December 15, 2008


NEW FORM 990 TURNS IRS SPOTLIGHT
ON NONPROFIT GOVERNANCE

Extensive new disclosure requirements regarding governance and executive compensation practices, now being phased in, require careful attention and
planning

The IRS has recently adopted a new Form 990 annual information return that will become applicable to many tax-exempt organizations for tax years beginning in 2008. Many other tax-exempt organizations will also be affected by the new form during a subsequent two-year phase-in period.

The Form has significant new disclosure requirements regarding the organization’s governance and executive compensation practices. It includes a box that is to be checked to indicate if the organization already has the applicable policy in place, as well as a schedule in which the reporting entity can supplement its responses. Nonprofits around the country, and their boards, auditors and counsel, are now beginning to focus on how these requirements will affect their practices and, in particular, whether new or revised policies and procedures should be implemented prior to the end of their current-tax year so that they can decide how to check the box. Examples of the new requirements are questions regarding the number of independent directors; conflict-of-interest, whistleblower protection and document retention policies; the process for setting executive compensation and details of amounts paid to the most senior staff; the existence of an independent audit committee; and board review of the Form 990 itself.

To see the new Form on the IRS website, please click here, then follow the further links for the Form, detailed instructions about it and the phase-in rules.

New Requirements Will Accelerate Focus on Best Practices for Nonprofits

The new Form 990 requirements will certainly accelerate the convergence of governance and compensation practices between the nonprofit and for-profit sectors that was already occurring as a result of the increased focus on governance and its relationship to performance and legal compliance over the past decades. This focus was intensified with the enactment of the Sarbanes-Oxley reforms in 2002. Most of these apply only to publicly traded companies, but two – relating to whistleblower protection and document retention – are applicable to nonprofits. The last several years have seen a significant increase in the literature discussing best practices for nonprofit governance (including guidelines from the IRS, which may be viewed here) and the topic is of vital importance for everyone involved in the nonprofit community, particularly during a period when economic conditions present special challenges for nonprofit funding.

The IRS has made it clear that there are no “right” or “wrong” answers to the new questions (and there is an opportunity for the reporting entity to supplement its requirements with “free-written” information in a new Schedule O). So exactly how the IRS will use the responses remain to be seen. What can safely be said right now, however, is that the IRS believes there is a meaningful connection between the governance and compensation practices of tax-exempt organizations and their compliance with the conditions of their exemption; and that the IRS will be scrutinizing the responses with that belief in mind.

It is also safe to assume, since nonprofits are required to make their Forms 990 publicly available, that the donor community (particularly major funders) can be expected to pay close attention to the responses to the new disclosure requirements. Even those nonprofits that report on different versions of Form 990 (Form 990-PF, Form 990N and Form 990-EZ) that do not yet contain the new disclosure requirements will need to pay attention to the questions the new Form 990 asks because what have been promulgated as descriptive requirements will likely morph, over time, into prescriptive expectations.

This does not mean that every nonprofit should immediately adopt the policies and procedures the new Form 990 asks about just for the sake of saying “yes” on the Form, nor that all nonprofits should address the requirements in the same way. What is widely accepted as true for governance in the for-profit world is equally applicable in the nonprofit world: one size does not fit all. Nonprofits have widely diverse financial and human resources, missions and methods of operations. Governance and compensation practices need to be tailored to individual circumstances.

Develop Your Response Now

However, the time for the nonprofit community to be reviewing these requirements and developing responses is now. This is not a project that can be assigned to auditors. It requires the close attention of boards of directors/trustees, senior executives and legal counsel.