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The Door Has Opened: New Form 990 Creates Strategic Opportunities and Risks for Nonprofit Organizations

A major step in transparency is unfolding in the nonprofit world. The vehicle delivering this change is the newly revised IRS Form 990, "Return of Organization Exempt from Income Tax," which nonprofit organizations have begun filing for the 2008 tax year. The impact that the increased transparency will have on nonprofit organizations has been severely underestimated. It is not sufficient for nonprofit staff and board members simply to be made aware of these changes. They must also be alert to the changes' strategic implications and have tools to manage them successfully. If prepared, nonprofit organizations can capitalize on the opportunities created by the increased transparency. If unprepared, they may be unnecessarily subjected to potentially damaging external risks. The key to strategic use of the new reporting requirements lies in nonprofit organizations' governance practices.

Transparency and Accountability: Three Key Documents

In the last several years, three federal government actions have effectively changed baseline expectations for nonprofit transparency and accountability. Two have received a great deal of attention from nonprofit associations and publications. The third has not.

First, the Public Company Accounting Reform and Investor Protection Act (commonly called the Sarbanes-Oxley Act), passed on July 24, 2002, significantly expanded reporting and accountability requirements for public corporations. Although only two of these requirements apply directly to nonprofit organizations (whistleblower protection and document retention and destruction), the entire statute and the discussion that accompanied its passage greatly increased scrutiny of nonprofit operations, expenditures, and reporting. In some cases, individual states have gone beyond the federal statute to apply additional accounting and reporting requirements to nonprofits.

Second, after extensive public comment and discussion, the Internal Revenue Service promulgated the new 990. For the most part, the revised form continues to be a reporting document, albeit with a very significant difference. The primary intended audience is no longer solely the IRS but now also includes the general public and, more specifically, donors. The format has been thoroughly revised to present, up front, information mostly likely to be of greatest interest to potential donors: organizational mission, governance, and comparative financials. It must be expected that when these reports are posted for public view, they will receive even broader interest than previous 990s.

The third key document has received little public commentary, yet it plays a fundamental role in translating expectations for public accountability and transparency into reality. Posted as an educational tool for the first time in 2004, the IRS’s “Life Cycle of an Exempt Organization” provides guidance for a nonprofit organization in all of its interactions with the IRS during its existence. One of the five major topics covered by the Life Cycle document is entitled “Starting Out.” Buried within the Starting Out section is an eight-page set of principles and requirements, “Governance and Related Topics.” Here the IRS presents six topics of crucial relevance to the disclosure and transparency requirements embodied in the new 990: Mission, Organizational Documents, Governing Body, Governance & Management Policies, Financial Statements & Form 990 Reporting, and Transparency & Accountability. The Governance and Related Topics section of the Life Cycle was, in fact, updated to parallel the governance-related revisions made to the new 990.

Nonprofit leaders should consider the strategic implications of these changes before their new Forms 990 are submitted to the IRS and ultimately made available to the public. At a minimum, a strategic approach will prepare board members for potential inquiries. It may also alter how the organization chooses to respond to governance-related inquiries and requirements in the new 990. Most important, a strategic review may ultimately lead nonprofit organizations to improve their governance practices.

Six Strategic Implications, Opportunities, and Risks

The governance-related revisions have transformed the Form 990 from merely a tax-exemption compliance form into an informative report for potential donors. Nonprofit boards and staffs must ensure that this report positions their respective organizations in a positive light. The strategic governance implications of the new 990 will be discussed within the context of the six topics covered in the Governance and Related Topics section of the IRS Life Cycle document.

1. Mission

The organization’s mission statement, previously buried on page three of the 990, is now prominently located on page one. Every nonprofit board should recognize the importance of this placement, which allows any reader to understand immediately why the organization exists. The increased visibility places greater emphasis on the mission for decision making and invites comparisons to the missions of similar or competing organizations.

The opportunity presented by this change is that nonprofit organizations can better leverage their mission statements, both for internal communication and guidance as well as for external marketing and public relations. Hence, the mission should be evaluated in terms of its effectiveness from these varying perspectives. At the same time, the increased visibility poses a risk if the mission is outdated or misrepresents a nonprofit’s current organizational goals and objectives.

At a minimum, each board should review its organization’s mission to ensure that it reflects current operations, is written clearly, and presents the organization in a positive light. It may be beneficial to research the mission statements of competing organizations and be prepared to speak to the differences between those statements and that of your organization.

2. Organizational Changes

The IRS clearly expects nonprofits to inform donors whether or not a fundamental change has occurred in the organizations’ governance (see Part VI, line 4). This reporting requirement provides an opportunity to update governance documentation, which is ultimately in an organization’s best interest. It also, however, increases the risk involved in improper documentation. Improper maintenance of organizational documents could result in loss of tax-exempt status. Every board should insist on an annual internal review of organizational documents that includes the issuance of an internal report detailing the review process as well as the findings.

3. Governing Board

According to the IRS Life Cycle, “The Internal Revenue Service encourages an active and engaged board” and “governing boards … persons who are informed and active in overseeing … operations and finances.” The new 990 has increased the number and specificity of questions regarding board independence and management oversight. With these changes, the IRS has essentially increased expectations for transparency and accountability.

Board members’ being “informed and active” in finances is a challenge but should be attainable through the proper utilization of finance and audit committees. The greater challenge is to be “informed and active” in operations. It is our opinion that to practice good governance, the board must have a clear understanding of the organization’s operations and have confidence that controls are in place and properly followed. Failure to do so will magnify inactive boards. Board members could be subject to criticism or worse if governance issues arise.

The following steps will help establish where the board currently sits along the “informed and active” continuum. First, a systematic internal review of each board member should be performed to ensure independence. Second, the board should develop a complete list of responsibilities and activities for which the board assumes ownership. Third, the board should assess whether or not its members have a good understanding of the organization’s finances, operations, and related controls. These steps will establish a baseline from which further analysis will be performed.

4. Governance and Management Policies

The Life Cycle makes it clear that the IRS will utilize the new 990 “to determine whether the nonprofit organization has implemented policies relating to executive compensation, conflicts of interest, investments, fundraising, documenting governance decisions, document retention and destruction and whistleblower claims.” One can infer that the IRS intends to use the answers to questions related to these areas to identify nonprofits for future audit.

The opportunity here is that the IRS has provided a template of minimum expectations to be met. Meeting these expectations provides donors and stakeholders with a standard level of assurance to move forward with potential contributions. The risk is that nonprofits answering “no” to the governance and management questions will create an atmosphere of doubt that may result in contributions moving to another organization.

Every organization should review existing governance and management policies and compare them to the minimum (implied) requirements set by the new 990. Policy gaps should be documented and addressed, with the understanding that policies that are not documented are of minimal value. In addition to written documentation, all policies should be accompanied with detailed procedures to ensure understanding and awareness. A review process for policies and procedures should be incorporated into an annual plan. Finally, all policies and procedures should be disseminated throughout the nonprofit organization (administration, staff, and board) each year.

5. Financial Reporting

The IRS Life Cycle could not be clearer in placing responsibility for accurate financial reporting directly on nonprofit boards: “Directors are stewards of a charity’s financial and other resources. The IRS encourages the board … to ensure … funds are appropriately accounted for by regularly receiving and reviewing up-to-date financial statements and any auditor’s letters or finance and audit committee reports.” This expectation gives boards an opportunity for increased involvement and understanding of financial information. The risk lies in the appearance of a board that has delegated its responsibility, which can erode public confidence and increase the opportunity for malfeasance.

Board members should have a solid understanding of the financial statements as well as Form 990. Further, the IRS Life Cycle indirectly suggests that the Form 990 be provided to the board for review. This review process should be incorporated into the annual review and completed prior to filing the 990, and board members should consider signing the return. A signature by the board would be a powerful public statement.

Potentially the most significant change introduced in the new 990 is the addition of comparative financial information in Part I, which appears on the front page of the form. Providing a year-to-year comparison is transformational and moves nonprofit reporting conceptually further towards the requirements of a publicly traded company. Year-to-year comparative information greatly increases reader insight into an organization’s performance and will generate significant external discussion about it.

Board members should expect an increase in inquiries, including a more informed line of questioning. Board members should have a solid understanding of the annual financial changes and the key factors driving them as well as the organization’s overall financial position. Responses to potential questions should be developed in advance and prepared by individuals who have the necessary financial and operational expertise. Board members should be properly briefed on the responses, and guidelines should be developed to ensure consistency and accuracy of external reporting.

6. Transparency and Accountability

As the Life Cycle clearly states, “The IRS encourages every charity to adopt and monitor procedures to ensure that its Form 990, annual reports, and financial statements, are complete and accurate, are posted on its public website, and are made available to the public upon request.” The fact that previous Forms 990 have historically been made available for external public review is not at all comparable to the new 990 with its revised reporting format, increased emphasis on governance, and accentuated year-to-year financial comparison. With each increase in transparency will come a corresponding increase in inquiries, which will require an increased number of external communications. Each communication creates risk for the nonprofit if information is either reported in error or, equally, misinterpreted in response to inquiries.

Conclusion and Recommendations

We offer several recommendations, with the caveat that they should not be considered exhaustive. The intention is rather to initiate discussion among board members and their organization’s administrators.

Immediate Term—A board meeting including legal and financial representation should take place. Although the new 990 may appear to be a finance committee matter, it clearly is much more than that. The new 990 is a strategic concern that the entire board should understand. Before the board meeting, each member should receive a draft copy of the new 990. Agenda items may include:

  • Review new Form 990 (including identification of internal and external stakeholders).
  • Develop a comprehensive list of current governance practices (policies and procedures).
  • Develop a list of critical governance practices that are not currently in existence (the new 990 and Life Cycle documents are excellent starting points).
Near Term—After the initial board meeting, an operational review should be performed. The purpose is less for evaluation than to develop a basic understanding of the organization’s operations. The agenda should include:

  • Review a list of employees and summary of primary responsibilities.
  • Use a strategy-mapping process to ensure that the operational review is completed in the context of the overall organization strategy.
  • Create and review responses to crucial questions on the Form 990, with particular attention to items that may put the organization’s credibility at risk.
  • Develop a communications strategy for responding to inquiries, including delegation of spokesperson responsibilities.

Joel R. Wilson, CPA, Francis J. Schweigert, Ph.D., Grover A. Cleveland, DBA, CPA
© 2009, College of Management, Metropolitan State University

Joel R. Wilson is assistant professor in accounting, College of Management, Metropolitan State University. Francis J. Schweigert is associate professor in public and nonprofit administration, College of Management, Metropolitan State University. Grover A. Cleveland is professor in accounting and accounting unit coordinator, College of Management, Metropolitan State University.
Topics: Policy