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“What do you mean we have to file a tax return? I thought we were tax exempt!” Barring any unrelated business income tax and other excise taxes, nonprofit organizations normally ARE exempt from taxation. But they are NOT exempt from filing an informational return. The Form 990, Return of Organization Exempt From Taxation, and its related schedules is actually one of the most complex returns the IRS requires U.S. organizations to prepare and file.

WHY Nonprofits Have to Complete a Form 990

Completing the Form 990 is time consuming and sometimes challenging, but the IRS has valid reasons for requiring it. With the benefit of zero taxation comes dishonest applications from organizations trying to defraud the system. This leaves a huge burden on the IRS and many state agencies to create methods and filing requirements to deter and identify these fake organizations. The Form 990 and other agency registration programs like GuideStar, Tax Exempt Organization Search, and various state databases help create a stable and reliable environment for informed donors to contribute nearly $500 billion annually.

This is why filling out the Form 990 timely and accurately is critical to all nonprofit organizations trying to comply with IRS requirements, validate their exempt purpose, and attract responsible donors. Errors in filling out the form can lead to misinterpretation of your organization or worse: an assumption that you may be one of the fake organizations.

HOW to Avoid Common Mistakes

Here are 11 common errors that many 501(c)(3) organizations can make that may have unintended consequences such as notices, audits, or revocation.

1) Failure to file: Failure to file for three consecutive years results in automatic revocation of your tax-exempt organization with the IRS. This will cause you to go through the entire application process for exemption all over again! And in some states, your status will be revoked within a much smaller time frame.

2) File the right return: The IRS understands the hardship it imposes on tax exempt organizations to file and has made varying levels of returns to help smaller organizations comply. The following are the income thresholds and guidelines for which return you should file:

-990-N (Postcard) – Most small organizations with less than $50,000 of revenue can satisfy their annual reporting requirements by simply submitting an online questionnaire and updating important contact information.

-990-EZ – This is the condensed version of the cumbersome Form 990. It applies to midsize organizations with revenues greater than $50,000, but less than $200,000 and assets less than $500,000. This is a consolidated four-page return that minimizes much of the complexity of the full Form 990. However, all required schedules must still be completed in full if they pertain to the organization.

-Form 990 – For larger organizations that surpass the thresholds for filing any of the other smaller returns, this complex 12-page return covers many different areas of the organization from the annual financial data to the qualitative information regarding internal controls, board members, governance, and management.

3) Hasty Mission Statement: Would you contribute to an organization that described their mission as “charitable activities”? Most donors wouldn’t since it’s lacking description and valuable information. You may not know it, but many informed donors use IRS resources, including your 990, to vet your organization before donating. GuideStar, the IRS database for nonprofit data, publishes every 990 filed under your organization. Pretend the IRS is your biggest donor and prepare your mission statement with them in mind. Your 990 may be reaching your biggest donors!

4) Combining program service accomplishments: Part III of the Form 990 asks for descriptions of your biggest program accomplishments. Don’t fall in the trap of consolidating everything you do into one all-inclusive program. For example, if you provide training services and also provide health services at a discount, these are two separate programs. Be sure to write about them separately and use as much detail as possible (see #3).

5) Understand the checklists: Part IV through Part VI are checklists, statements, and disclosures for your organization to fill out and provide understanding to the IRS. These sections identify the proper schedules you should be filling out, your activity compliance, and how you manage your organization. When completing these questionnaires, understand that a “yes” normally signifies a supplemental schedule to be filed. And in the compliance and governance sections a “no” response may mean you have no controls on your organization. Even if your accountant is preparing the return for you, they will need your input in properly responding to these sections.

6) Compensation: Part VII requires that you show all compensation paid to directors and officers. If you pay any one person more than $150,000, you must fill out Schedule J.

7) Revenue Classification: The average for-profit business entity normally has 10 lines or fewer to report income whereas nonprofit organizations have an entire page dedicated to revenue classification. Part VIII has over 15 lines, multiple subsets, and four different categories that revenue may apply to. Be sure you’re putting the right amounts on the right lines and categories.

-Revenue derived from the activities listed in your mission statement, contributions and program services, should be categorized as “Related or Exempt Function Revenue”

-Certain investment income should be categorized as “Revenue Excluded from Tax”

-If you have revenues that are neither investment income or pertaining to your mission, they are considered “Unrelated Business Revenue”

8) Unrelated Business Taxable Income (UBTI): UBTI are revenues derived NOT in the course of your exempt activity and are subject to taxation at corporate rates. Advertising in your monthly newsletter, a coffee shop in your lobby, or even an investment in publicly traded partnerships may be triggering UBTI. If you have these revenues you may need to file and pay tax on a Form 990-T. But BE CAREFUL, if you have more than 15% of your total revenues coming from these sources, you run the risk of being seen as a business entity and losing your tax-exempt status.

9) Expense Classification: If you thought the revenue reporting was complex, Part IX, the Statement of Functional Expenses, is widely considered the toughest part of Form 990. The IRS requires all 990 filers to breakout their expenses into three categories: Program, Management & General, and Fundraising.

-Program expenses are directly related to your tax-exempt purpose (program supplies)

-Management & General expenses are related to the proper running of your organization or assets and not specifically related to your programs (accounting or filing fees)

-Fundraising expenses are related to raising revenues (mailings and solicitations)

-You may think that everything you do is related to your exempt purpose, but it is not. The bigger your organization is, the more management is required. The purpose of this part is to show the IRS, and donors, where every dollar contributed is going.

Although it would be nice to throw everything in Programing and show 100% productivity, that is actually a sign that either the Form 990 was not prepared correctly or that someone is intentionally misrepresenting their activity. Depending on your organization’s industry standard, percentage application is around 80% Program, 15% Management, and 5% Fundraising. But don’t just multiply each expense by those percentages, that too is a red flag. For each indirect expense, determine the cost driver and apply a methodology for categorizing that expense.

10) Fundraising Activities: Gala dinners, golf outings, or even a bake sale are all considered fundraising activities. These should be broken out from your normal related tax-exempt activities. There’s a special location in Part VIII to report these revenues. Consider these subsets from your normal financial activity in that they should be handled independently from your other activities. The bright side is that you don’t have to include it on Part IX, Statement of Functional Expenses. Also make sure to segregate contributions raised from these events from the actual price of tickets sold for the event. Fundraising activities generating revenues greater than $15,000 require that you fill out Schedule G.

11) Matching: Several sections of the Form 990 or Schedules should match total lines reported elsewhere on the Form 990. Having these areas show different amounts looks sloppy. Make sure the following areas match:

-Part I is a summary of all amounts coming from different areas of the 990.

-Part III, line 4e, Total Program Service Expenses should match Part IX, line 25, Column B, Total Program Service Expenses.

-Part VII, Total Compensation (Column D) should match Part IX, line 5.

-Schedule D, Part VI, Land, Buildings, and Equipment should match Part X, Line 10 of Form 990.

The Form 990 isn’t just an annual filing requirement, it can be one of your biggest marketing tools. Not filing, improperly filing, or hastily filing the Form 990 can create many unintended consequences for your organization. Remember, it’s not just the IRS looking at your Form 990, so are your potential donors! Use the Form 990 as an opportunity to tell your nonprofit’s story.

Cray Kaiser is always here as a resource for you. Please contact us today if you have any questions about filing Form 990.