Tax Planning & Compliance Insights

When completing Form 990 for your nonprofit organization, it is important to report the correct number in the governing body.  By definition, the governing body is the group of persons authorized under state law to make decisions on behalf of the organization.  The governing body is, generally speaking, the board of directors or trustees.  All of the directors or trustees must maintain independence in order to participate in the decision-making process.

The number of directors to be reported on Page 1 and Page 6 Section A of the Form 990 is the total number of members of the governing body as of the end of the organization's tax year who have the power to vote on all matters that may come before them.  Anyone who does not participate in the actual decision-making for the organization is not part of the governing body.  Therefore, advisory boards and committees and other trusted advisors of the organization are not part of the governing body.

Determining Independence

Independent voting members of the organization's governing body are those members who:

• Are not compensated as an officer or other employee of the organization or of a related organization, 
• Did not receive total compensation or other payments exceeding $10,000 during the organization's tax year from the organization or from related organizations as an independent contractor, and
• Were not involved in a transaction with the organization either directly or indirectly through affiliation with another organization that would be required to be reported on Schedule L.

Transactions that would be required to be reported on Schedule L include excess benefit transactions, loans, grants to interested persons, and business transactions.  Learn more about these items in, “About Form 990 Schedule L – Excess Benefit Transactions."

• The member is a donor to the organization, regardless of the amount of the contribution or
• The member receives financial benefits from the organization solely in the capacity of being a member of the charitable class serviced by the organization in the exercise of its exempt function.

The organization need not engage in more than a reasonable effort to obtain the necessary information to determine the independence of members of the governing body and may rely on information provided by such members.

Family or Business Relationships

Although family and business relationships do not negate independence, the organization is still required to disclose any such relationships among the members of the governing body or between any of those members and the organization. 

Family relationships are ancestor/descendant and siblings including spouses.

A "business relationship" between two people on the governing body includes any of the following:

• One person is employed by the other in a sole proprietorship or by an organization with which the other is associated as a trustee, director, officer, key employee, or greater-than-35% owner.
• One person is transacting business with the other (other than in the ordinary course of either party's business on the same terms as are generally offered to the public), directly or indirectly, in one or more contracts of sale, lease, license, loan, performance of services, or other transaction involving transfers of cash or property valued in excess of $10,000 in the aggregate during the organization's tax year.
• The two persons are each a director, trustee, officer, or greater than 10% owner in the same business or investment entity.  There may be ownership through multiple tiers of entities.

A "business relationship" does not include a relationship between:

• Attorney and client, 
• Medical professional and patient, or
• Priest/clergy and penitent/communicant

The organization is not required to provide information about a family or business relationship between two officers, directors, trustees, or key employees if it is unable to secure the information after making a reasonable effort to obtain it.  One way to make a reasonable effort is to make it part of the conflict of interest questionnaire that is required of these people each year.

When reporting the number of directors, it is important to consider independence, family and business relationships.

For more information on Form 990, post a comment below or contact our Tax Planning & Preparation Group at 440-449-6800.
 

Form 990 Schedule L is required for all nonprofit organizations that answered questions 25, 26, 27, or 28 in Part IV of the Form 990 relating to transactions between various parties.

Transactions that are required to be reported on Schedule L include:

• Excess benefit transactions
• Loans to and/or from interested persons
• Grants or assistance benefitting interested persons
• Business transactions involving interested persons

The definition of interested persons is different for each one of these transactions.

Excess benefit transactions:

An excess benefit transaction is an excess payment to a disqualified person.  An excess payment means that the value of the benefit received from the organization is greater than the benefit given (including services) by a disqualified person.

The definition of a disqualified person for purposes of the excess benefit transaction begins with a five year look back period.  Anyone in a position to exercise substantial influence over the affairs of the organization in the last five years ending on the date of the transaction is a disqualified person.  It is not necessary for the person to actually exercise substantial influence, only that he be in a position to exercise substantial influence.  Certain individuals are automatically deemed to have the requisite substantial influence:

• Voting members of the organization's governing body (Board of Directors/Trustees)
• Anyone who regardless of title is in charge of implementing the decisions of the governing body
• Anyone who regardless of title is in charge of managing the organization's finances

Others who are considered to have substantial influence unless the organization can prove otherwise include:

• Family members of anyone listed above
• Substantial contributors i.e., those who have contributed $5,000 or more or more than 2% of all contributions to the organization
• A person who manages a discrete segment or activity that represents a substantial portion of the organization's total activities, assets, income or expenses

To determine whether an excess benefit transaction has occurred, all consideration and benefits exchanged between a disqualified person and the organization and all entities it controls are taken into account. Common examples of an excess benefit transaction include:

• Payment of unreasonable compensation
• Sale of property by the organization for less than fair market value
• Sale of property to the organization for more than fair market value
• Expense reimbursements under a nonaccountable plan not treated as compensation
• Payment of personal expenses
• Embezzlement

If none of these transactions has occurred or any other transaction where more value is given than received, there is no excess benefit transaction.

An excess benefit transaction can be alleged where there is no documentation regarding the method that the organization uses to determine compensation for its disqualified persons including the appropriate comparable data used in the determination.  If it is determined that the compensation exceeds the appropriate comparable compensation levels, an excess benefit transaction will be deemed to exist.
 
An excess benefit transaction may have serious implications for the disqualified person that entered into the transaction with the organization, any organization managers that knowingly approved of the transaction, and the organization itself.  The disqualified person is subject to an excise tax of 25% of the excess benefit received.  If the excess benefit transaction is not corrected, i.e., the excess benefit returned to the organization within the prescribed time, a penalty equal to 200% of the excess benefit is assessed.

In addition, if the excise tax is assessed against a disqualified person, then any organization manager who participated in the excess benefit transaction is subject to a tax of 10% of the excess benefit.  This tax will not be assessed if the manager can prove that their participation was not willful and is due to reasonable cause.  If more than one manager participates in a transaction, each of them is liable for the tax.

Transactions that can become excess benefit transactions should be carefully monitored by the organization for the benefit of all interested parties.  Procedures for maintaining relevant records can help alleviate any problems in this area.

For more information on Form 990, post a comment below or contact our Tax Planning & Preparation Group at 440-449-6800.