United States: IRS Gives Mixed Signals On Revised Exempt-Organization Annual Reporting Procedures And The Form 990

The Form 990 annual federal income tax return for tax-exempt organizations has undergone significant changes and expansion in the last two years. In 2006 (for returns covering fiscal years beginning in 2005), the IRS revised the Form 990 in three major respects. The IRS now requires disclosure of: all compensation and benefits provided to any former officer, director, trustee or key employee; broad compensation and benefits information for independent contractors (adding the five highest paid independent contractors for non-professional services); and outside compensation, outside business interests and interrelationships involving officers, directors, trustees, key employees, the five highest paid other employees, the five highest paid independent contractors for professional services, and the five highest paid independent contractors for non-professional services (what can be referred to as "insiders"). These changes (and in particular the third one) have been controversial, since on the surface they require a very extensive inquiry into and disclosure of insiders’ compensation and business interests.

IRS representatives have recognized in recent months that some of these changes were overly broad. As a result, they stated that the new Form 990 in 2007 (for returns covering fiscal years beginning in 2006) would provide a simpler and narrower definition of "relatedness," which then would be used to report outside compensation and business relationships of directors and other insiders.

The revised Form 990 and instructions were released very recently by the IRS, and tax-exempt organizations will be surprised to find that the changes increase, rather than reduce, the complexity. The revised Form 990, schedules and instructions are available to the public on the IRS website. In addition to new disclosure requirements for "donor advised funds" required by the Pension Protection Act, the revised Form 990 and related instructions include the following key changes effective for 2006 reporting.

Reporting organizations must now include complete summaries of compensation provided to officers, directors, trustees and key employees of the reporting organization in two locations: Part II, lines 25(a) and (b); and Part V-A and -B. Both Part II and Part V require reporting organizations to provide compensation information for current and former officers, directors and trustees of the organization who received compensation during the reporting year. Reporting organizations must assure that compensation reported on lines 25(a) and (b) corresponds with compensation reported in Part V-A and -B. Reporting organizations also must allocate the total compensation reported on lines 25(a) and (b) to program services, management, and general expenses and fundraising.

A new line 25(c) has been added to 2006 Form 990 that requires the reporting organization to describe any compensation provided to other "disqualified persons" (as defined in the intermediate sanctions tax law rules) during the reporting year. The reporting organization would exclude amounts already disclosed in response to lines 25(a) or (b), and must attach a schedule that provides a breakdown of the type and amount of compensation provided to each disqualified person who is not a current or former officer, director, trustee or key employee who received compensation or any other distribution from the organization. For each disqualified person, the schedule must include: loans and advances; compensation; contributions to employee benefit plans and defined benefit plans; expense accounts and other allowances; and other distributions. It is unclear who the IRS intends this to cover since the usual categories of disqualified persons are already captured in other places.

Form 990 for 2005 had required the organization to disclose all situations in which insiders are related to each other through family or business relationships. This question is far more complex than it first appears, but the IRS provided no instructions on the 2005 Form 990 to assist in addressing the intricacies of the potential relationships. While organizations were hoping that the IRS would provide instructions for this year’s Form 990, the only thing added for line 75b is the note that "family" and "business relationship" are defined under line 51 of the Form 990. The remaining questions and intricacies are not guided by any instructions, and they will need to be addressed with the usual degree of business and tax law judgment.

Line 75(c) of the 2006 Form 990 requires the disclosure of an insider’s compensation from organizations that are related to the reporting organization, provided that the reporting organization and the outside organization provide at least $50,000 in aggregate compensation to the insider. On last year’s Form 990 the IRS had provided a very expansive view of "relatedness," which was illustrated in the instructions with six forms of "close connection" that would trigger the disclosure requirement. The new Form 990 deletes certain examples of a "close connection" that would trigger the disclosure of outside compensation arrangements, but then introduces several new forms of relatedness that make this disclosure requirement all the more complex.

The IRS provides two disclosure categories that depend on the type of relationship between the reporting organization and the related organization. Both categories of relatedness require disclosure of the name of the insider receiving compensation from the related organization, the name and employer identification number of each related organization,and a description of the relationship between the organization and the related organization. For certain of these relationships, the outside compensation arrangements and amounts must be disclosed, although some exceptions are provided. The new categories of "relatedness" are:

• One organization owns or controls the other organization

• The same person owns or controls both organizations

• The organizations have a relationship as supporting and supported organizations

• The organizations use a common paymaster

• The other organization pays part of the compensation that the reporting organization would otherwise be contractually obligated to pay

• The organizations are partners in a partnership or members in an LLC or other joint venture

• The organizations conduct joint programs or share facilities or employees

• One or more persons exercise substantial influence over both organizations (e.g., serving in an executive capacity at both organizations)

These new relationship categories are more specific and in some ways broader than the indices of relatedness contained in prior Forms 990. These changes may therefore require reporting organizations to provide additional reporting and disclosure. It will be necessary for reporting organizations to learn the new relatedness categories, determine how to communicate these to insiders, gather new forms of disclosed interests and relationships, apply the new definitions and exceptions to disclosure, and fashion an appropriate response for the Form 990. Surely, this falls short of the expected degree of simplification.

A new Part XI was added to Form 990 that requires disclosure of transfers to and from controlled entities. These changes are required by the Pension Protection Act. The required disclosure must list the name and address of each controlled entity, the employer identification number of such entity, a description of the transfer and the amount of the transfer. The reporting organization must also indicate whether the transfers were made in accordance with a binding written contract in effect on August 17, 2006.

Form 990 Line 54 has been revised to require that reporting organizations separately report investments in publicly traded securities and all other securities. Previously, investments in all securities were reported together.

Organizations with at least $10 million in total assets at the end of the calendar year that file at least 250 returns during the calendar year must file Form 990 electronically. The asset threshold in effect prior to the implementation of 2006 Form 990 was $100 million.

Although changes to the 2006 Form 990 seem less extensive than those contained in prior revisions of the form, the 2006 revisions are likely to result in significant additional or revised disclosures when compared to those made in prior years. The process of gathering the necessary information from insiders will become even more complex and onerous. Completing the revised Form 990 in the most efficient and least intrusive manner will be a challenge.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.