Many in the nonprofit world know Form 990 as the all-important nonprofit tax form that details an organization’s activities and financial standing. In addition to justifying an organization’s tax-exempt status, Form 990 reveals key information that charity-rating organizations and grantmakers use when evaluating nonprofits.
The IRS does not mandate that nonprofit boards review Form 990, but due to the form’s importance, board review is a widely adopted best practice. And if the board does review the form, the IRS requires an organization to disclose its Form 990 review process. Establishing a consistent board review process helps organizations mitigate compliance risk, but also helps board members identify and address any issues that may raise a red flag to funders, donors and charity watchdogs.
Form 990 should include detailed information about the significant programs the organization conducts, how much revenue it generates and where it is spending money. It’s also important to note that prominent foundations and other philanthropic institutions look for a detailed Form 990 during their grantmaking due diligence, and making sure this information is accurate, up-to-date, and readily available can help board members secure larger donations.
Enhancing Accuracy and Addressing Compliance Concerns
Most nonprofit boards see reviewing Form 990 as a part of their fiduciary responsibility to the organizations they serve. Given this responsibility, legal and financial professionals who have the skills to understand the information reported in the return and flag compliance concerns can provide a great deal of value as nonprofit board members. When reviewing Form 990, here are some issues the board should look for:
- Compensation issues: If the IRS determines nonprofit executives are unreasonably compensated, executives may be liable to pay an excise tax and return the excess benefit. Board members who approve the excessive compensation may also be liable for an excise tax. Beyond the IRS, funders and donors may also want to understand how executive compensation is determined as they make funding decisions.
- Cost allocation: In part IX of Form 990, nonprofits are required to allocate their expenses between program service activities, management and general expenses, and fundraising. The IRS requires that the process for cost allocation is reasonable under the circumstances and that the allocation process is documented thoroughly. Additionally, charity watchdogs and funders and donors will analyze what percentage of overall funding is going toward program activities to help determine their funding decisions.
- Transaction and loan ethics: The IRS is interested in transactions that may involve “interested persons” such as directors and officers and others with substantial influence in the organization. These transactions are disclosed in Schedule L of the return and should be “at fair market value and arm’s length” as it pertains to the nonprofit. Board members should review Form 990 for these transactions in order to confirm that they meet the arm’s length and fair market value standard. In addition to transactions, loans made by an organization to an interested person could raise a red flag. The IRS will look for these loans to carry commercially reasonable terms and carry an interest rate and security as a bank loan would.
If organizations cannot demonstrate that transactions and loans “are at fair market value and arm’s length,” the organization and individuals involved could be subjected to excise tax penalties. If these transactions and loans are particularly egregious, they could jeopardize the organization’s tax-exempt status.
As nonprofits face increasing demands for transparency, a formalized board review process for Form 990 can help organizations put their best foot forward with the IRS, the public and donors.
Creating a Powerful Narrative to Support Your Mission
Form 990 is an important component of an organization’s ability to navigate increasing scrutiny and pursue funding opportunities. By applying their knowledge and experience to the reporting process, board members can help the nonprofits they serve maintain compliance with IRS regulations as well as reinforce the organization’s commitment to its mission in the eyes of donors and the public. Finally, a detailed Form 990 arms the organization with the information it needs to communicate its story, highlights the impact of its work, and makes a compelling case to donors, grantmakers and the public at large.
Written by Marc Berger. Copyright © 2023 BDO USA, P.C. All rights reserved. www.bdo.com