Chapter

1. Chapter 14 Not-for-Profit Organizations—Regulatory, Taxation, and Performance Issues

2. Learning Objectives After studying Chapter 14, you should be able to: • Identify oversight bodies and the source of their authority over not-for-profit organizations (NFPs) • Describe how and why states regulate NFPs, and describe: • Not-for-profit incorporation laws • Registration, licenses, and tax-exemption

3. Learning Objectives (Cont’d) • Identify how the federal government regulates NFPs, and describe: • Tax-exempt status—public charities and private foundations • Unrelated business income tax • Restricting political activity • Excessive benefits received by officers • Reorganization and dissolution

4. ` Learning Objectives (Cont’d) • Describe governance issues of NFP Boards, including: • Incorporating documents • Board membership • Identify how benchmarks and performance measures can be used to evaluate NFPs

5. Not-for-profit Organizations • NFP organizations receive tremendous amounts of contributed resources and benefits, including, in many cases, tax-exempt status • It is important that NFPs be held accountable for the resources and benefits provided

6. Oversight Bodies • State governments have oversight over NFPs because states grant legal existence through not-for-profit incorporation laws, charitable trust laws, or limited liability companies • The federal government has oversight over NFPs because the federal government grants exemption from federal income taxation (i.e., tax-exempt status)

7. States Regulate NFPs in Several Ways • (See Ill. 14-1) • Starting out (registering as a not-for-profit corporation, charitable trust, LLC) • Licenses (e.g., for charitable solicitation or to operate a facility) • Annual compliance reporting • Tax compliance (e.g., sales and use tax) • Limit on political activity

8. Federal Government Oversight of NFPs • An NFP will interact with the Federal • government throughout its life cycle • (see Ill. 14-2): • Starting out • Applying to the IRS for tax-exemption • Required annual filings • Ongoing compliance • Significant events

9. Applying for Tax-exempt Status • NFPs will apply on Form 1023 or Form 1024 to be exempt from federal income taxes • Churches, integrated auxiliaries of churches, and NFPs with gross receipts not more than $5,000 per taxable year need not apply for exempt status to be considered exempt under 503(c)(3)

10. Public Charity or Private Foundation? • Public charities are funded by the public at large rather than a limited number of donors • Private foundations receive support from a limited number of individuals or corporations and investment income • When an NFP first applies for tax-exemption, it will be presumed to be a public charity and will have to meet the public support test at the end of the fifth year to remain a public charity

11. Public Charities – Public Support Test • The public support test is generally met if > 1/3 of total support comes from the government, directly or indirectly from the general public, or some combination thereof • There is a limit on how much support given by one individual can be counted toward meeting the public support test

12. Political Activity • Participating in a political campaign for (or against) a candidate for public office can result in the loss of tax-exempt status • No substantial part of a charity’s activities can involve propaganda (biased information with a tendency to have little or no factual basis) • A charity is allowed a limited amount of direct lobbying and grass-roots lobbying (appeal to the general public) without jeopardizing its tax-exempt status

13. Required Annual Filings • Based on annual gross receipts, NFPs will file either a Form 990-N, Form 990-EZ, or Form 990 information return annually • NFPs that have more than $1,000 of gross income from an unrelated business will file a Form 990-T and be taxed at corporate tax rates

14. Which Organizations Must File a Form 990 with the IRS? • NFPs that are tax-exempt under IRC Sec. 501 • Private foundations file a Form 990-PF • Note that churches and federal agencies are not required to file Form 990s

15. Form 990 (See Ill. 14-4) • The Form 990 is comprised of a 12-page core form and 16 different schedules (prepared as needed) • Included are a summary front page with the signature of the NFP officer and questions related to governance and performance in addition to the NFP’s financial information

16. Information on a Form 990 • Financial information includes: • Balance sheet and statement of activities • Details of revenue sources and functional expenses • Compensation to key employees and others • Lobbying expenses • Nonfinancial information includes: • Largest contributions with donors’ names • Statement of program services accomplishments

17. Unrelated Business Income Tax (UBIT) An NFP that earns income from activities that are not substantially related to its charitable or tax-exempt mission must pay tax • On the unrelated business net income • That exceeds $1,000 • At corporate tax rates

18. Activities That are Not Subject to UBIT: • Investment income • Royalties and fees for use of intangible property (including sale of mailing lists according to recent court cases) • Gains on sale of property • Work done by volunteers • Legally conducted games of chance • Rents from real property • Activities that primarily benefit members

19. Examples of Activities That Could Result in Unrelated Business Income • Sponsorships • Advertising • Affinity credit card arrangements • Travel services • Fund-raising events

20. Excessive Benefits Received by Officers • Intermediate sanctions or revocation of an NFP’s tax-exempt status can occur if excess benefits are provided to officers or those with substantial influence over the NFP • Excess benefits include unreasonable compensation, sales at bargain prices, and special lease arrangements

21. Excessive Benefits Received by Officers • Intermediate sanctions result in these penalties: • Repay the excess benefit • Pay a tax of 25% of the excess benefit • Pay another 10% tax if the managers were aware the transaction was improper • Pay 200% more of the excess benefit if the transaction is not corrected within the period

22. Reorganization and Dissolution • Reorganization may occur if the NFP finds it needs to redefine its mission to better meet society’s needs • Alternatively, an NFP may opt to merge or dissolve • If dissolution is selected some accounting issues include: • Ensure all creditors are paid • Ensure all taxes are paid • Ensure all assets are appropriately transferred according to incorporation laws, state laws, or IRS regulations

23. Governance Issues: • Incorporating Documents • Articles of incorporation (external focus) describe the purpose of the organization and exempt purpose for which it was established • By-laws (internal focus) describe the functional rules of the organization • Minutes of the board meetings (legal history of the organization)

24. Governance Issues: Responsibilities of Board Members • Set policy • Provide fiscal and ongoing guidance • Monitor continuous quality improvement • Fund-raising

25. Board Treasurers • Have custody of corporate funds and securities • Keep full and accurate records of all receipts and disbursements • Deposit money and valuables in designated depositories • Authorize disbursements

26. Benchmarking & Performance • Increasingly, information about NFP operations is becoming available, allowing for contributors and oversight bodies to assess an NFP’s performance • The Web sites for several watchdog agencies provide useful information for those attempting to assess an NFP’s performance

27. Watchdog Agencies Several groups monitor and evaluate NFPs and compare their performance measures to benchmarks, and/or provide resources for NFPs and donors. For example, • BBB Wise Giving Alliance www.give.org • American Institute of Philanthropy www.charitywatch.org • Independent Sector www.independentsector.org • Urban Institute www.nccs.urban.org • Guidestar www.guidestar.org (makes Form 990s easily accessible on the Internet)

28. Financial Performance Measures (See Ill. 14-6) • Liquidity measures (Can the organization pay its current bills?) • Going concern measures (Are revenues sufficient to cover expenses?) • Capital structure (Does the organization rely more on debt or equity to finance its operations?) • Program effectiveness (Is an appropriate amount spent on accomplishing the NFP’s goals?)

29. Financial Performance Measures (Ill. 14-6) (Cont’d) • Efficiency (Is the cost per achieved output decreasing over time?) • Leverage and debt coverage (Is the debt service expense adequately covered by revenue?) • Fund-raising ratio and efficiency (What percent of contributions remains after adjusting for the cost of raising the contributions?) • Investment performance (Is the rate of total return on investments reasonable?)

30. Non-financial Performance Measures • In addition to financial performance many donors and creditors what to know that the NFP is effective in meeting its goals and mission • The Urban Institute reports a common outcome indicator framework that can be used to monitor and chart effectiveness in 14 program areas

31. Concluding Comments • Accountants report on whether NFPs comply with laws and regulations • NFPs first receive legal status from a state and then apply to the IRS for exemption from federal corporate income taxes; hence are accountable to state and federal governments throughout their life cycle • The ability to benchmark and compare NFP performance is increasing with the availability and revision of the Form 990 • END