Author Archive | David-McRee-CPA

Why IRS Form 990 is so Important for Your Nonprofit Organization

Many nonprofit organizations and their CPA’s and attorneys don’t realize the serious penalties imposed by the IRS for filing Form 990 late, or for filing an incomplete return.

Did you know that simply failing to check a box and forgetting to attach a Schedule B to the Form 990 can result in penalties?

I hope after watching the video above you’ll see the necessity of devoting some of your organization’s resources to preparing a proper and timely Form 990. A well-prepared Form 990 creates transparency and trust in the community and makes donors feel more comfortable that their money is truly being put to good use.

Nonprofits Must Keep Adequate Accounting Records or Risk Loss of Tax Exemption

On a regular basis I encounter tax-exempt organizations that do not have sufficient accounting records to prepare a proper Form 990. Often, records are lacking for multiple years. Even bank statements may be unavailable–perhaps left in the care of a treasurer who departed the organization years ago.

In a worst-case scenario, this situation can result in an organization having its tax-exemption revoked.

Generally, the IRS only seems to resort to revocation when an organization fails to respond to repeated demands for accounting and financial records. It is, for the IRS, a last resort.

When might the IRS make a demand for accounting records? Usually this would happen in the case of an investigation into the activities of the organization, either in a routine examination, or in response to a complaint lodged against the organization.

Tax-exempt organizations must be operated in furtherance of their tax-exempt purpose. To prove that they are doing so, they are required to file an information return (Form 990) each year to disclose their items of income and expense in addition to non-financial information. This requires the keeping of adequate accounting records.

Without adequate books and records, it is not possible to demonstrate to the IRS that an organization continues to qualify for its tax-exemption.

In 2011, the IRS revoked the tax-exempt status of a 501 (c)(3) daycare organization (LTR 201150031). As part of an examination into the organization’s Form 990, the IRS requested that the organization produce accounting records for several years. The organization failed to produce sufficient books, records and documentation, in part because the treasurer had stage 4 cancer. Further, though the president thought the records were at the daycare facility, the daycare was unable to produce them.

In trying to resolve the problem, the IRS even went so far as to contact the state office that partially funded the daycare to determine the amount of revenue given to the organization. You can imagine the high level of cooperation they got from the state agency (sarcasm intended). In short: “Nothing could be found that substantiated the financial activities of the organization, and no books and records could be found that summarized and demonstrated the activities of the organization.”

Thus, the IRS revoked the organization’s tax-exempt status.

Later in this article I regurgitate the laws that apply to keeping adequate books and records, but let’s talk about what you can do if you find yourself serving as management or as director of an organization that lacks proper accounting records for one or more periods and the IRS is asking for either a Form 990 or for the accounting records and documentation.

What if Your Organization Lacks Adequate Accounting Records?

First, understand for which years the IRS is requesting information. It may be that you can provide proper records for some years but not for others. If you can provide the IRS with records that substantiate that your organization met the operational test for some years, you may be able to convince them that the organization is legitimate and is being operated properly even though some years lack proper records.

For those years where records don’t exist, you will need to contact the bank and attempt to get bank statements and check copies so your accountant can reconstruct items of income and expense to the extent possible.

If the IRS can see that the organization is trying to comply and is being cooperative, it is more likely to be reasonable. This is especially true with small all-volunteer organizations like high school booster clubs and neighborhood associations. The IRS understands the nature of volunteer work.

As a preventative measure, you should never allow one person to have complete control over the accounting process. The organization should always know where the books and records are and should keep back-up copies of all records, documentation and tax returns. Further, the organization, even a small one, should have a document retention and destruction policy.

Internal Revenue Code and Regs.

Let’s have a look at the laws that apply and why the IRS can revoke exempt status for failing to keep adequate books and records:

Operational Test

Treasury Regulation 1.501(c)(3)-1(a) provides for the Organizational and operational tests:  In order to be exempt as an organization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt. The organizational test is met by the proper construction of the Articles of Incorporation. The operational test is met by the type of day-to-day activities the organization engages in and the associated items of income and expense. Failure to meet either test negates the exempt status of the organization. TC Memo 1993-116 WL 87864 (U.S. Tax Court).

Requirement to File an Annual Return

IRC 6033(a)(1) and Regulation § 1.6033-2(a)(1) state that except for a few listed exceptions, every organization exempt from taxation under IRC Section 501(a) shall file an annual return, stating specifically the items of gross income, receipts, and disbursements, and such other information for the purpose of carrying out the internal revenue laws…

Mandate to File Form 990

Treasury Regulation § 1.6033-2(a)(2)(i) states that organizations required to file an information return under section 6033 must do so by filing Form 990.

Requirement to Keep Accounting Records

Treasury Regulation 1.6001-1(a) provides that any person subject to income tax, or any person required to file a return of information with respect to income, shall keep such permanent books of account or records as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return of tax or information.

Requirement to Retain Records

Section 1.6001-1(e) of the regulations provides that the books and records shall be retained so long as the contents thereof may become material in the administration of any internal revenue law.

Termination of Exempt Status

In Revenue Ruling 59-95, it was held that failure or inability to file the required information return or otherwise to comply with the provision of section 6033 of the Code and the regulations which implement it, may result in the termination of the exempt status of an organization previously held exempt, on the grounds that the organization has not established that it is observing the conditions required for the continuation of an exempt status.

The exemption from paying Federal Income Tax is a matter of legislative grace–a privilege–rather than a right (Christian Echoes National Ministry 470 F2d 849, 857 (1972).

When the creators control the affairs of the organization there is an obvious opportunity for abuse which necessitates an open and candid disclosure of all facts bearing upon the organization, operations and finances. Where such disclosure is not made, the logical inference is that the facts, if disclosed, would show that the taxpayers fail to meet the requirements of IRC Section 501(c)(3) (Bubbling Well Church of Universal Love v. Commissioner, 74 TC 531, 535 (1980). Afd 670 F2d 104 (9th cir, 1981)).

Procrastination Undermines Penalty Abatement Efforts

One of the most frustrating situations I deal with when writing a penalty abatement request on behalf of a nonprofit organization is that they did not deal with their situation in a timely manner.

Missing the Deadline

A typical scenario goes like this: The Do-Gooder organization misses the May 15th filing deadline for its Form 990. Normally the treasurer handles all the tax filings, and no one else is really involved with or knowledgeable about the Form 990 due dates. Unfortunately, the treasurer resigned three months earlier and a replacement has not yet been found.

Discovering the Error

Because no was aware of the deadline, no extension of time to file was requested. One month later, during the preparation of a grant application, it is discovered that no Form 990 has been filed for the recently completed year. It is then that the organization realizes that it has missed a required filing deadline.

Procrastinating Compounds the Problem

It takes the organization until August to hire a new treasurer, who completes and files the delinquent Form 990 by sometime in October.

Do you see the problem here? The organization discovered in June that it was delinquent but did not correct the delinquency until October–a delay of four months. How do you explain that delay to the IRS? It appears to the IRS that the organization does not really take its filing responsibility serious.

Best Practices

What is the take-away from this scenario?

  • There should be more than one person in the organization who knows and tracks the due dates of Form 990 (and all other tax and legal filings as well). The due dates should be on the calendar of the board of directors. The board should see and review the Form 990 before it is signed and filed.
  • As soon as an organization realizes that it has missed a Form 990 filing deadline, it should prepare and file the Form 990 within 30 days if at all possible.
  • If there is no one in the organization with sufficient knowledge to prepare Form 990, hire a professional. In an attempt to avoid paying $800 to $1,500 to a professional tax return preparer, many organizations end up owing $10,000 or more in late filing penalties.
  • If you know the organization will not meet the initial filing deadline, file Form 8868 before the deadline passes to request a 3 month extension of time to file. Remember, the extension request is not valid if filed after the due date of the return.

Penalties for late filing of Form 990 are steep: $20 for each day the return is late for smaller organizations and $100 per day for larger organizations.  Even at $20 per day, you are looking at $600 per month. A return that is 6 months late can incur as much as $3,600 in late filing penalties at the lower rate.

While the IRS does tend to be more lenient with nonprofit organizations in certain situations, abatement of late filing penalties is far from certain. To make matters worse, the IRS is under a directive from Congress to be a lot tougher on non-compliant exempt organizations.

Late-Filing IRS Penalty Relief for Nonprofits

It happens to lots of nonprofit organizations for various reasons. But failing to file Form 990 on time doesn’t have to end with writing a large check to the IRS.

The filing requirements are clear; A nonprofit organization (with limited exceptions) MUST annually file either Form 990-N, Form 990-EZ, Form 990, or Form 990-PF. Which form it files depends largely on the level of gross receipts and total assets owned.

However, the IRS understands that nonprofits often rely on well-meaning but uninformed volunteers to manage the organization, keep the books and financial records, and perform tax-exempt functions. So it has historically offered a considerable amount of leniency and forbearance to nonprofit organizations that it does not offer to for-profits.

Officers, directors, managers, and professional advisers to non-profit organizations should not be shy about asking the IRS to abate penalties assessed for late filing of the Form 990 series when the organization generally has a good filing history, or if it is a newly formed organization, or has otherwise encountered circumstances beyond its control which resulted in the late filing of a return, even when multiple years may be involved.

While it does appear that the IRS may be taking a harder line on non-compliant nonprofits now than it has in the past, it is still likely that for two years or less of non-compliance, a nonprofit stands a very good chance of receiving abatement of late filing penalties if it can convince the IRS that it had reasonable cause for being late.

The IRS code and regulations as well as the IRS website and other published guidance has some helpful guidance on what it considers reasonable cause and what has to be shown to demonstrate that reasonable cause exists.

Writing a reasonable cause penalty abatement request letter to the IRS is not difficult. But in order to be successful you need to structure your argument properly, include all relevant facts and circumstances, and anticipate all the questions that the IRS might ask concerning why the organization was late.

Unless you are familiar with the code’s reasonable cause provisions, you should probably get some professional help.

Learn how to write a reasonable cause penalty abatement request for tax-exempt organizations that have been assessed late filing penalties for Form 990.

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