Nonprofit tax compliance; IRS Raises the governance bar with the revised form 990

California CPA, August, 2008 by Martin J. Trupiano

the IRS has raised the governance bar for public charities. It has issued a revised Form 990, the annual information return filed by most nonprofits based on the premise that good governance produces better tax compliance (see Sidebar I). The form includes an entirely new goverance the management policies and practices of nonprofit organizations in matters directly and indirectly related to the organization's tax law compliance. Careful responses to the substantial issues raised by these new governance questions will require advance review and planning by the charity, its CAPs and legal advisers.

The revised Form 990 will be effective for tax years beginning after January 1, 2008. Now is the time to encourage your nonprofit clients to review their organizations' polices so that they are fully prepared to demonstrate compliance with both tax laws and "best practices" of nonprofit governance.

IRS Form 990 Revision

In June 2007, the IRS proposed substantial changes to its Form 990. It explained that the existing form, last revised in 1979, "failed to keep pace with changes in the law and with the increasing size, diversity, and complexity of the exempt sector," and "fail[ed] to meet the Service's tax compliance interests or the transparency and accountability needs of the states, the public, and local communities served by the organization."

More than 700 public comments (3,000 pages) were filed in response to the proposed revisions, prompting the IRS to make additional changes. The final version was published December 20, 2007, and draft instructions were published for comment on April 7, 2008. The IRS expects to finalize the instructions by the end of the year.

The revised Form 990 expands the "core" form from nine to 11 pages, and increases the number of potential schedules to 15. Organizations will determine which schedules they need to file by completing a new, 37-question checklist. The revised core form, schedules, draft instructions and IRS background explanations can be found on the IRS' website (see Sidebar 2).

An entirely new part entitled, "Governance, Management and Disclosure" (GMD) is particularly important to nonprofit directors, officers and managers. It seeks information on governance and management, the process for determining executive compensation, policies regarding conflicts of interest, whistleblower encouragement and protection, document retention, and public disclosure of tax returns and other governance and financial information.

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Opponents of GMD argued that the information it sought is not required by law, and that the inclusion of questions on such topics might make them de facto legal requirements. Although the IRS admitted that much of the requested information was not required, it insisted "the existence of an independent governing body and well-defined governance and management policies and practices increases the likelihood that an organization is operating in compliance with federal tax law."

Besides the IRS, donors and grantors will likely be very interested in a nonprofit's responses to the new governance questions and may use the questions as additional criteria for their donations and grants.

For example, Line 10 asks whether a copy of Form 990 was provided to the directors before filing with the IRS. The form's follow-up question underscores the point: it requires a description of the process by which directors, officers or other management, if any, reviewed the Form 990, including by whom and when the review was conducted, and the extent of the review. Both the IRS and the nonprofit's funding sources seek assurances that the directors are properly supervising tax law compliance.

Key Governance Questions

The new Part VI of the revised Form 990, GMD, is divided into three sections: Governing Body and Management, Policies, and Disclosures. Below is a discussion of some of the information it seeks.

A. Governing Body and Management

* Existence of Independent Directors: The total number of voting members of the governing board and the number that are "independent." From a risk perspective, the IRS may use the response to this question regarding "independent" directors to indirectly discover potential "excess benefit" transactions subject to excise taxes. Also, a response that indicates that more than 49 percent of the directors of a California nonprofit public benefit corporation are "interested" highlight the nonprofit's noncompliance with California Corp. C. [section] 5227, which reflects a standard more stringent than the IRS.

* Got Minutes? On the surface, the question simply reflects good management practice (recording board meeting minutes) to keep timely, accurate, records of actions taken by board and board committees. However, a negative response potentially precludes reliance upon the executive compensation "safe harbor" provisions of federal "excess benefit" prohibitions which, inter alia, require contemporaneous recording of the board's deliberations and decision (Treas. Reg. [section] 53.4958-6).