How to Read a Not-For-Profit Tax Return (Even if you are not a tax professional) Part I

According to the Internal Revenue Service, there are approximately 1.5 million public charities and private foundations in the US. That’s a lot of good work being done! Public charities depend on donations from the general public to carry out their missions. With 1.5 million organizations to choose from, how do you decide which you want to support? In making that decision, here are some questions you want to know the answers to:

• What the charity does,
• who is in charge,
• how much money it takes in,
• how much money the organization spends on carrying out its exempt purposes, and
• how much money it spends on administration and management activities.

Nonprofits are required to file tax returns (technically called “information returns”) every year and filing organizations are required to make copies of these returns available to the public on request. The returns may look complicated and intimidating, but you can answer all the questions we posed above by looking at an organization’s tax return. This article will tell you how to do just that.

Where to find copies of an organization’s Form 990

1. Ask the organization for a copy –Nonprofits are required to provide copies of their Form 990 to the public when asked. Some organizations provide the form on their website.
2. IRS website - Tax Exempt Organization Search | Internal Revenue Service allows you to search for a charity by name or by employer identification number (EIN).
3. Nonprofit databases such as GuideStar have copies of many organizations’ 990s free of charge.

Types of nonprofit tax returns

There are three different information return forms public charities might complete each year and one that private foundations must prepare. The form a nonprofit will file depends on the section of the Internal Revenue Code the tax exemption is granted under and the charity’s annual income. The three public charity forms include:

1. Form 990 is filed by public charities with gross receipts (income not decreased by expenses) of $200,000 or more per year or have total assets of $500,000 or more. Although large nonprofits must file this form, smaller nonprofits can file it if they choose to. This is a 12-page form with 16 different sub-schedules. We will look at the income and expense sections of the main form here. In Part II we will look at the governance sections, financial statements, and two of the most commonly use sub-schedules.
2. Form 990-EZ, a four-page form, is filed by public charities with gross receipts between $50,000 and $200,000 and that have assets of less than $500,000. In general, Form 990-EZ provides much less detail than Form 990 does, but you can still get a good idea of how the charity functions by looking at the shorter form. We will discuss 990-EZ in Part III.
3. Form 990-N is an online “postcard” tax return filed by organizations with less than $50,000 in annual gross receipts. The 990-N provides very little information other than that the charity is small and is in operation.

Form 990-PF is filed by private foundations of all sizes and will not be considered in this article.

990, Page One   

Click this link to see a blank Form 990:   www.irs.gov/pub/irs-pdf/f990.pdf

The Heading section of page one contains the name, address, and other information about the nonprofit. Look at:

1. Item L, year of formation, tells you how long the nonprofit has been doing business, giving you information about how stable and well established it is. Of course there are deserving charities that are new, but understanding their prospects for long-term operations will be limited and is something you should consider.
2. Item I, tax-exempt status, tells you the type of organization filing the return. If the status is other than 501(c)(3), you cannot deduct contributions to the organization on your personal tax return.

After the heading section is the Part I Summary. This section provides a quick overview of the organization’s activities and governance, revenue, expenses, and total assets and liabilities at the end of the tax year. Each of these sections has corresponding pages in the tax return that provide detail for the information summarized in Part I. We’ll reference these pages as we step through each section of the summary.

The page one Activities & Governance section gives information about the organization’s overall mission and the number of people making it happen. Line 1 in this section gives a brief description of the organization’s mission. Details for this line can be found on page 2 of the return where the organization provides a narrative description of their mission and main programs. Additionally, because the space on page one is limited, some organizations provide more information on the organization’s mission on Schedule O, so you may need to dig into the schedules to find it. The schedules are in alphabetical order after the main form.

Also look at lines 3 and 4 for information about the size of the governing board and how many board members are considered independent. A board member is independent if they aren’t compensated as an officer or employee of the organization and don’t have significant business transactions with the organization. They can receive “reasonable compensation” for their service as a member of the board and still be considered independent. Generally, the majority of the board members should be independent to ensure board decisions are objective, avoid conflicts of interest, and maintain public trust. Page 6, Section A of Form 990 provides additional general information about how the board governs itself, and Page 7 lists the names, positions, and compensation of each board member.

The page one Revenue section summary gives the total revenue the organization earned during the year and more importantly, what activities generated their income. Contributions and grants are the amounts individual donors or governments give to the organization. Program service revenue is derived from the sale of goods or services directly related to the organization’s mission. Investment income includes interest and dividends earned on invested assets. Some investment income indicates that the organization is careful with its assets. If investment income exceeds other types of income, you will want to consider how the organization uses its assets. Are they using the assets to accomplish their mission or are they hoarding cash and investments?

Page 9 of Form 990, Part VIII, Statement of Revenue, provides details about the organization’s income. It provides information on how much of the income was from sources or activities related to the mission and how much was from unrelated activity. For example, suppose an orchestra sells advertising space in their concert program. The orchestra’s mission is to bring music to the general public, not to sell advertising. Therefore, the advertising revenue is considered “unrelated business revenue.” In general, nonprofits will pay tax on unrelated business income, but not on their related income.

The Part I Summary Expenses section shows a summary of the various kinds of expenses the organization has. These expenses are shown in greater detail on page 10, Part IX, Statement of Functional Expenses. Most large charities are required to partition expenses among program service (their purpose for existing), management and general, and fundraising expenses. Look at the compensation amounts on page 10, lines 5 and 6 to see what percentage of income goes to paying salaries and wages compared to how much goes to the charity’s programs. You would expect charities that primarily provide some kind of service to use a larger percentage of their income paying salaries, so check to see if the wage and salary expense seems to align with the charity’s work.

Compare the amount of program service expenses to management and general expenses on page 10. Keep in mind that charities must spend some funds on managing and running their business. A well-managed charity can have up to 35 percent of its total expense allocated to management and general expenses. More than that amount should make us question how the charity is managed and how committed management is to the charity’s exempt purpose. Less than 15 percent of total expense in the  management and general column indicates that the managers are “starving” the charity and hampering its long-term prospects for success. Likewise, you expect to see some fundraising expenses, but a disproportionate amount spent on these activities can be a warning sign.

The last block of information in the Summary section of page one gives the total assets and total liabilities of the organization. Assets include anything the organization owns or controls that has a measurable value and is expected to provide future economic benefits, such as cash, buildings, and equipment. Liabilities are any debts the organization owes. Net assets represents the difference between what a company owns (assets) and what it owes (liabilities). Generally (but not always), we worry about how an organization is being managed when the liabilities are larger than the assets.

Page one, Part II, Signature Block, contains the signatures of an authorized officer of the organization and the signature of the person paid to prepare the return. If you don’t see a paid preparer listed, it can mean that the board has exceptional talent and experience with preparing nonprofit tax returns. It can also mean that the organization is cutting corners and is trying to manage without professional guidance.

We’ve finished our examination of page one of Form 990 and have now answered all the questions we posed about what we want to know when deciding what charity to give our support to.

In Part II of this article, written for the truly brave, we will look at the more technical information found in Form 990. In the meantime, please let us know if you have questions or would like some help with your own nonprofit. R&A loves nonprofit organizations, and we have many professionals in tax and assurance that have a great deal of knowledge to share.