IRS GIVES BIRTH TO FORM 990 AND THE INSTRUCTIONS: TAX-EXEMPT ORGANIZATIONS NOW KNOW THE RULES OF THE GAME—PART I

DATELINE: August 19, 2008, Chicago

What do Apple and the IRS have in common? Both launch new products that are the subject of rumors months before the actual product debut. As hard as it may be to believe, like the Apple second generation iPhone, the redesigned Form 990 has been the subject of rumors for much of this year. Just as Apple watchers monitored shipping containers to determine whether iPhones would be available for sale in early in June, tax lawyers have had a cadre of summer associates posted outside the Kinkos at 1612 K Street in Washington, D.C. watching for Steven Miller, Loris Lerner, and Ron Schultz as they drop off the final version of the Form 990 and the accompanying instructions for copying. This apparently resulted in much confusion because Miller, Lerner, and Schultz or people who look like them have been using Kinkos a lot this year, fueling speculation that the final form and instructions were about to be released.

We, with our limited resources, have been monitoring the IRS Web site for developments. Sometime around 2PM EST today, the IRS posted the forms and the instructions, captioned...

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"August 2008." Regrettably, although supposedly final, the documents still carry the dreaded "DRAFT" stamp, suggesting that more changes may be in store. Moreover, the posted instructions are not in the three-column format, raising questions about the ever-important formatting.

Here are some preliminary observations:

General Instructions, Page 9--Failure-to-File Penalties. The instructions make clear the IRS's intention to impose failure-to-file penalties on organizations that file incomplete forms. These penalties could be triggered if an organization fails to provided required information regarding compensation, fundraising expenses, or related-party transactions.

Glossary. There is a helpful 19 page glossary of terms. Notably, the definitions are only applicable for purposes of filing the Form 990. Happily, the instructions use bold-faced type when referring to terms defined in the glossary. Interestingly, the instructions to Schedule C, Political Campaign and Lobbying Activities, deviate from the one-Glossary approach. Those instructions include a separate listing of defined terms.

Appendix of Special Instructions. The IRS took our suggestion to place special instructions applicable to particular categories of organizations in an appendix. This should make it easier for preparers to read the basic instructions. Moreover, it will permit them to identify the special instructions that apply to a particular type of organization with just one glance.

Core Form, Part I, Summary—Volunteers. The Summary to the Core Form asked for information regarding the number of volunteers. There was a great deal of concern regarding the potential recordkeeping burden posed by this question. The IRS has addressed those concerns by permitting reasonable estimates.

Core Form, Part II, Signature Block. The instructions provide a procedure for paid preparers to obtain a PTIN so that they do not have to disclose their social security numbers.

Core Form, Part VI Governance, Management, and Disclosure.

• The introduction to the instructions for this part makes clear that organizations are not required to adopt the policies that are the subject of the inquiry. The IRS does a nice job of placing these questions in context.
• The IRS provides two examples that help explain whether a director is independent. Example 1, which involves a law firm, is quite helpful. Expect to see associates rather than partners serving on nonprofit boards.
• The IRS significantly reduced the potential burden on organizations to determine director independence by permitting organizations to use reasonable efforts to gather the data and to rely on annual surveys.
• The IRS simplified the definition of business relationships that must be reported on Line 2/Schedule O. Most notably, the IRS addressed the problem of board members who have dealings with other boards members that are in the ordinary course of business. For example, the board member who owns a car dealership where four other board members have purchased automobiles. Those sorts of transactions need not be reported.
• The rules also provide that certain privileged relationships need not be reported. These include relationships between attorney and clients, medical professionals and patients, and clergy and communicants. The instructions also provide very helpful instructions. Example 5, however, is shocking in its liberalness. It provides:

  Example 5. K is a key employee of the organization, and L is on its board of directors. L is a greater-than-35% partner of a law firm that charged $60,000 during the organization's tax year for legal services provided to K that were worth $600,000 at the law firm's ordinary rates (thus, the ordinary course of business exception does not apply). However, the relationship between K and L is not a reportable business relationship, because of the privileged relationship of attorney and client.

  We would have granted this exception only if the services had been provided at market rates.

• The IRS adopts a reasonable inquiry standard for purposes of identifying reportable relationships. Organizations must make reasonable efforts to obtain the information, but are not required to provide it if such efforts don't produce the information.
• The question regarding material diversion of assets will catch far more thefts and embezzlements after the modifications that were made to the instructions. Organizations must make the calculations without taking into account restitution or insurance recoveries.
• The IRS screwed up when it comes to Question 10 relating to governing board receipt of the Form 990. They remain steadfast, requiring the board to receive a final version of the form before it is filed. They do provide an example which clarifies that review is different from provision of the final copy. This may mitigate extensions for filing, but we suspect that there will be increased reliance on extensions.

Core Form, Part VII, Compensation. Part VII requires disclosures regarding compensation.

• The IRS left the basic compensation thresholds unchanged. Consequently, any compensation paid to officers, directors, and trustees must be disclosed, compensation paid to a key employee must be disclosed if the amount is over $150,000 and the compensation for the five highest compensated employees (other than key employees, officers, and directors) must be disclosed to the extent individual compensation exceeds $100,000.
• In terms of key employees, the final instructions make one important change. The organization need only disclose the compensation for the highest paid Top 20 key employees to the extent that each satisfies the $150,000 test and the responsibility test. In Eve Borenstein lingo, we now have the Hi 5s, the Key 20s, and the TDOKEs. If someone would be a Key 20 but for the fact that twenty other key employees make more than that person, she becomes eligible for inclusion in the Hi 5 category. See the example on Page 5 of the instructions to Part VII.
• The matrix on Pages 15 and 16 of the Instructions to Part VII of the Core Form will be very helpful to people giving speeches on the new Form 990. It summarizes the reporting requirements for Part VII of the Core Form and Schedule J.

Core Form, Part VIII, Statement of Revenue. The instructions to Part VIII regarding statements of revenue contain a clearer example involving how revenue from fundraising events are to be treated.

Stay tuned for additional comments tomorrow.

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." Copyright 2008, Charity Governance Consulting LLC. All Rights Reserved. You may not copy any portion of this post to a computer "clipboard" for re-posting anywhere or e-mailing, or otherwise reproduce this post. If you want others to review this post, you may provide them with a link to this web blog. Any use of the material or ideas in this post by reporters or other publishers shall make reference to Jack Siegel, author of "A Guide for Non-Profit Directors, Officers and Advisors: Avoiding Trouble While Doing Good" and this web blog.  For additional information call 773-325-2124