Dateline: May 30, 2007, Chicago
At the ABA's Exempt Organizations Committee meeting a couple of weeks ago, IRS officials were excited when they talked about the long-awaited revised Form 990. A draft is expected to hit the streets sometime in June, with the IRS asking that the public file comments before the end of summer. We wouldn't expect to see a new Form 990 for the 2007 tax year, but maybe one for 2008.
With so much attention on the nonprofit sector during the last five years, everybody is hoping that the revised Form 990 will provide far more insight into the finances and operations of nonprofit filers. We expect to see lots of comments from the public, including all the good governance folks.
That brings us to yesterday's....
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press release from Senators Baucus and Grassley. They sent a letter to Treasury Secretary Henry Paulson throwing their support behind a major overhaul of the Form 990. Interestingly, the letter makes no mention of the IRS's current revision project. We can only wonder how much consultation there was between the IRS and the two senators. Did those in the IRS convince the senators to help them grease the skids? In other words, is the letter to Paulson signal a concerted effort to accelerate completion of the project? We certainly hope so.
In their letter, Baucus and Grassley suggested several revisions they would like to see made to the Form 990. In doing so, they may have not so subtly tipped their hands regarding future tax legislation affecting charities.
They begin by making the obvious and appropriate suggestion that the Form 990 gather industry specific information. The letter notes that there is a need for specific information about hospitals and universities. Based on comments made by IRS officials, we would not be surprised to see this suggestion reflected in June's draft revisions. As we understand current thinking, the plan is to have a core form, which all organizations will complete, followed by schedules that will be applicable to particular types of organizations.
Baucus and Grassley also urge Paulson to make sure that the new form permits the IRS to more effectively and efficiently audit tax-exempt entities. No one should disagree with that sentiment. The two senators are concerned in particular with UBIT and tax-exempt bonds.
No letter bearing Senator Grassley's signature would be complete without a comments regarding executive compensation and perquisites. This letter specifically mentions housing, first-class-travel, spousal travel, deferred compensation, incentive compensation and bonuses, fringe benefits, loans, dining and entire lifestyles. Given recent scandals, we already expected to see the draft Form 990 to require detailed tally sheets. This latest letter likely seals the deal on that score, particularly after Baucus and Grassley use the phrase "crystal clear." They then note that understanding Fortune 500 CEO compensation is often easier than understanding charity CEO compensation. Don't be surprised if the IRS looks to SEC disclosure requirements for a template.
By page 3, Baucus and Grassley acknowledge their need to digress for several paragraphs from their focus on the Form 990. This is where universities and other institutions with large endowments should see the handwriting on the wall. Baucus and Grassley refer to the commensurate test, which noted authority Bruce R. Hopkins indicates was first enunciated in 1964, but until recently, rarely used. See The Law of Tax-Exempt Organizations (Wiley 2003). Related to the operational test, the commensurate test asks whether a charity's programs and activities are commensurate with its financial resources. See Revenue Ruling 64-182, 1964-1 C.B. 186, which provides absolutely no guidance on how the test is applied. Hopkins points out that the test sat largely dormant until 1990, when the IRS issued a technical advice memorandum taking the position that one organization's expenditures on charitable activities were insufficient when measured against its fundraising and administrative expenses. Hopkins then notes that the question of exemption in that situation was finally resolved by the courts on inurement grounds, with no mention of the commensurate test. See United Cancer Council, 109 TC 326 (1997), rev'd and rem'd 165 F.3d 1173 (7th Cir. 1999). For additional insight into the commensurate test, see Evelyn Brody, A Taxing Time for the Bishop Estate: What is the I.R.S. Role in Charity Governance?, 21 University of Hawai'i Law Review 537 (1999).
While the IRS may have tried to use the commensurate test to police perceived inappropriate practices, Baucus and Grassley couch their discussion in terms of endowments, inadequate spending rates, and billions of dollars of subsidies. At a minimum, the two senators want the Form 990 to ask specific questions that are designed to determine whether the commensurate test is being met. They also ask that the Treasury and IRS put more teeth in the commensurate test and consider audit plans that focus on it. None of this should be taken lightly. This is a shot across the bow, possibly paving the way toward a minimum payout requirement applicable to public charities. We can only wonder how Harvard and other large universities are reacting.
Baucus and Grassley then return to the Form 990, calling for changes that will develop a greater understanding of related organizations and joint ventures. Not surprisingly, the phrase "private benefit" comes up.
The senators also address governance, suggesting that the IRS pay close attention to the BBB WiseGiving Alliance and the Panel on the Nonprofit Sector. They then return to hospitals. You should expect to see the section of the final revised Form 990 that focuses on hospitals asking specific questions about charity care and community benefits, as well as debt collection practices. We aren't sure whether it would be practical to coordinate with state property tax assessors, but this portion of any revised Form 990 clearly will be of interest to those who regulate property tax exemptions.
Senators Baucus and Grassley conclude with a request for suggestions on what changes to the Internal Revenue Code might better assure the accuracy of the information included on the Form 990.
In sum, Baucus and Grassley have written a thoughtful letter and one that should create the momentum in the Treasury and the IRS to push the Form 990 revision project forward. We are also pleased that the subject matter of the letter is clearly within the traditional jurisdiction of the Senate Finance Committee.
We plan to comment when the IRS issues its proposed Form 990. Here a few things we hope to see in any revised Form 990:
- In addition to a balance sheet and income statement, a statement of cash flows.
- A requirement that audited financial statements, if otherwise available, be included as part of the Form 990.
- A question as to whether any elected officials (or their spouses) serve on the board or as principal officers.
- Questions as to whether the charity has been the victim of a theft or financial fraud. If the amount in question exceeds $5,000, whether the perpetrator was prosecuted, what portion of the loss was recovered through insurance or restitution, and what specific changes were made in financial controls to reduce the risk of reoccurrence.
- A question regarding board attendance rates for each director or trustee
- A question as to whether any claims have been filed under a D & O insurance policy and the nature of those claims.
- Greater clarity as to what portion of membership fees and admission fees to charitable events (e.g., charity balls) are classified as revenue and what portion is classified as charitable contributions.
- More information regarding overhead allocation formulas.
As an overall suggestion, we would like the revised Form 990 to be less reliant on a lenghty set of instructions. The questions and schedules should be designed and formatted to permit answers without the need to constantly flip back to the instructions. Anyone who has taken a computer out of the shipping carton knows that no one really reads the manual. Ignoring the manual is human nature. As a consequence, computer manufacturers have had to make the set up process far more intuitive. That approach should be incorporated into the design of the revised Form 990.
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL. If you liked this post, please visit http://www.charitygovernance.com for a description of our training and consulting services. You will also want to acquire a copy of Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good."
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