5 Keys to IRS Form 990 Success for Early-Stage Nonprofits

Published by LTBD, P.C. | May 10, 2017

Forming and building a nonprofit organization can be an exhilarating process, as you create an entity whose sole purpose is to serve the needs of the community you and your cofounders seek to assist. At the same time, many emerging nonprofit professionals and newly formed nonprofit boards underestimate the legal, financial and compliance responsibilities that they have to undertake and maintain in order to build a solid organization.

One key stumbling block for many nonprofit organizations is the IRS Form 990, the reporting form that federally mandated tax-exempt organizations are required to file every year with the IRS. The purpose of the Form 990 is to allow both the IRS itself, and the taxpaying public at large, to evaluate the operations and financial health of an organization that is being provided with tax-exempt status.

To be clear, a tax-exempt organization does not pay taxes, but it still must file an informational return, and in most cases (including all 501(c)3 entities), that document is the Form 990. Even very small nonprofits must file the Form 990, although those with gross receipts of less than $50,000 per year can file the Form 990-N, which is a simplified version. Tax-exempt organizations that do not file their Form 990 for three years in a row automatically have their tax-exempt status revoked by the IRS — something that has happened to more than 500,000 nonprofits in the last decade.

The Form 990 is more than just an IRS report — it is also a public document that is being increasingly used to evaluate and assess charitable organizations. GuideStar provides instant, searchable digital access to Form 990 reports, and many charity rating services such as Charity Navigator use the Form 990 as a core element in their evaluation process. In addition, the federal government is using Form 990 data to assist in identifying fraud, conflicts of interest and other problems that have been causes of financial and legal concern across the nonprofit community.

Just like a small business owner must file her or his taxes whether the company has one employee or 1,000 — the same is true for nonprofits. From the day you receive your tax-exempt status from the IRS, you will need to prepare and file an accurate and up-to-date Form 990 every year. Here are five things you should know about achieving success with your Form 990 process:

1. Governance comes first.

The very first section of the IRS Form 990 focuses on governance issues, beginning with a summary of the nonprofits mission and including the number of voting members of the board or governing body vs. those whom the IRS defines as independent voting members; the number of employees and volunteers; and information on sources of revenue outside of core operations (what the IRS refers to as ‘unrelated business revenue’).

The section also provides a prior-to-current-year comparison of key financial indicators. It’s clear from this section that the IRS and other parties are looking to collect data that can be quickly used to benchmark effectiveness and assess organizational health.

2. Track progress in your programs.

The third section of the form is a Statement of Program Service Accomplishments, and requires the organization to indicate whether it undertook any new activities or programs that were not reported on the prior year’s Form 990, and whether it eliminated any activities or programs that were.

As missions shift or expand/contract, the form intends to capture this trend. The form requires the entity to report in some detail on its three largest program service accomplishments with a narrative review as well as reporting code, expenses, grants and revenues tied to each of these activities.

3. Effective management must become a core competency.

The Form 990 also contains a section on Governance, Management & Disclosure that includes many critical questions that expand upon the governance discussion begun at the outset. These include details on how your board of directors is organized, how voting membership is determined, whether assets have been protected or diverted for any unanticipated purposes, what role committees have in decision-making, and whether the entity maintains local chapters, branches or affiliates.

It cannot be stressed enough that — regardless of the urgency of the mission — a nonprofit that is poorly managed is a nonprofit that should not expect or receive financial support from donors or anyone else. The message to emerging nonprofits is clear: commit now to management effectiveness as a core competency.

4. Compensation will be (and should be) questioned.

The Form 990 also requires a detailed review of how compensation is provided to a wide range of personnel involved in the organization, including officers, directors, trustees, key personnel (typically senior executives), and the five most highly compensated employees (regardless of title).

It also requires such reporting for independent contractors. For each person, an average of time spent working or donating time to the organization must be reported as well as reportable compensation from this entity *and* any other related organizations. The threshold for required compensation reporting for former directors or trustees is $10,000 and for former officers and key employees is $100,000.

Compensation is one of the deeper and darker secrets of the nonprofit world. Unlike for-profit executives, nonprofit executives cannot be compensated with ownership equity in the entity they lead. However, they can be (and often are) paid in many other ways, often amounting to a very comfortable level of total compensation.

This has led to extensive and widely reported cases of waste, fraud and abuse across the charitable sector. It’s essential for nonprofit leaders to understand that compensation must be carefully evaluated across a wide range of factors. For example, if a board member provides paid work or sells property to a subsidiary of the entity, in most cases that constitutes compensation and needs to be recognized as such.

Stay alert and be aware that good governance involves both the structure of the organization’s leadership, and the independence and lack of entanglements (including financial interests) among those doing the governing.

5. Shine a clear and compelling light on your financials.

At this point, you might be forgiven for forgetting that the Form 990 is, at its core, a financial report. With that in mind, you should understand how the financial component of the Form 990 is structured, and what it is intending to focus on and explore. Some of the questions that the Form 990 clearly seeks to answer are:

  • Where is your organization’s revenue coming from, and how much of that is from fundraising vs. investments, service revenue and other sources?
  • What expenses are you incurring, and are some of those associated with the cost of professional fundraising services (this category actually receives its own line in the Statement of Functional Expenses)?
  • Are there points of concern with who provides funding to you and who receives from you? Examples include foreign governments, compensation to officers, costs associated with lobbying, travel or entertainment expenses, or payments to other entities with whom you are affiliated?

The Form 990 concludes with a balance sheet, reconciliation of assets and a summary of financial statement and reporting standards. Some of the closing questions include verifying the accounting method used (cash vs. accrual); whether an independent accountant compiled, reviewed or audited the statements; and if there is a board audit or finance committee responsible for oversight of this process.

Conclusion: Using the Form 990 as a Guide to Nonprofit Leadership

Far more than just a tax reporting document, the IRS Form 990 actually serves as a useful blueprint for building a robust, professionally managed and effectively governed nonprofit organization. Viewed through this lens, the accountability standards embedded in the Form 990 can serve as a robust list of key ‘best practice’ considerations that emerging nonprofits should attend to from day one.

Governance, management, compensation, mission effectiveness, operational efficiency, financial consistency and a healthy balance sheet: these are the keys to building a nonprofit organization that can sustain its mission and meet the needs of its community, well into the future.

Note: For more information on the role of the IRS Form 990 and overall recognized standards for effective nonprofits, see the IRS guide, Life Cycle of an Exempt Organization available online.

For more information on nonprofit accounting and the role that an outsourced accounting partner can play in the success of your nonprofit, contact LTBD today.

Image Credit: zalevski (Flickr @ Creative Commons)
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