, and the continuity of their usually unpublicized work outweigh the public interest in this information. (The IRS will still have the required information.) Affected EOs should urge the IRS to keep this information confidential. However, amendments to 6104(d) of the Code and the regulations may be required to authorize withholding this information from the public. SCHEDULE G Supplemental Information Regarding Fundraising Activities Despite its general title, Schedule G is required to be filed only by EOs that: 1. Raise more than $10,000 from special events, or 2. Pay more than $10,000 in fees and expenses for professional fundraising services, including direct mail consulting and telemarketing. Schedule G will be filed principally by 501(c)(3) and 501(c)(4) EOs. Schedule G requires detailed information about payments to individuals or organizations for fundraising services; a list of the states in which the EO is authorized to solicit contributions; revenue from and expenses incurred for special events and gaming; and additional information about how the EO conducts any gaming activities. The responses to these questions are relevant for determining whether revenues from gaming may be subject to unrelated business income tax. For this purpose, gaming includes bingo, pull-tabs, raffles, video games, casino nights, and similar activities. A complete definition is in the glossary that is part of the instructions for Form 990 and its schedules. Comment: The filing threshold is under-inclusive. Charities that do not hire outside fundraisers or fundraising consultants, and that do not have special events, will not be required to file Schedule G, even if they conduct substantial gaming. All charities that incur fundraising expenses above a threshold should be required to file Schedule G, regardless of whether they incur those expenses in-house, or engage others to assist them. In addition, if the IRS views gaming as a high-risk activity, then all EOs that conduct substantial gaming should be required to file Schedule G. SCHEDULE H Hospitals Schedule H is entirely new, and must be filed by any 501(c)(3) EO that operates or maintains a facility to provide hospital or medical care, including, but not limited to, most organizations classified as public charities under 170(b)(1)(A)(iii). Schedule H requires the hospital to report its charity care and other community benefit expenses; state whether it has a charity care policy, and if so, to describe the policy; provide information about its billing and debt collection policies and practices; and report management companies and joint ventures, including those that are jointly owned with officers, directors, key employees, or doctors. Hospitals must also describe their emergency room policies, procedures, and hours of operation; and list all their facilities, and the programs and activities conducted at each facility. Comment: The instructions do not exclude public charities, e.g., those operating in third-world countries that operate hospitals or medical clinics as a part of their charitable activities from the requirement to file Schedule H. These hospitals are typically quite different from those U.S. organizations classified as hospitals in 170(b)(1)(A)(iii), and the IRS concerns about the typical U.S. hospital conglomerate are irrelevant to the typical third-world hospital operated by U.S. charities.

5 IRS RELEASES DRAFT REDESIGNED FORM 990 Page 5 of 8 SCHEDULE I Supplemental Information on Grants and Other Assistance to Organizations, Governments, and Individuals in the U.S. Schedule I is also new, and must be filed by any EO that, during the year, made grants (including scholarships) of more than $5,000 to organizations or individuals in the United States. The required information includes whether any recipient had a relationship with the EO; and the amounts, forms (cash or non-cash), and purposes of the grants. SCHEDULE J Supplemental Compensation Information Schedule J requires more detailed information about compensation paid to officers, directors, trustees, key employees, and highly compensated employees. It must be filed by any EO not only 501(c)(3) EOs that Information about policies regarding reimbursement of travel and entertainment expenses; Incentive compensation based on gross revenues, net earnings, or other factors. Section 501(c)(3) and (c)(4) EOs must also report whether any compensation was paid to a disqualified person under 4958 under a contract that was subject to the first contract exception to the excess benefit transaction rules. (Under this exception, and provided certain conditions are satisfied, the first contract with an individual who becomes a disqualified person by reason of the contract cannot result in an excess benefit transaction. Treas. Reg (a)(3).) SCHEDULE K Supplemental Information on Tax-Exempt Bonds Paid (with any related organization) compensation of more than $100,000 to any former officer, key employee, or five highest compensated employees; Paid (with any related organization) compensation of at least $10,000 to any former director or trustee; Paid (with any related organization) more than $150,000 in reportable compensation to any current or former officer, director, trustee, key employee, or five highest compensated employees; Paid or accrued (with any related organizations) more than $250,000 in total compensation to any current or former officer, director, trustee, key employee, or New Schedule K is required to be filed by any 501(c)(3) EO that, during that taxable year, had taxexempt bonds outstanding. Schedule K requires information about the purpose and uses of each outstanding bond issue. This information will enable the IRS to assess whether the EO is observing the rules governing tax-exempt bond issues. SCHEDULE L Supplemental Information on Loans Schedule L is required to be filed by any EO that, during the year, had Loans receivable from current officers, directors, trustees, key employees, other related persons, or other disqualified persons described in 4958 (f)(1); or five highest paid employees; or Loans payable to current or former officers, directors, trustees, or key employees. Had any current or former officer, director, trustee, key employee, or five highest paid employees receive or accrue compensation from any unrelated person for services rendered to the EO. Schedule J requires detailed reporting of Types and amounts of taxable and nontaxable compensation. Schedule L requires the EO to report the name of the debtor or creditor, the original principal, the balance due, the date the loan was made, the interest rate, any security given, the purpose, and whether the loan agreement or note is in writing. This information will enable the IRS to track all such outstanding loans from year to year, and may lead to an audit in the event it appears that any such loan may be an excess benefit transaction.

6 Page 6 of 8 IRS RELEASES DRAFT REDESIGNED FORM 990 Comment: The non-profit corporation law in many states prohibits loans from non-profit corporations to officers or directors. In addition, state charity regulators may also use this information to determine whether assets held by a 501(c)(3) organization are being properly used, and could challenge particular loans as inappropriate uses of charitable assets when a loan is made primarily to benefit the borrower. For example, assuming state law permits, a charity is probably justified in lending money to a new CEO when he is moving from a low-cost area to a high-cost area, and needs additional funds to buy a home. In contrast, a loan to the incumbent CEO to enable him to invest in higher-yielding stocks may be inappropriate, even if it does not result in unreasonably high compensation. SCHEDULE M Non-Cash Contributions purposes. Of course, the charity must report to the donor and the IRS the amount it receives upon the sale of a used car or other vehicle, see Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, and must file Form 8899, Notification of Income from Donated Intellectual Property, to report qualified donee income from donated intellectual property. Similarly, a charity that receives property for which the donor claims a deduction of at least $5,000 must report the amount received for the property if the property is sold or otherwise disposed of within three years after it is given to the charity. See Form 8282, Donee Information Return (Sale, Exchange, or Other Disposition of Donated Property). (This reporting requirement doesn t apply to property used by the charity in its exempt activities, e.g., donated food given to disaster victims.) EOs that receive more than $5,000 in non-cash contributions must report the number of contributors, values, methods of valuation, and the balance sheet value (if any) of the contributions. For this purpose, non-cash contributions include contributions of art; books; clothing; household goods; cars, boats, and airplanes; intellectual property (copyrights, trademarks, and patents); publicly traded and closely held securities or partnership interests; qualified conservation interests; real estate; collectibles; food inventory; drugs and medical supplies and equipment; and taxidermy. Comment: EOs should be very careful about their method of valuing non-cash contributions. Charities that are the recipient of bulk contributions of food, clothing, medical equipment or supplies, books, or other commodities should usually value the gift at not more than wholesale value, and document the value through dealers or published price lists. When receipting a non-cash contribution, EOs should not provide a value to the donor. Donors are responsible for establishing the value (e.g., the amount to deduct as a charitable contribution) of any non-cash contribution to a charity or other EO. A charity may provide a letter describing the property received. In addition, the charity will usually be asked to sign IRS Form 8283, Non- Cash Charitable Contributions (which the donor must attach to his or her return), to acknowledge receipt of a non-cash gift, but the charity is not attesting to the donor s valuation for deduction SCHEDULE N Liquidation, Termination, Dissolution, or Significant Disposition of Assets Any EO that, during the year, discontinued its operations or disposed of more than 25 percent of its assets must file schedule N. Disposal of more than 25 percent of assets includes sales, exchanges, or other transfers. Schedule N requires the EO to report details regarding the distribution of assets or payment of fees (e.g., to lawyers or accountants) in connection with the liquidation, termination, or dissolution. SCHEDULE R Related Organizations Schedule R requires each EO filing Form 990 to identify each disregarded entity (single-member LLC); tax-exempt entity; partnership or multi-member LLC; and taxable corporation or trust to which it is related. The EO must also report details regarding each transaction between itself and any related organization (other than a disregarded LLC) that it is required to identify. For purposes of Schedule R, an EO is related to a taxable entity if: 1. It is a parent or subsidiary (more than 50 percent control) of the other entity, 2. It is under common control with the other entity, or

7 IRS RELEASES DRAFT REDESIGNED FORM 990 Page 7 of 8 3. It is a supporting or supported organization (within the meaning of 509(a)(3)) with respect to the other entity, even if no control relationship exists. TRADE ASSOCIATIONS AND PROFESSIONAL SOCIETIES Although most of the attention to date has focused on the effects of the redesigned Form 990 on charities, trade associations and professional societies that are exempt from income tax under 501(c)(6) will be required to disclose substantially more information than is currently required. Most such EOs will be required to disclose additional details about lobbying activities, international activities (a growth area for many associations), executive compensation, and related organizations. WRITTEN POLICIES In keeping with the IRS reasonable assumption that a well governed EO is also more likely to be in compliance with the Internal Revenue Code, Form 990 and the schedules ask several questions regarding whether the EO has a written or other policy related to a particular area. These include: Form 990, Part II, Section B, Item 3: Did the EO approve certain executive compensation in accordance with the safe harbor provisions in Treas. Reg ? Form 990, Part III, Item 3a: Does the EO have a written conflict of interest policy? Form 990, Part III, Item 4: Does the EO have a written whistleblower policy? Form 990, Part III, Item 5: Does the EO have a written document retention policy? The whistleblower and document retention policies are responsive to the two requirements in Sarbanes- Oxley that actually apply to EOs that they not retaliate against whistleblowers, and that they not destroy documents with the intent to obstruct the investigation or administration of any matter under the jurisdiction of a federal agency (18 U.S.C. 1513(e) and 1519). Form 990, Part III, Item 7: Does an EO with local chapters, branches, or affiliates have a written policy ensuring that their activities are consistent with its own? Schedule D, Part VIII, Item 7: Does an EO holding conversation easements have a written policy regarding periodic monitoring, inspection, and enforcement of its easements? Schedule H, Part I, Item 13a: Does a hospital have a charity care policy? Schedule H, Part II, Item 6a: Does the hospital have a written debt collection policy? Schedule H, Part IV, Item 3: What are the hospital s emergency room policies and procedures? Schedule I, Part I, Item 1: Does a grant making EO maintain records of the criteria by which recipients were evaluated? Schedule J, Part I, Item 2: Did the EO follow a written policy regarding payment of travel and entertainment expenses? In light of these questions, incorrect answers to which will increase the likelihood of an audit, EOs should ensure that they have appropriate policies approved by the Board and implemented before FORM 990 PREPARATION AND REVIEW Many EOs consider Form 990 to be little more than an annual financial report to the IRS, and incidentally for charities, to the states where they are registered for charitable solicitation purposes. However, Form 990 is much more than that. Its principal purpose is to enable the IRS to make a reasonable judgment about whether the EO continues to qualify for exemption under the governing paragraph of 501(c), e.g., 501(c)(3), as well as to ascertain whether the EO may be liable for unrelated business income tax, and whether it may be liable for various other excise taxes. More recently, Form 990 has also become a principal tool for state regulators who oversee charitable solicitation, and, in the eyes of some, a valuable means of public disclosure about the EO s activities. In fact, most donors don t know how to read Form 990, nor what the information means. However, Form 990 has become an important

8 Page 8 of 8 IRS RELEASES DRAFT REDESIGNED FORM 990 means for various watchdogs to gather information about charities and other kinds of EOs, which they then analyze, publish, and comment on. For these reasons, Form 990 and its schedules are necessarily financial, legal, and public relations documents. Even when an EO reports financial information, it is necessarily drawing legal conclusions, e.g., regarding whether certain payments are contributions or program service revenue, whether income is related or unrelated, whether certain activities are lobbying, or whether compensation is reportable. EOs should always have their draft Form 990 and schedules prepared by an accountant or auditor who is familiar with non-profit accounting and reporting rules and requirements, and reviewed by their lawyer (who should also be familiar with tax-exempt organizations) before it is filed with the IRS. A legal review, focusing on why numbers are reported in one line or column and not another, instead of on the accuracy of the numbers, will help ensure that the form is both accurate and complete. Legal review is increasingly important because several states are focusing their review of charitable solicitation registrations on whether Form 990 has been accurately and correctly completed. In several cases, they are rejecting Forms 990 that, e.g., report functional expenses on a separate schedule instead of in the Form 990 itself. Another common error that states focus on is a 501(c)(3) EO failing to report any fundraising expenses. No doubt the redesigned Form 990 will receive commensurate scrutiny from the state reviewers. In addition, the IRS is likely to increase its staffing at the Ogden, Utah service center, where Form 990 is filed, to step up its screening of Forms 990 when they are received, and reject those with obviously incomplete or inaccurate information. For this reason, it is increasingly important that EOs work cooperatively with both their auditors and their lawyers in the preparation and review of Form 990 and the required schedules. This will necessarily require the Form 990 preparer (presumably the EO s auditor) to complete the draft form earlier in the process, to allow time for legal review before the form is required to be filed. FILING THRESHOLD AND FORM 990-EZ In connection with the redesign of the Form 990, the IRS is considering whether to raise the filing threshold. EOs with average annual gross receipts of more than $25,000 (using a three-year rolling average) are now required to file Form 990 or 990- EZ. The IRS is considering whether to increase that threshold, perhaps to as much as $50,000. In addition, EOs with gross receipts for the year of at least $100,000, or with total assets at the end of the year of at least $250,000, must file Form 990, and cannot file Form 990-EZ. The IRS has suggested that the gross receipts threshold could be increased to $200,000. The IRS has also suggested that, in light of the redesigned Form 990, it might require all filers to file Form 990, and eliminate Form 990-EZ. If Form 990- EZ is retained, it will have to be revised in light of the changes to Form 990 and Schedule A. In that event, Form 990-EZ filers will probably be required to file some of the new schedules if warranted by their activities or transactions. CONCLUSION The IRS is expected to require EOs to file the redesigned Form 990 beginning in 2009, for taxable years beginning in The redesigned Form 990 will require all EOs to re-tool their processes and procedures for preparing and filing Form 990 and the required schedules. Although the redesigned Form 990 is not yet final, the effect of any additional changes as a result of the comments received by the IRS is likely to be nominal. Accordingly, senior EO executives should now be working with the EO s accountant and auditor to identify changes that will be required in the EO s accounting systems to ensure that, during 2008, it has collected, and thereafter has ready access to, the financial and other information required to correctly and accurately complete, and timely file, the redesigned Form 990 and all required schedules. EOs that wish to submit comments on the redesigned Form 990 may do so by to Form990Revision@irs.gov or by regular mail to Form 990 Redesign, ATTN: SE:T:EO, 1111 Constitution Avenue, NW, Washington, D.C Comments must be filed by September 14, 2007.

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