Thinking ahead to your next Form 990

The deadline for most not-for-profits to file Form 990 with the IRS (May 15, 2024) has come and gone. Assuming your organization operates on a calendar-year tax basis and filed its Form 990 on time, you probably don’t want to think about tax reporting again until next spring. However, it’s important to keep your future Form 990 in mind as your organization carries out its programs and events this year.

4 overlooked issues

You’re probably already alert to issues such as unrelated business income and the risks potentially posed by political participation, excess benefit transactions and excessive compensation (and the need to report some of them). But you may not be paying as much attention to the following four:

1. Fundraising expenses. Your not-for-profit must report its income from fundraising activities, as well as its expenses, on Schedule G of Form 990. The IRS is always on the lookout for events that produce a relatively small amount of income compared with claimed expenses. In such situations, make sure you keep good records to withstand any potential IRS challenge.

2. Operations abroad. Nonprofits are permitted to operate outside the United States without penalty. But your organization is required to answer questions on Form 990 relating to foreign bank accounts, activities in foreign countries and grants by foreign entities. The IRS will likely ratchet up its scrutiny if it finds inconsistencies or evidence of activities that don’t measure up to U.S. standards. If you operate abroad, professional tax advice is essential.

3. Diverted assets. Form 990 asks whether there has been any “diversion” of assets during the past year. Essentially, “diversion” means that funds have been misappropriated for personal reasons. If you answer “yes” to this question, you’ll need to provide a detailed explanation of the diversion and its resolution. However, even if you’ve provided a plausible explanation, a “yes” answer to this question may lead to an IRS audit. If you fail to attach an explanation, your audit exposure increases exponentially. To avoid the issue altogether, take every step (including implementing robust internal controls) to prevent fraud and other illegal asset diversions.

4. Loans to disqualified persons. Generally, loans from a tax-exempt organization to a disqualified person are prohibited on the state level. Form 990 asks if your nonprofit has made such loans. In the event your nonprofit has made a prohibited loan, your Form 990 will need to reflect a declining balance. Otherwise, it may look as though the loan isn’t being paid off in time — a certain red flag for the IRS. Again, if you don’t allow this activity, you won’t have anything to report.

Of course, if you engage a professional tax advisor to prepare your Form 990, your advisor will ask about all these subjects to ensure your organization properly reports its activities. But you can help your nonprofit minimize audit risk by keeping possible pitfalls top of mind.

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