Final Instructions to New Form 990 Released

The Internal Revenue Service (IRS) released Final Instructions to the redesigned Form 990 (Return of Organization Exempt from Income Tax) on August 19, 2008. This is the first major overhaul since 1979 of the information return filed annually by most exempt organizations. The IRS has also released three papers that provide background on and the rationale for the redesign of Form 990, a comparison between the old Form 990 and the new one, and an overview of the specific changes the IRS made to the draft instructions released in April.

This advisory includes a summary of the Final Instructions, a discussion of the redesigned Form 990 and the practical implications for most exempt organizations.

Emphasis on corporate governance and transparency

The Final Instructions and the redesigned Form 990 reflect the IRS's emphasis on the corporate governance of exempt organizations and increased transparency regarding compensation and related-party transactions. The redesigned Form 990 makes significant changes in the presentation of reported information and adds reporting requirements in new areas, including governance and management practices. For additional discussion on the redesigned Form 990, see our June 2007 advisory “Redesigned Reporting Form for Tax-Exempt Organizations: IRS Releases Draft Form 990.”

First filing due May 15, 2009

The Final Instructions will assist organizations filing the revised Form 990 for tax year 2008 (filed in 2009). Small organizations have a three-year phase-in period based on gross receipts and asset levels during which time they can file the abbreviated Form 990-EZ instead of the revised Form 990. Exempt organizations classified as private foundations will continue to file Form 990-PF, which remains unchanged.

Final revisions provide clarity but disclosure burden still high

Based on extensive public comments, the IRS modified the draft instructions that were released on April 7, 2008, to provide greater clarity on the specific information required to be reported, to establish or revise certain definitions and to provide additional examples. The Final Instructions contain significant changes to the draft instructions for governance, compensation, Schedule F (International Activities), Schedule H (Hospitals), Schedule K (Supplemental Information on Tax-Exempt Bonds) and Schedule L (Transactions with Interested Persons). In a few areas, the modifications reduce the reporting burden, but in general the revised Form 990 and the Final Instructions represent a significant increase in the reporting burden for most exempt organizations.

Final Instruction highlights

Highlights of the Final Instructions include:

• Governance (Part VI). The instructions recognize that the section on governance asks information about policies and practices that are not required by federal tax law and that each organization should consider its own situation when determining whether to adopt or revise its policies and practices. Changes from the draft instructions include:
  
  
  • Definition of “independent” director. A director will be considered to be independent only if: 1) the director was not compensated as an employee or officer of the organization or a related organization; 2) the director did not receive total compensation or other payments exceeding $10,000 during the organization's tax year as an independent contractor (other than reimbursement for expenses under an expense reimbursement procedure or for services provided as in the capacity as a director); and 3) neither the director, nor any family member, was involved in a transaction with the organization reportable on Schedule L (see “Schedule L" below).
  • A requirement that the organization must disclose whether the final Form 990 was provided to each voting member of the organization's board of directors before filing with the IRS and the extent to which the organization's officers, directors, trustees, board committee members or management reviewed the form; and
    
    
  • A clarification that the organization must disclose only significant changes to its organizational documents.
    
    
• Compensation (Part VII and Schedule J). In general, compensation to officers, directors, trustees and key employees must be reported in more detail. The final instructions provide clarification regarding certain definitions and reporting requirements, including:
  
  
  • “Key employee” is now defined as any employee who: 1) had reportable compensation exceeding $150,000 for the year; 2) had or shared organization-wide control or influence similar to that of an officer, director, or trustee, or managed or had authority or control over at least 10 percent of the organization's activities; and 3) was within the group of the organization's top 20 highest-paid employees for the year;
    
    
  • Officer is now defined to include “top financial official” and the “top management official”;
    
    
  • The definitions of “reportable compensation” and “other compensation” are also clarified;
    
    
  • Organizations that pay more than $150,000 to an officer, director, trustee, or key employee or that have paid compensation to certain former officers, directors, trustees or key employees must provide additional information on Schedule J (Compensation Information); and
    
    
  • Compensation reporting is now required by all types of exempt organizations that file Form 990.
• Schedule F (International Activities). Activities of an organization in a foreign country are reported by region and not by country. For purposes of providing information regarding grants and other assistance to organizations or entities outside the United States, such organizations and entities do not include U.S. entities even if they have international operations.
  
  
• Schedule H (Hospitals). An organization that operates at least one facility that is, or is required to be licensed, registered or similarly recognized by a state as a “hospital” must file Schedule H. Organizations must list each hospital or other facility that is licensed, registered or similarly recognized by a state as a “health care facility,” including facilities other than licensed hospitals. The instructions clarify the reporting requirements for foreign hospitals located outside of the United States. Schedule H also requires an organization to include information to describe how it determines bad debt expense, for which the hospital must use “the most accurate system and methodology available.”
  
  
• Schedule K (Supplemental Information on Tax- Exempt Bonds). The instructions exempt from reporting refunding bonds issued after 2002 to refund pre-2003 bonds.
  
  
• Schedule L (Transactions with Interested Persons). Excess benefit transactions, loans, grants and other financial assistance involving interested persons must be reported on Schedule L. The instructions clarify that reporting of transactions is based on payments made during the year, regardless of when the transaction was entered into.

Practical implications

Early review of the Final Instructions will help organizations address the revised Form 990's significant practical implications:

• Plan on increased preparation time. Form 990 will take organizations longer to prepare this year, not only because organizations will have to become familiar with the new form, but also because additional information must be reported.
  
  
• Implement governance procedures. Organizations will need to work with management to implement procedures related to governance and management practices, and potentially draft or update policies and practices.
  
  
• Update recordkeeping procedures. Organizations may need to modify their recordkeeping procedures to be able to provide detailed reporting for transactions with interested persons and related organizations, fundraising, grantmaking and compensation.
  
  
• Resolve potential problems in advance. Organizations may mitigate the risk of negative publicity through Form 990 public disclosure by addressing potential issues in advance and can make positive use of the revised Form 990's disclosure opportunities.
  
  
• Establish process for internal review of Form 990. Procedures for the review of Form 990 by the board or a board committee should be established, and in some cases a formal policy regarding 990 review should be adopted. Such review will also help to ensure compliance with new state laws requiring certain organizations to obtain board review and acceptance of any financial report submitted to the Secretary of State. For more information, see our July 2007 advisory “Soliciting Charitable Contributions in Washington State: New Legislation Changes the Rules.”

An exempt organization should work with legal counsel to identify and evaluate potentially problematic arrangements resulting from the new requirements of the redesigned Form 990, to implement safeguards and compliance measures and to adopt policies that are appropriate to its operations and activities.