By Andrew Hedrich – SENIOR MANAGER
SMITH + HOWARD ADVISORY LLC
IRS Form 990 is an invaluable opportunity for organizations to craft a meaningful narrative around their work and impact.
Form 990 is a public document: one that’s scrutinized by donors, charity rating organizations, and potential partners. Form 990 is a platform that affords charitable organizations opportunities to seek out new donors, improve their reputation, and advance the mission of their organization.
Understanding the key areas that an organization should present well in its Form 990 filing is key to a smooth filing process that boosts your nonprofit’s standing with donors and the wider community. In this overview, we provide a summary of each of these focus areas, highlighting key considerations and sharing a series of best practices that nonprofit leaders can adopt.
Form 990: An Introduction
IRS Form 990, Return of Organization Exempt from Income Tax, is an informational tax filing that should be filed with the IRS every year. The form summarizes details on program activities, governance, financial performance, and other matters directly related to the operations of the tax-exempt organization.
The form was significantly revamped in the early 2000s in response to rampant abuse of the nonprofit public charity status. Its role today is to provide the public with faith and trust in charitable organizations, shining light on the wider operations of a nonprofit organization.
All Form 990 filings are public. Many publish their Form 990 on their website and charity rating bodies like GuideStar and Charity Navigator use the data in Form 990 to shape the ratings they provide nonprofit organizations. Donors actively consult Form 990, as do grant makers, journalists, and a wide variety of other entities.
Key Focus Areas of Form 990
Given the broad audience for Form 990 and its importance in driving the overall narrative surrounding an organization, leaders of nonprofits must take a considered approach to preparing their filing each year.
Of particular concern are the following areas:
- Program activities
- Governance and internal controls
- Functional expense allocation
- Financial performance
- Executive compensation
Read on as we explore each of these areas in more detail and highlight best practices that institutions should be aware of for each topic.
Program Activities
A nonprofit organization’s program activities are the items, policies, and initiatives that it has in place to enact the organization’s wider mission. Organizations should list their top three programs by program expense in Form 990.
Often, organizations only list the name of these programs: for example “School Visits to Museum”. This does little to reflect the impact of the program on the nonprofit’s wider goals. Instead, use this opportunity to create a narrative around your organization’s program activities. Add quantitative metrics that demonstrate impact, such as “Provided free museum admission and educational experiences for 500 elementary school children from underprivileged neighborhoods”.
The IRS allows organizations to write a short narrative paragraph for each activity. Take the opportunity to describe your organization’s programs in more detail and add impactful metrics that illustrate the role program activities play in helping your nonprofit advance its mission.
Governance and Internal Controls
Nonprofit organizations disclose information about their governance and internal controls on Part VI of Form 990. This is an enlightening section that illustrates to interested parties how well your organization is run.
On the first line of this section, organizations report the number of board members that have voting interests in strategic matters, and on the second line, they report how many of these board members are independent. Ideally, a nonprofit board should be largely independent and have few conflicts of interest, although there can be exceptions to this rule.
Organizations must have a clear policy that outlines what happens in instances where board members have a conflict of interest. This policy should be explicitly stated on Form 990. One situation that can lead to errors is when a family member of a board member works for a nonprofit organization and receives compensation over $10,000. The IRS considers this to be a transaction with an “interested party” and requires this to be disclosed on Schedule L.
Functional Expense Allocation
An organization’s functional expense allocation refers to how it splits expenses between program expenses, management and administrative expenses, and fundraising expenses. It’s not uncommon for nonprofits to allocate expenses incorrectly in an attempt to cast the organization in a more favorable light, allocating almost all expenses as program expenses.
Generally, a healthy functional expense allocation would see between 70 – 80% of a nonprofit’s expenses be allocated toward program activities, with the remaining expenses split roughly equally between management and administrative expenses and fundraising expenses.
Allocating a percentage of expenses to these activities reassures donors and other interested parties that the organization is expending sufficient resources to ensure it can continue operating on an ongoing basis. Make sure that officers of the organization allocate some percentage of their time to fundraising, as this is an activity that’s vital to the organization.
Financial Performance
Unlike the vast majority of tax filings, an organization’s financial performance is not front-and-center of Form 990, instead appearing around three-quarters of the way through the document. This allows the reporting organization ample opportunity to detail its programs, internal controls, and functional expenses before presenting its financials.
The financial information reported in your organization’s Form 990 should closely match that in your audited financial statements. Charity rating agencies use automated technologies to calculate metrics such as debt-to-equity ratios, cash on hand, and the net profit of your organization. Financial leaders at nonprofits should keep these in mind as they assess their strategic goals throughout the year.
Executive Compensation
Reporting the compensation of the leading executives of your nonprofit organization is non-negotiable and leaders must accept that their compensation is public knowledge. The IRS specifies several rules that determine which employees’ compensation must be reported, including:
- The Executive Director or CEO
- The CFO, or person in charge of finance
- Officers of the organization, including those in marketing, technology, and security
- Key employees – individuals who make over $150,000 and have decision-making power over more than 10% of the organization’s revenue, expenses, or assets
- Individuals that are compensated over $100,000 annually and are one of the top five individuals that earn this amount
These thresholds have remained consistent in recent years, even as the wider nonprofit sector has seen significant salary growth.
Effectively leveraging the opportunity that Form 990 affords nonprofits demands a thoughtful approach anchored in deep knowledge of the filing itself. Form 990 can be a complex filing, but it’s one that’s pivotal in attracting donor dollars and grant funding.
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Andrew joined Smith + Howard in 2014 as an intern and is a senior manager in the Tax practice. Andrew’s main focus is with the firm’s Professional Service and Nonprofit groups, specializing in law firms and private schools. Beyond his specializations, he also works with corporations, multi-state partnerships, and high-net-worth individuals all in an effort to provide comprehensive, value-added consulting to his clients’ immediate and future needs. If you’re curious about starting a long-term strategy or need more information, reach out to Fortify Foundation today! Together, we can secure the future of Christian education.
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