This blog is part of a series designed to serve as a foundational guide for CPAs who are new to the nonprofit space, enabling them to navigate the sector and gradually deepen their knowledge. This post, understanding federal filing requirements, focuses on key forms and concepts, common pitfalls, and strategic practices when it comes to federal filings for nonprofits.
By Monika Briggs, CPA
This series is designed to serve as a foundational guide for CPAs who are new to the nonprofit space. It aims to help them navigate this sector confidently at the outset and gradually deepen their understanding as they progress in their journey. As the series unfolds, each installment will delve into an aspect of nonprofit management, offering essential information, practical advice, and expert insights. The goal is to demystify the complex regulatory landscape. This series will empower CPAs with the knowledge necessary to thoughtfully manage nonprofit finances and adeptly handle the myriad regulatory and compliance challenges they will encounter.
Last month, we launched the series with "Essential Nonprofit Compliance: What Every CPA Needs to Know about Nonprofit Status," exploring the distinctions between nonprofit and tax-exempt status. This month, we shift the focus to understanding the federal filing requirements that tax-exempt nonprofits must navigate. As CPAs integrate into nonprofit roles, mastering federal filing requirements becomes one of their first and most daunting challenges. Strict adherence to these requirements is crucial, not only for legal compliance but also for demonstrating the organization's transparency and integrity.
This article delves into the essentials of federal filing for nonprofits, focusing on key forms and concepts, common pitfalls, and strategic practices that ensure compliance and enhance organizational effectiveness. Understanding these requirements is more than just satisfying IRS demands; it’s about leveraging compliance to strengthen trust and engagement with donors, volunteers, and the communities served.
Nonprofit organizations with tax-exempt status are bound by strict IRS reporting requirements, primarily through the Form 990 series. Far more than just a tax return, Form 990 is a crucial tool for compliance, financial transparency, and public trust. It demands detailed disclosures about an organization's finances, operations, and activities, allowing the IRS, donors, and the public to closely examine a nonprofit's financial health and effectiveness. This information not only helps stakeholders make informed decisions but also supports state regulatory oversight and sectorwide analyses, thereby enhancing accountability, facilitating charitable giving, and shaping policy within the nonprofit sector.
The specific Form 990 needed depends on an organization’s financial activity, total assets, and gross receipts during the fiscal year:
Form 990 filing exemptions apply to certain organizations, such as churches and some state-funded institutions.
Typically, a Form 990 is due by the 15th day of the fifth month following the end of the organization's fiscal year. So, for organizations operating on a calendar year, this deadline falls on May 15 (or the next business day if May 15 is a weekend or holiday). However, it’s common for nonprofits to have fiscal year ends on June 30 or Sept. 30, which alters the filing deadline accordingly. It is important to note that the filing obligations commence from the tax year the organization is considered legally formed, which coincides with the application for an employer identification number. This is not always in the same year that an entity receives its determination letter from the IRS.
The consequences of late or incorrect filings can be significant. Late or incorrect filings can result in penalties ranging from $20 per day (up to $10,000 or 5% of the year's gross receipts) and increasing to $100 per day with a maximum of $51,000 for larger entities. Failure to file for three consecutive years results in automatic revocation of tax-exempt status. Furthermore, inaccuracies can trigger IRS audits and precipitate severe legal and financial consequences, damaging the organization’s reputation and operational capabilities.
Alongside the Form 990 and its variants, several schedules and additional forms may need to be filed, depending on the specific activities, financial circumstances, and characteristics of the nonprofit organization:
Each schedule helps paint a more complete picture of the nonprofit’s activities, governance, and financial situation, ensuring transparency and compliance with IRS regulations.
In the first article of our series, we discussed the key differences between public charities and private foundations. The Public Support Test, calculated on Schedule A of Form 990, is crucial for determining whether an organization qualifies as a public charity. Maintaining public charity status is highly beneficial because it enhances eligibility for grants, increases donor confidence due to the perceived transparency and accountability, and usually results in more favorable tax treatment compared to private foundations. Additionally, public charity status offers more favorable deduction limits for donors.
The Public Support Test quantifies the diversity of an organization's funding sources, with calculations performed in two separate schedules, Part II and Part III.
For the purpose of completing Schedule A, qualifying public support includes grants from government entities, contributions from other public charities, and gifts from donor-advised funds. Membership fees and revenues from activities closely related to the nonprofit’s mission, as well as proceeds from fundraising events, also count toward public support. Finally – with some limitations – direct donations from individuals constitute public support and are crucial for demonstrating community and public backing.
Per Stacy Cullen, nonprofit tax director at Aprio, the Schedule A public support calculations are some of the most nuanced and miscalculated portions of Form 990. A misstep on Schedule A could land an organization in private foundation status. If your public support percentage is getting below 40% or you anticipate changes in your organization’s funding, it is important to reach out to a nonprofit tax specialist who can model what your public support may look like over the next few years while there is time to make necessary changes to retain your public charity status.
If an organization fails to meet the Public Support Test, it is classified by the IRS as a private foundation. Unlike public charities, private foundations typically have a limited number of donors, often centered around a single individual, family, or corporation. The concentration of control and funding raises concerns about the potential misuse of assets or influence for personal gain, which is not aligned with the charitable purposes for which tax exemptions are granted.
Given their significant investment assets and the potential for funding nontraditional grantees – including those that are not tax-exempt – private foundations undergo stringent regulatory oversight. This includes rules against self-dealing, mandatory asset distribution requirements, and detailed reporting on all financial transactions and grant-making activities. Such measures are essential, not only to prevent the misuse of substantial financial resources but also to ensure that private foundations contribute effectively and positively to societal welfare.
Private foundations face filing requirements and regulatory obligations different than those of public charities. Here are some key differences:
Tax-exempt entities generally do not pay federal income tax on most income, but they may be subject to unrelated business income tax (UBIT) for revenue not substantially related to their primary exempt purpose. UBIT was enacted as part of the Revenue Act of 1950, largely in response to concerns that tax-exempt organizations were unfairly competing with taxable businesses. It ensures that tax-exempt status is not used to avoid taxation inappropriately and encourages nonprofits to focus on their primary missions.
The following key criteria determine if income is subject to UBIT:
Some nonprofits engage in activities that can generate income that subjects them to UBIT. A typical example is when a nonprofit sells advertising space on its website, in newsletters, or other publications. The revenue generated from these activities is usually considered unrelated to the organization’s exempt purpose. Similarly, providing fitness or recreational facilities to the general public for a fee (common among organizations like YMCAs or university gyms) produces income that does not align directly with educational or charitable purposes, thereby constituting taxable income. In my own experience, I’ve seen youth sports organizations generate revenue through the sale of branded apparel and other merchandise on their websites. Since their primary mission is promoting youth sports, not retail, the income from these sales is classified as unrelated business income.
Tax-exempt entities file Form 990-T, Exempt Organization Business Income Tax Return, to calculate and report UBIT. This form must be filed if gross income from unrelated businesses totals $1,000 or more during the fiscal year. The first $1,000 is exempt from tax. Organizations must deduct directly connected business expenses from gross income to calculate UBIT, and losses from one unrelated business can offset income from another. The tax rate applied is the same as corporate or trust tax rates, depending on the nonprofit's structure.
The timely and accurate filing of Form 990-T is crucial, and noncompliance can lead to penalties and jeopardize the nonprofit's tax-exempt status. Nonprofits engaged in any business activity should closely monitor these ventures and consult with tax professionals to ensure compliance with UBIT regulations and avoid potential financial liabilities.
Tax compliance is critical to nonprofits preserving their integrity and tax-exempt status. Unfortunately, many organizations encounter compliance challenges. Some of these issues were discussed earlier in this article, but they are worth emphasizing again due to their critical impact. Here are key pitfalls to avoid:
By being aware of these pitfalls and proactively addressing compliance issues, nonprofits can safeguard their tax-exempt status and continue to operate effectively and transparently.
Form 990 often elicits mixed feelings within the nonprofit sector. Many view it solely as an administrative task – a checkbox to be ticked off each year. Thus, it’s not uncommon for organizations to delay addressing their Form 990 until the deadline looms, forcing them to scramble and treat the process as a last-minute chore.
This perspective overlooks the Form 990's strategic potential, and can lead to missed opportunities for strategic communication and storytelling. Form 990 is publicly accessible through platforms like GuideStar and the IRS website, making it a primary source of information for donors, grantmakers, and other stakeholders who are evaluating an organization's credibility and effectiveness. Here are some strategic ways to use Form 990 to effectively communicate with donors, stakeholders, and the general public:
By leveraging Form 990 as a communications tool, nonprofits can enhance their credibility, attract and retain donors, and effectively showcase their mission and impact. It's crucial to approach each section of the form, not just as a compliance requirement but as an opportunity to tell the organization’s compelling story. Here are some tips for maximizing the strategic use of Form 990:
By shifting the perspective on Form 990 from a burdensome chore to a valuable communications asset, nonprofits can significantly enhance their credibility, attract and retain donors, and effectively showcase their mission and impact.
This exploration into the federal filing requirements for tax-exempt nonprofits has highlighted the critical role that compliance plays, not only in maintaining legal status but also in building transparency and trust within the nonprofit sector. Clearly, the Form 990 series is not merely a regulatory requirement – it's vital to providing a window into a nonprofit's financial health, strategic direction, and overall impact.
As CPAs and nonprofit leaders navigate this complex landscape, it’s essential to approach filing requirements with diligence and strategic foresight. Proper management of Form 990 and its schedules can transform a routine filing obligation into an opportunity to showcase the organization’s dedication to its mission and accountability.
Your insights and engagement are invaluable to this series. I have enjoyed connecting with many of you since the first article's publication, and I invite you to share your experiences, questions, or challenges related to these topics. Your input enriches our discussions and helps tailor this series to your needs, fostering a more informed nonprofit community.
In the next installment, the focus will shift to state-level regulatory compliance for nonprofits, highlighting the requirements for registration, reporting, and charitable solicitations. The discussion will also address the complexities faced by organizations operating across multiple jurisdictions and delve into the Charleston Principles and related disclosures on solicitation materials.
The Essential Nonprofit Compliance Series
May 6 | What Every CPA Needs to Know about Nonprofit Status
Monika Briggs, CPA, has a particular passion for nonprofit finance and compliance, actively enhancing her expertise while helping organizations navigate complex regulatory environments. She can be reached at monika.briggs@gmail.com.
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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.
Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of PICPA officers or members. The information contained in herein does not constitute accounting, legal, or professional advice. For professional advice, please engage or consult a qualified professional.