It’s important to pay attention to the following areas.
Program Service Accomplishments: Part III
Part III of Form 990 is an opportunity for an organization to tell its story. The section includes descriptions of the organization’s mission, changes in programs, and program accomplishments. It can provide readers information that may not come through in the rest of the organization’s return.
Form 990 is the only federal return that can use adjectives, and this section is often a focus for grantors and donors.
Governance: Part IV
Form 990, Part IV contains a series of questions about governance, management, and policies.
The governance section asks questions such as:
- Are board members independent, and what relationships do they have with each other outside of their board role?
- Who manages the organization?
- Were significant changes made to the governing documents?
- Does the organization have members, and what is their role in governance?
- Are governance decisions documented?
The policy section includes questions geared towards understanding:
- Review of Form 990 before filing
- Monitoring and enforcement of conflict-of-interest policy
- Setting of executive compensation
- Whistleblowing and document retention and destruction policies
While the IRS doesn’t require these governance policies and procedures, they catalog gold standards for good governance of a tax-exempt organization. Good governance generally indicates an involved and compliance-driven board.
While not an absolute, an organization lacking good governance potentially faces more compliance issues or fraud.
Some questions in these sections require additional details on Schedule O which furnish the organization with an opportunity to showcase its good governance.
Compensation: Part VII & Schedule J
The compensation section of the form often gets most of the attention from readers. Form 990, Part VII, and Schedule J provide compensation for current and former board members, officers, key employees, and the five highest-compensated employees.
Compensation disclosed includes taxable W-2 wages, but also nontaxable compensation such as deferred compensation and health benefits.
Schedule J reports additional details for employees compensated more than $150,000. Compensation figures reported here include further classifications of base, bonus, other taxable compensation, deferred compensation, and other nontaxable benefits.
Compensation included in taxable wages previously reported as deferred compensation on a previous Form 990 is also reported on Schedule J.
In addition to additional details on compensation amounts, Schedule J includes questions and requests additional information on:
- Certain benefits that are often provided to executives
- Severance payments
- Nonqualified deferred compensation plans
- Compensation based on the financials of the organization
- Non-fixed payments
The IRS’s focus on compensation assesses whether a tax-exempt organization pays reasonable compensation for the services those listed provide. Unreasonable compensation can be considered an excess benefit transaction.
These transactions are subject to an excise tax on the excess benefit ranging from 25%-200%. It could also potentially be considered private inurement, which could lead to the revocation of the organization’s exempt status.
In recent years, Congress created an excess compensation excise tax on compensation to an individual above $1 million and excess parachute payments indicating their desire to discourage undue compensation. This new excise tax is similar to compensation rules applicable to publicly traded organizations.
However, this doesn’t automatically mean compensation above $1 million is considered an excess benefit; nor does it mean that severance packages automatically trigger the excise tax. It’s important to substantiate the reasonableness of the compensation provided in exchange for services.
Political and Lobbying Activities: Schedule C
Schedule C discloses information on political and lobbying activities. Organizations exempt from taxation under IRC 501(c)(3) can’t conduct political activities without placing their tax-exemption status at risk.
Other exempt organizations may conduct political activities, but unless they’re a 527 political organization, political activities must not constitute a substantial amount of its activities.
The related political expenditures are taxed on Form 1120-POL. Contributions to political organizations must be disclosed, along with the name of the organization and amount.
Lobbying is the attempt to influence actual legislation either directly with legislators or indirectly through the general public.
Lobbying doesn’t include:
- Communicating with members regarding legislation without a call to action
- Nonpartisan analysis, study, or research
- Discussions of broad social and economic problems
- Requests for technical advice
IRC 501(c)(3) organizations, outside of private foundations, may conduct limited lobbying activities as long as they’re not a substantial portion of the organization’s activities. While “substantial” hasn’t been defined, an organization can elect to be measured by the expenditure test which provides thresholds. Find more information on this election here.
Excessive lobbying can lead to the imposition of penalties—on the organization and board members—and possible revocation of exempt status.
Other tax-exempt organizations such as IRC 501(c)(4), (5) & (6) organizations may engage in lobbying related to its exempt purposes. If that organization receives membership dues or similar amounts, it most often must notify members of the portion of the dues they use for lobbying, or pay a proxy tax on those amounts.
Foreign Activities: Schedule F
Schedule F provides information about foreign activities including fundraising, program services, investments and grants to foreign organizations and individuals.
There are 10 international reporting regions, and the schedule provides the number of offices along with employees and independent contractors an organization has in a foreign region.
It’s important for an organization with large investment portfolios, especially alternative investments, to keep track of and verify foreign investments as they report them on Schedule F.
Organizations that have offices, employees, or independent contractors in a foreign region should know about business reporting requirements as well as compensation withholding and filing requirements of the foreign country.
Conversely, if the organization has foreign persons providing services within the United States, there are potential withholding reporting requirements based on treaties. Foreign persons providing services in the United States need not appear on Schedule F.
Included on the schedule is a checklist that can indicate other potential foreign filing obligations. Foreign filings and activities have been a major focus of the IRS and Congress in recent years, and there are penalties for noncompliance with filing such international forms, which often begin at $10,000 per form.
Hospitals: Schedule H
Tax-exempt hospital organizations that operate a licensed hospital facility must complete Schedule H.
The schedule includes information pertaining to financial assistance, community benefits, community building activities, bad debt, Medicare, collection practices, certain management companies, and joint ventures and information regarding requirements under IRC Section 501(r).
Congress and state legislators continually focus on the amount of financial assistance and community benefit tax-exempt hospital organizations provide. Several critics believe that tax-exempt hospitals underprovide community benefit to warrant such tax-exempt status.
This emphasis contributed to the creation of Internal Revenue Code (IRC) Section 501(r) with passage of the Affordable Care Act (ACA) in 2010. In 2008, Schedule H ran only three pages when it was added to the form schedules. After the passage of the ACA, the schedule expanded to a minimum of 10 pages.
Under IRC 501(r), organizations are required to conduct a Community Health Needs Assessment (CHNA) every three years, and meet certain financial assistance and billing and collection policy requirements.
Failure to complete a CHNA can result in an excise tax of $50,000 per year. Gross or willful negligence in complying with financial assistance policy and billing and collection policy requirements can lead to revocation of the hospital facility’s exempt status.
By law, the IRS must review Schedule H of each organization at least once every three years and report its findings to Congress. With requirements of the CHNA and to make policies available to the public, including on the organization’s website, it’s easy for the IRS to check the information Schedule H provides.
The most common cause for compliance checks or exams stem from failing to provide documentation on the organization’s website, and the CHNA or policies failing to meet all the requirements under IRC 501(r).
Tax-Exempt Bonds: Schedule K
One of the benefits of being a 501(c)(3) tax-exempt organization is it opens up financing through tax-exempt bonds, which can provide better terms than other financing.
With the tax-exempt income treatment to bond investors, the IRS regularly enforces compliance with tax-exempt bond requirements.
Schedule K reports information on the organization’s tax-exempt bond that center around verification of compliance. This includes use of bond proceeds, private business use, arbitrage, policies, and procedures.
Private business use refers to using proceeds, including bond-financed property, in an unrelated trade or business or by a nongovernmental person other than an IRC 501(c)(3) organization. That can include, but isn’t limited to, leases, certain management contracts, and research agreements.
An organization is allowed up to 5% private business use before triggering taxes on interest income to the bond’s investors.
Arbitrage is investing tax-exempt bond proceeds in higher yielding taxable securities that provide a return greater than the bond’s paid interest. Certain tax-exempt bonds require arbitrage calculations every five years unless a specific exemption applies.
If the calculation results in excess investment income earned, the organization must report and pay the excess back to the IRS.
Related Party Transactions: Schedules L & R
Ranking second after the compensation sections of the return, readers of the form most often examine related party transactions. Schedule L reports transactions with disqualified individuals and organizations. A disqualified person, in general, includes the following:
- Current or former officer, director, or key employee listed on Form 990, Part VII
- Substantial contributor
- Family member of one of the above
- Entity controlled 35% or more by one or more individuals and organizations listed above
Reportable transactions include loans to or from, grants or assistance provided, compensation to family members, and other business transactions such as leases, professional services, and others.
Many exceptions and thresholds for each transaction determine what kind of reporting needs to happen.
Schedule L also reports on excess benefit transactions, in which a disqualified person receives more benefit than they provided in exchange. Such reporting often catches the attention of the IRS and other seasoned users.
Schedule R requires a listing of related organizations. These include disregarded entities—the financials of which should be consolidated into the organization’s return—tax-exempt organizations, partnerships, corporations, and trusts.
Reportable related organizations aren’t merely those directly related to the organization. They also include organizations that are indirectly related to the filing organization.
Along with a list of related organizations, Schedule R includes a list of transactions that an organization must indicate if they conduct them with a related organization. Organizations that control related parties, outside of disregarded entities, must report dollar amounts of those transactions when they exceed a certain threshold.