A Big Makeover Coming for Charity Tax Form

Nonprofit groups may soon be required to provide the IRS with details on governance and management

When nonprofit officials and advisers get their first peek, expected this week, at the Internal

Revenue Service’s overhaul of the primary tax document that charities file each year, the key question will be whether the changes streamline the reporting process and better inform the public — or whether they exacerbate long-held complaints.

The new Form 990, which charities will be required to start using for the 2008 tax year, reflects the first top-to-bottom makeover of the form since it was created in 1941. Charities with annual revenue of $25,000 or more are required to file the form with the Internal Revenue Service and must give copies to donors and other people who ask for it.

“Our hope is that the changes would support the nonprofit community’s reporting needs to clearly demonstrate mission, values, and results in a way that satisfies their responsibility to the donor public,” says Brian Gallagher, president of United Way of America. The worst result of the overhaul, he says, would be if the IRS “ends up with a form that is more complicated.”

Calls for the IRS to update and improve the Form 990 have been mounting over the years and have come from many corners, including members of Congress.

In a letter just last month to the Treasury Department, Sen. Max Baucus, chairman of the Senate Finance Committee and Democrat of Montana, and Sen. Charles E. Grassley, Republican of Iowa, urged the IRS to add tough new questions to the form to make it more effective in identifying and preventing charity abuses, especially those involving overly generous pay and perquisites for charity officials.

“It can be easier to understand how much a Fortune 500 executive is paid than how much a charity is compensating executives due to the shell games that go on in some cases,” Senator Grassley said in a statement accompanying the letter.

The revised document is expected to be roughly the same length, about eight pages for the main form that organizations file annually with the IRS. But there will also be new supporting forms (or schedules), as many as 15, that charities may be required to fill out, depending on their circumstances and type of organization. Charities will have three months to weigh in on the draft document and recommend changes.

IRS officials say nonprofit leaders should expect to see new questions on such issues as employment taxes, executive compensation, overseas operations, justifications for tax-exempt status (such as details about free care provided by nonprofit hospitals), and joint ventures between nonprofit organizations and businesses.

The most controversial part of the form is likely to be a new section that the IRS hopes will promote greater accountability among charities by asking them specific questions about whether they follow certain management and governance policies and practices in their organizations. For example, charities may be asked if they have an ethics policy in place or who is responsible for making certain kinds of decisions.

IRS officials say they do not plan to impose penalties on organizations that lack such policies, but warn that charities without them run a greater risk of being audited.

By pushing charities to adopt specific governance policies, the IRS is wading into uncharted waters, say experts on tax law. Some people say such questions will prompt charity leaders to pay more heed to how they operate their organizations. Others doubt the questions will accomplish much, and charge that the IRS is overreaching by trying to teach charities about governance instead of sticking to the enforcement of tax laws. What’s more, some experts fear that the new disclosure requirements could make many people less willing to serve on nonprofit boards.

Lois G. Lerner, director of the IRS’s exempt-organizations office, says that asking charities about the way they are run makes sense for the IRS because it will help the tax agency find nonprofit scofflaws more easily. “We don’t think it’s our place to tell you how to govern, but we do believe it’s our place to educate and push organizations into developing a governance structure of their own,” she says. “Organizations that have good governance structures and practices in place are better tax-exempt organizations.”

Following the Law

Ms. Lerner declined to provide specifics about the governance questions or the rest of the form, which the IRS has been working to revise for the past four years.

In changing the 990, the IRS has struggled to balance the competing interests of those who rely on it, including members of Congress, state regulators, watchdog groups, the news media, donors, and members of the public. Yet the final result may end up pleasing no one but the IRS, Ms. Lerner acknowledges.

“The bottom line is, while it’s a form the public looks at, it’s also our form that we have to use to make sure exempt organizations are complying with tax laws,” she says.

Ms. Lerner says charities should expect the new form to have a very different look and feel from the current 990, which often requires charities to respond to questions that don’t apply to them. The new main form, she says, should be easy to fill out for small organizations, while complex subjects will be dealt with in separate forms required only of those groups to which they apply.

Over all, the new form should eliminate redundant, unnecessary, or outdated questions, and streamline both the form and the instructions — which are being released for comment as well — so they are easier to understand, Ms. Lerner says. “A very big focus is to have it be a logical tool and have it make sense,” she says.

Not That Simple

But some legal experts warn that charities may not find the new 990 all that simple.

“People will be surprised, not to mention unhappy, by the length of the core form,” says Eve Borenstein, a Washington lawyer who is reviewing the new form for the American Bar Association. Many groups had been expecting a much shorter form, she says. She urges all charities to read the new form and comment on it, so they can make sure it meets their needs. The IRS, she says, “is not populated with people who are used to governing organizations or who are used to filling out a 990.”

IRS officials say they consulted with charity leaders, state regulators, accountants, lawyers, and watchdog groups, and met with members of Congress when revising the form.

Charities hoping the new version of the Form 990 would make it easier to explain their finances and activities to donors could also be disappointed, says Trent Stamp, executive director of Charity Navigator, a watchdog group. Having seen early drafts of the new form, Mr. Stamp says: “It’s not any more user-friendly, it’s not any easier to read, and it doesn’t tell your average donor anything more than they knew with the old 990.”

Some nonprofit tax experts say the IRS’s effort to require charities to file their returns electronically and its attempts to conduct more-sophisticated computer analyses of returns could mean the form will offer few places for charities to explain how they operate or provide details about unusual numbers.

State regulators, however, are pleased by the move to electronic filing as well as by the greater disclosure they expect the IRS to require on noncash donations, transactions between related parties, and executive compensation, among other things.

“We’re optimistic that a revised Form 990 will provide for greater transparency in these areas,” says Jody Wahl, an investigator who specializes in charities in the Minnesota attorney general’s office and president of the National Association of State Charity Officials.

Of all the provisions that concern charities, the new governance section represents the biggest departure from the old form, which focused almost entirely on financial information.

Based on other work the IRS has done, charity officials speculate that the governance section could ask questions such as what steps groups take to protect whistle-blowers who reveal abuses.

Without seeing the form, charity leaders say it is difficult to predict how the greater disclosure rules will affect their groups. One lawyer, however, is concerned that the IRS might go too far in demanding information from members of nonprofit boards.

Ralph DeJong, a Chicago lawyer who works with nonprofit groups, says some business leaders are already overloaded by the disclosure rules imposed on corporations, and might balk if they were asked to provide yet more information in order to volunteer as a nonprofit trustee.

“We’re really talking about the potential disincentive for some very valuable people to continue to serve as directors. They’ll say, if I have to disclose all this stuff, I don’t know that I want to be a director of any exempt organization,” Mr. DeJong says.

However, Robert Ottenhoff, who oversees GuideStar, an online database that posts copies of Forms 990 for anyone to see, says he thinks the changes make sense. An organization that abuses charitable tax laws is often one whose board members or managers aren’t doing their jobs, says Mr. Ottenhoff, who is president of Philanthropic Research, in Williamsburg, Va., which operates GuideStar. “Some of the charitable abuses we’ve seen in recent years are because there were no boards or they were shadow boards, acting in name only,” he says.

Others question the effectiveness of adding governance questions, saying they could make honest charities look bad in the eyes of donors while doing little to prevent or catch abuses.

John Edie, a lawyer in Washington who was formerly a top official of the Council on Foundations, an organization that represents the nation’s largest grant makers, suggests that the IRS’s time would be better spent on its role as a tax examiner. “Is the IRS putting its energy into questions that might embarrass charities, rather than going out and finding the organizations that have caused all these problems and created all this extra work?” he says.

Suzanne Ross McDowell, a Washington lawyer who sat on the advisory committee that last year helped the IRS revise the form, says the committee urged the IRS to focus on its tax mission rather than try to oversee charity governance. “It’s very difficult to assess good governance,” she says.

For the public, it is not so much which questions are on the form that matters as whether charities answer those questions properly and completely — something many organizations currently fail to do, says Daniel Borochoff, president of the American Institute of Philanthropy, in Chicago, a charity watchdog group. “It would be helpful if the IRS could get groups to fill it out and not just leave stuff off,” he says.

The IRS says it has stepped up its efforts to send forms back to charities that don’t complete them, and that the move to electronic filing will force organizations to file complete returns.

More Changes Possible

While many of the changes being promoted by charity officials, state regulators, and members of Congress are likely to be part of the draft form unveiled this week, others — such as questions about how much universities, hospitals, and other charities should spend from their endowments on expenses related to their charitable missions — probably won’t appear, says Jack B. Siegel, a Chicago lawyer.

Senators Baucus and Grassley, in their recent letter to the Treasury Department, urged the IRS to require nonprofit institutions to show how much of the money they raise, or hold in endowments, goes toward charitable programs.

“The point of giving is to help the community and those in need and not to help a charity build an even bigger bankroll,” they wrote.

While Congress is unlikely to pass new requirements on endowment spending any time soon, Mr. Siegel and others say charity leaders need to realize that major changes could still come about even after the revised Form 990 is made final.

Mr. Siegel adds that, based on what the senators’ letter said, “it would not be a big leap if Congress eventually proposed a minimum-distribution requirement for charities” on the Form 990, similar to the rules imposed on private foundations, which must distribute at least 5 percent of their assets, on average, each year.

During the next three months, charities and other organizations and people interested in the Form 990 will have the chance to make their views on the current draft known. The document will be available on the IRS Web site for charities to look at, and will flag particular sections on which the revenue service is specifically seeking feedback. Organizations will also be able to send their comments to the IRS at form990revision@irs.gov.

“This is not the final form,” Ms. Lerner says. “We do know there are things we’re going to have to be polishing.”