McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 14 Not-for-Profit Organizations— Regulatory, Taxation, and Performance Issues

14-2 Learning Objectives After studying Chapter 14, you should be able to:  Identify oversight bodies and the source of their authority over not-for-profit organizations (NFPs)  Describe how and why states regulate NFPs, and describe: Not-for-profit incorporation laws Registration, licenses, and tax-exemption

14-3 Learning Objectives (Cont’d)  Identify how the federal government regulates NFPs, and describe: Tax-exempt status—public charities and private foundations Unrelated business income tax Restricting political activity Excessive benefits received by officers Reorganization and dissolution

14-4 ` Learning Objectives (Cont’d)  Describe governance issues of NFP Boards, including: Incorporating documents Board membership  Identify how benchmarks and performance measures can be used to evaluate NFPs

14-5  NFP organizations receive tremendous amounts of contributed resources and benefits, including, in many cases, tax- exempt status  It is important that NFPs be held accountable for the resources and benefits provided Not-for-profit Organizations

14-6  State governments have oversight over NFPs because states grant legal existence through not-for-profit incorporation laws, charitable trust laws, or limited liability companies  The federal government has oversight over NFPs because the federal government grants exemption from federal income taxation (i.e., tax-exempt status) Oversight Bodies

14-7  Starting out (registering as a not-for-profit corporation, charitable trust, LLC)  Licenses (e.g., for charitable solicitation or to operate a facility)  Annual compliance reporting  Tax compliance (e.g., sales and use tax)  Limit on political activity States Regulate NFPs in Several Ways (See Ill. 14-1)

14-8 An NFP will interact with the Federal government throughout its life cycle (see Ill. 14-2):  Starting out  Applying to the IRS for tax-exemption  Required annual filings  Ongoing compliance  Significant events Federal Government Oversight of NFPs

14-9 Applying for Tax-exempt Status  NFPs will apply on Form 1023 or Form 1024 to be exempt from federal income taxes  Churches, integrated auxiliaries of churches, and NFPs with gross receipts not more than $5,000 per taxable year need not apply for exempt status to be considered exempt under 503(c)(3)

14-10 Public Charity or Private Foundation?  Public charities are funded by the public at large rather than a limited number of donors  Private foundations receive support from a limited number of individuals or corporations and investment income  When an NFP first applies for tax-exemption, it will be presumed to be a public charity and will have to meet the public support test at the end of the fifth year to remain a public charity

14-11 Public Charities – Public Support Test  The public support test is generally met if > 1/3 of total support comes from the government, directly or indirectly from the general public, or some combination thereof  There is a limit on how much support given by one individual can be counted toward meeting the public support test

14-12 Political Activity  Participating in a political campaign for (or against) a candidate for public office can result in the loss of tax- exempt status  No substantial part of a charity’s activities can involve propaganda (biased information with a tendency to have little or no factual basis)  A charity is allowed a limited amount of direct lobbying and grass-roots lobbying (appeal to the general public) without jeopardizing its tax-exempt status

14-13 Required Annual Filings  Based on annual gross receipts, NFPs will file either a Form 990-N, Form 990-EZ, or Form 990 information return annually  NFPs that have more than $1,000 of gross income from an unrelated business will file a Form 990-T and be taxed at corporate tax rates

14-14 Which Organizations Must File a Form 990 with the IRS?  NFPs that are tax-exempt under IRC Sec. 501  Private foundations file a Form 990-PF  Note that churches and federal agencies are not required to file Form 990s

14-15  The Form 990 is comprised of a 12-page core form and 16 different schedules (prepared as needed)  Included are a summary front page with the signature of the NFP officer and questions related to governance and performance in addition to the NFP’s financial information Form 990 (See Ill. 14-4)

14-16  Financial information includes: Balance sheet and statement of activities Details of revenue sources and functional expenses Compensation to key employees and others Lobbying expenses  Nonfinancial information includes: Largest contributions with donors’ names Statement of program services accomplishments Information on a Form 990

14-17 An NFP that earns income from activities that are not substantially related to its charitable or tax- exempt mission must pay tax On the unrelated business net income That exceeds $1,000 At corporate tax rates Unrelated Business Income Tax (UBIT)

14-18  Investment income  Royalties and fees for use of intangible property (including sale of mailing lists according to recent court cases)  Gains on sale of property  Work done by volunteers  Legally conducted games of chance  Rents from real property  Activities that primarily benefit members Activities That are Not Subject to UBIT:

14-19  Sponsorships  Advertising  Affinity credit card arrangements  Travel services  Fund-raising events Examples of Activities That Could Result in Unrelated Business Income

14-20  Intermediate sanctions or revocation of an NFP’s tax-exempt status can occur if excess benefits are provided to officers or those with substantial influence over the NFP  Excess benefits include unreasonable compensation, sales at bargain prices, and special lease arrangements Excessive Benefits Received by Officers

14-21 Excessive Benefits Received by Officers  Intermediate sanctions result in these penalties: Repay the excess benefit Pay a tax of 25% of the excess benefit Pay another 10% tax if the managers were aware the transaction was improper Pay 200% more of the excess benefit if the transaction is not corrected within the period

14-22 Reorganization and Dissolution  Reorganization may occur if the NFP finds it needs to redefine its mission to better meet society’s needs  Alternatively, an NFP may opt to merge or dissolve  If dissolution is selected some accounting issues include: Ensure all creditors are paid Ensure all taxes are paid Ensure all assets are appropriately transferred according to incorporation laws, state laws, or IRS regulations

14-23  Articles of incorporation (external focus) describe the purpose of the organization and exempt purpose for which it was established  By-laws (internal focus) describe the functional rules of the organization  Minutes of the board meetings (legal history of the organization) Governance Issues: Incorporating Documents

14-24  Set policy  Provide fiscal and ongoing guidance  Monitor continuous quality improvement  Fund-raising Governance Issues: Responsibilities of Board Members

14-25  Have custody of corporate funds and securities  Keep full and accurate records of all receipts and disbursements  Deposit money and valuables in designated depositories  Authorize disbursements Board Treasurers

14-26 Benchmarking & Performance  Increasingly, information about NFP operations is becoming available, allowing for contributors and oversight bodies to assess an NFP’s performance  The Web sites for several watchdog agencies provide useful information for those attempting to assess an NFP’s performance

14-27 Several groups monitor and evaluate NFPs and compare their performance measures to benchmarks, and/or provide resources for NFPs and donors. For example,  BBB Wise Giving Alliance  American Institute of Philanthropy  Independent Sector  Urban Institute  Guidestar (makes Form 990s easily accessible on the Internet) Watchdog Agencies

14-28  Liquidity measures (Can the organization pay its current bills?)  Going concern measures (Are revenues sufficient to cover expenses?)  Capital structure (Does the organization rely more on debt or equity to finance its operations?)  Program effectiveness (Is an appropriate amount spent on accomplishing the NFP’s goals?) Financial Performance Measures (See Ill. 14-6)

14-29  Efficiency (Is the cost per achieved output decreasing over time?)  Leverage and debt coverage (Is the debt service expense adequately covered by revenue?)  Fund-raising ratio and efficiency (What percent of contributions remains after adjusting for the cost of raising the contributions?)  Investment performance (Is the rate of total return on investments reasonable?) Financial Performance Measures (Ill. 14-6) (Cont’d)

14-30  In addition to financial performance many donors and creditors what to know that the NFP is effective in meeting its goals and mission  The Urban Institute reports a common outcome indicator framework that can be used to monitor and chart effectiveness in 14 program areas Non-financial Performance Measures

14-31  Accountants report on whether NFPs comply with laws and regulations  NFPs first receive legal status from a state and then apply to the IRS for exemption from federal corporate income taxes; hence are accountable to state and federal governments throughout their life cycle  The ability to benchmark and compare NFP performance is increasing with the availability and revision of the Form 990 END Concluding Comments