IRS Tax Compliance

Let’s Talk About Form 990 Part 2 – Filing Requirements

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In recent years, thousands of tax-exempt organizations have lost exemption status for failure to file a Form 990 for three consecutive years. In this article, we write about the filing requirements under the tax law because we believe this tax information is especially important for nonprofits to know. This is not legal or tax advice, and is not a substitute for the need to seek professional advice.

This article for the most part, pertains to organizations required to file either a Form 990, 990-EZ or 990-N. The first consideration with respect to the Form 990 is the type of tax exempt organization. There are several types of organizations that qualify for tax exempt status under Code Section 501. Some organizations that are tax-exempt are not required to file based upon its exempt purpose. For example, a church and its integrated auxiliaries are not required to file. There are many other similar examples of religious and political organizations that are not required to file, which are not mentioned here – another reason organizations in doubt should have their situation reviewed by a legal or tax professional.

In general, organizations that must file a Form 990, 990-EZ or 990-N are:

  • Code Section 501(c)(3) charitable organizations (not including private foundations);
  • Code Section 501(c) subsection organizations except (c)(21), Black Lung Trusts;
  • Code Section 501(e) cooperative hospital service organizations;
  • Code Section 501(k) child care organizations; and
  • Code Section 501(n) charitable risk pools

The next consideration regarding the filing requirements is the minimum income and asset thresholds.

  • Organizations with gross receipts of $200,000 or greater and assets of $500,000 or greater must file a Form 990.
  • Organizations with gross receipts greater than $50,000 and less than $200,000 and total assets less than $500,000 must file Form 990-EZ or a complete Form 990.
  • Organizations that generally have gross receipts less than $50,000 must file a Form 990-N or a complete Form 990 or 990-EZ.

Gross receipts generally are the total sum of all amounts received by the tax-exempt organization from all sources during the period covered by the return. The organization is not permitted to offset expenses in calculating its gross receipts for purposes of determining the filing requirement. According to the instructions in Form 990, the organization must also account for amounts received using the same method of accounting used to keep the organization’s books or financial records. Hence, if the organizations uses the accrual method, it must calculate gross receipts using the accrual method.

This article provides general information only. Thus, it is important for organizations to seek appropriate tax advice regarding its filing requirements from a professional who can review the organization’s facts and circumstances and exercise appropriate judgment regarding the organization’s situation.

Let’s Talk About IRS Form 990

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Do you feel overwhelmed by IRS Form 990?  We want to provide helpful information for newly formed nonprofit organizations that are required to file IRS Form 990 Informational Returns. There will be several parts to this blog entry where we discuss certain aspects of Form 990 and steps that nonprofits can take to cut costs in its preparation. In this first segment, we will discuss the need to maintain proper bookkeeping practices. Yes, maintaining accurate financial data that is properly compiled is essential. Proper bookkeeping practices will result in cost or time savings in the long-run and should be at the top of every organization’s list of priorities when it comes to the financial operation of the organization.   If the organization uses an outside preparer, ask the preparer if they also provide bookkeeping services and whether the organization can receive a reduced fee for its Form 990 preparation if the preparer performs year long bookkeeping.

If the organization properly maintains its financial data within an accounting software program, then the organization will also have the ability to produce financial statements. Of course proper setup of the accounting program along with accurate transaction reporting is necessary to achieve accurate financial statements. For instance, the nonprofit organization’s chart of accounts must be set up properly to generate reports that conform to Generally Accepted Accounting Principles. Hence, seeking accounting or bookkeeping advice in advance of preparation of Form 990 is warranted. Once the accounting software is set up properly and transactions are entered accordingly, then the organization can produce financial records such as a Statement of Activities and a Statement of Financial Position.

The Statement of Activities has several parts that identify the income and expenses of the organization for a specified time period such as an annual period. An organization’s Statement of Activities has strong importance not just for assisting a preparer with Form 990 preparation, but also the statement is extremely useful for budgeting, forecasting and other operational analysis purposes. Again, the organization must enter its transaction details accurately in order to receive ascertainable results.

Other transaction details will be reported on the Statement of Financial Position also known as a Balance Sheet. This information includes details about the organizations fixed asset mix, asset depreciation, liquidity, and stability. If balance sheet information is collected and reviewed overtime, the various data points can will also say something about the organization’s growth and growth potential. Two other financial statements – Statement of Cash Flow and Statement of Net Assets are also essential in providing a complete picture of the health of the nonprofit organization.

One should not take shortcuts when it comes to the financial health and viability of the nonprofit organization. Maintaining accurate financial data throughout the year in an accounting system with proper reporting of transaction history is the first step in potentially cutting the cost of Form 990 preparation. It also in the long run will pay off by yielding financial data necessary to improve efficiencies of the organization.

Who is a Disqualified Person in a Nonprofit Organization?

Business Pressure  It is vitally important for leaders managing nonprofit organizations to understand who may be a “disqualified person” within the nonprofit organization to avoid engaging in transactions that may jeopardize the organization’s tax-exempt status. A disqualified person generally is a person who has a close relationship to the nonprofit organization such that they perceivably can exert substantial influence over the affairs of the organization. When identifying persons who may substantially influence the operations of the nonprofit, titles are not as important as actual responsibility. For instance, if an influential volunteer is given wide discretion, control and responsibility over a defined segment of the organization, he or she may be deemed to be a “disqualified person” despite the fact that he or she is a volunteer with segmental responsibility. Substantial contributors may also be classified as “disqualified persons” depending on the amount of influence the contributor holds over the organization. Determining who is a “disqualified person” is vital if the organization engages in any transaction involving persons involved with the organization. This is because there are certain IRS rules that penalize transactions with disqualified persons, especially if such transaction confers an excess benefit on the disqualified person. If the organization anticipates entering into a major financial transaction such as a loan with a potential disqualified person, the organization should seek the guidance of a lawyer or nonprofit tax advisor.

What is Unrelated Business Income?

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A 501(c)(3) organization can lose its tax exempt status if earns excessive income from a regularly carried on trade or business that is not substantially related to its tax exempt purpose.   The controlling law for this is found under IRC Sections 511 through 515 and the applicable treasury regulations.  The treasury regulations provide good context regarding the primary objective of the applicable statutes and the definition of “trade or business”.

The primary objective of the unrelated business income tax is to eliminate a source of unfair competition by requiring the same tax basis as nonexempt businesses whenever a tax exempt entity engages in business activity defined under IRC Section 162. For purposes of IRC 513, the term “trade or business” has the same meaning it has in IRC 162.  “Trade or business” generally means any activity carried on for the production of income from (i) selling goods or (ii) performing services.

More simply, a tax exempt organization would be unfairly advantaged if it could engage in business activity and not be taxed in the same manner as a commercial business. Therefore a tax is imposed under IRC 513 when a nonprofit engages in commercial activity. There are also two IRS publications concerning the unrelated tax provisions.  Publication 598 discusses the applicable statutes on unrelated business tax and Publication 1018 provides guidance on how the unrelated business tax applies to churches and church organizations.

To determine whether a tax exempt organization is subject to the unrelated business income tax UBIT, a three part test is first applied.  Three conditions must be met before the tax exempt organization’s activity will be construed as unrelated business activity under IRC 513.

  • The activity must be a trade or business;
  • The trade or business must be regularly carried on; and
  • The trade or business must substantially unrelated to the entity’s tax exempt purpose.

If all three conditions are present, then under IRC 513(a) (1) we look to see an exception to the rule applies:

One exception involves volunteer labor. An unrelated trade or business does not include any trade or business where substantially all the work is performed for the organization by unpaid volunteers.  For example, in St. Joseph Farms of Indiana v. Commissioner, 85 T.C. 9 (1985), a religious organization operated a farm and sold the food commercially.  The farm was operated entirely by unpaid volunteers.  The court ruled that the farming operation was an unrelated trade or business, but because the farm was operated by persons who received no compensation for their farming services, there was no unrelated business tax liability.

Other exceptions to the rule include the “convenience exception” under IRC 513(a)(2) and Regs. 1.513-1(e)(2) which provides that any trade or business carried on by a 501(c)(3) organization for the convenience of its members is not an unrelated trade or business and donated merchandise that is sold by the tax exempt organization is another exception.

It is important that any organization that needs assistance on UBIT issues consult with a lawyer, accounting professional or tax advisor.  This information is not legal advice.  Please, contact our office at info@scottpractice.com if you request assistance.