While 2016 may be in the books, there may be items related to 2016 that you are still thinking about. Maybe your nonprofit’s financial statement audit is currently underway. Along with that comes the organization’s 2016 tax or information return for the year. Whether your organization files the long version (Form 990), the short version (Form 990-EZ), or a return for a private foundation (Form 990-PF), there are items you should be aware of before signing the return.
The board of directors should have a policy in place to review the Form 990 prior to it being signed and filed with the IRS. There are multiple schedules included with the return, and there are multiple users of this information. The general public may obtain your organization’s tax return from your website (if published), by direct request or from the Guidestar website. Nonprofit tax returns are much more than general tax compliance returns because of the significant amount of non-financial information reported. Some items board members should be aware of are as follows:
- The description of programs and activities
- The requirement to disclose family and business relationships and transactions with interested persons described on Schedule L
- Understanding the drivers of and methods for determining the expense allocations
- Consider if the organization is subject to unrelated business income tax (UBIT)
Unrelated business income is reported on Form 990-T. If an organization doesn’t file Form 990-T, the IRS uses two indicators to trigger a limited scope audit (1) the organization has significant periodical income from advertising, or (2) it has rent or royalty income from debt-financed property. These are two common examples that will give rise to UBIT. The three requirements for most organizations where a business activity generates UBIT are (1) it is a trade or business, (2) it is regularly carried on, and (3) it is not substantially related to furthering the exempt purpose of the organization. Here are two examples:
- A university runs a pizza parlor that sells pizza to students and non-students. The university is a tax-exempt organization and its pizza parlor generates UBIT. While the tuition and fees generated by the university are tax-exempt, its income from the pizza parlor is not tax-exempt because the pizza parlor is unrelated to the university’s education purpose.
- On the other hand, a social-service nonprofit organization holds an annual bake sale. While the sale is unrelated to their mission, it is tax-exempt because it is not regularly carried on. Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and they are pursued in a manner similar to comparable commercial activities of for-profit entities.
Nonprofit organizations should also revisit the tax-exempt requirements under Internal Revenue Code Section 501(c)(3). This is important for obvious reasons, as losing your tax-exempt status will have negative consequences. Members of management and the board of directors should review the organization’s programs and activities and make sure they agree to its mission statement. Some examples of activities that may jeopardize tax-exempt status include the following:
- Private benefit or inurement: If the organization’s activities serve private interests or private benefit of any individual or organization more than insubstantially, its tax-expemt status may be jeopardized. Private inurement is allowing the organization’s income or assets to benefit insiders – typically board members, officers, directors, or key (important) employees.
- Lobbying activities: Lobbying occurs when the organization contacts, or urges the public to contact, members or employees of a legislative body for the purpose of proposing, supporting, or opposing legislation, or when the organization advocates the adoption or rejection of legislation.
- Political activity: All 501(c)(3) organizations are prohibited from participating in any political campaign on behalf of, or in opposition to, any candidate running for public office. This applies to campaigns at the federal, state and local level.
- Neglecting annual reporting obligations: While 501(c)(3) organizations are exempt from federal income tax, the Internal Revenue Code requires most of these organizations to report certain information annually. This is done by filing one of the Form 990 series of returns, as discussed earlier.
- Not operating in accord with stated exempt purpose(s): An organization must pursue the exempt activities it promised in its IRS application for exemption. If an organization has deviated from its original purposes, it must inform the IRS.
- Unrelated Business Income Tax (UBIT): Examples of UBIT activities were discussed earlier. However, generating too much income from unrelated activities can jeopardize an organization’s 501(c)(3) tax-exempt status.
Several fundamental requirements must be satisfied for an organization to remain tax-exempt. Two of these are as follows:
- The nonprofit must be organized exclusively for exempt purposes.
- The nonprofit must be operated exclusively for exempt purposes.
The organizational test is an objective test. The entity’s articles of organization must limit the entity’s purpose to one or more exempt purposes. It also must not expressly empower it to engage in activities that do not further its stated purposes, other than insubstantial activities. This language must be located in the organization’s articles of organization. Inclusion only in the bylaws or other governing documents does not satisfy the organizational test. It is recommended that ambiguous language be avoided.
If more than an insubstantial part of the entity’s activities do not further an exempt purpose, the operational test precludes Section 501(c)(3) status. Commercial operations, like offering services that are similar to those provided by for-profit entities are generally not an exempt activity. However, there is an exception to this general rule when the organization provides services substantially below cost and, thus, must cover costs through contributions.
These tax tidbits are just a few of the items nonprofit organizations should consider as 2016 tax returns are prepared. Please consult with your local Hawkins Ash representative to discuss any of these topics or any other nonprofit tax related questions.