Watching the story develop, it was interesting how quickly attention turned to how the IRS should
have done more to stop the misdeeds of the scofflaws and how the Form 990 should
have uncovered these transgressions. It is important to understand the purpose of the Form 990 and everyone’s role in producing the Form 990.
What is the Role of the Form 990?
The Form 990 has three goals:
- Transparency – A reasonably informed reader should be able to get a clear picture of the financial and operational workings of the organization.
- Accountability – The Form 990 disclosures around governance and transactions with insiders and related organizations are designed to hold those charged with governance accountable.
- Compliance – If the organization knows it must file the Form 990 each year, in alignment with the first two goals, the theory is its governance practices and the organization as a whole will be more compliant with federal and state tax exempt and nonprofit laws.
What is the Role of the IRS?
The U.S. income tax system relies on the “voluntary compliance” of taxpayers. That means each taxpayer is expected to prepare and file tax returns that are honest and accurate, without burdensome government involvement. This holds true for all tax returns filed with the IRS, including the Form 990. Thus, the goals described above cannot be accomplished without voluntary cooperation of the public and individual taxpayers.
The role of the IRS is education and enforcement with the ultimate goal of collecting revenues from taxpayers voluntarily complying with tax laws passed by Congress. The tax exempt sector is an ever expanding portion of the overall part of the U.S. Treasury’s workload. In 2019, the IRS reported the 2017 data on exempt organizations. There are nearly 1.8 million tax exempt organizations in total. This includes all types of organizations, including the National Football League, which is not charitable but is tax-exempt nonetheless. The one-year increase in the number of organizations identified as charities exempt under 501(c)(3) alone in 2017 grew from 1,237,094 to 1,286,181. Providing oversight is a big task which depends upon voluntary compliance.
What Does This Say About KWF and its Managers?
Perhaps the most important lesson for those following this story may be gleaned from comparing what has been reported in the news with the information KWF’s management reported on the Form 990. There are several instances where the information reported by KWF on its Form 990 appears to possibly deviate from the news reports. The FBI and IRS have alleged the founder of KWF committed a fraud which, if true, would support a conclusion that KWF provided inaccurate information on its Form 990. In particular, this case provides a good example of three areas of disclosure in the Form 990 that should not be overlooked by tax-exempt organizations and tax preparers.
Transparency in Leadership
Independence of leadership is an important question to address when interviewing any potential new nonprofit client. Any pushback or equivocation on this topic is a sign the nonprofit may not be a suitable client. In 2014, Schedule L, Parts II, III, and IV expanded the requirements for disclosing loans, assistance, and certain business transactions with a founder/creator. There is no definition of founder/creator in the Form 990 instructions. However, if a prospective client finds the question challenging to answer, this may be a sign they are not excited about the three goals of the Form 990. (See above.) If the charity has a business transaction with a founder or creator, there is likely a need for transparency.
Rick Singer, who was at the center of the controversy, owns a for-profit company, The Edge College & Career Network, LLC., also known as The Key. KWF reported no business transactions between itself and The Key on its Form 990. KWF also disclosed no financial transactions with any board member except a $200 loan to Mr. Singer. Finally, KWF disclosed no board member as independent on the 2013 through 2015 Forms 990 with no explanation on Schedule O, while the 2016 return reported all board members as independent. It is unknown whether the information reported on the Form 990 was accurate or not. However, such disclosures are critical for meeting the goal of transparency and for IRS enforcement.
Transparency with Substantial Donors
This is another Schedule L sunlight disclosure. Any transaction between KWF and a contributor listed on the organization’s current Schedule B, List of Donors who contributed more than $5,000 (or in some cases more than 2% of total support), which is involved in a loan, assistance, or business transaction reportable on Schedule L, will generate a Schedule L reporting requirement.
The news accounts indicate there may have been some financial transactions with parents who should have been reported on Schedule L as “substantial contributors.” Because Schedule B Donor Information is only provided to the IRS and not open to public disclosure by public charities, it is impossible to determine if the relationships and transactions are fully disclosed on the Form 990. However, for any organization filing a Form 990, this is an area for self-reflection and an often-missed disclosure.
Transparency in Revenue and Fundraising
This last issue has been ongoing in the exempt sector for years and at one time generated compliance check letters from the IRS. Does the organization have significant contributed revenue reported on Part VIII, line 1 but little or no expenses on either Part VIII, line 8 (special events) or Part IX, column D (fundraising expenses)? If so, it is possible there is a logical explanation. The organization may have board members or others who conduct all fundraising activities on a volunteer basis. The organization may be a research organization and the fundraising activities are a recoverable cost under general and administrative grant recovery costs included in Column (C) or (B), direct program costs. Alternatively, the organization may be part of a group of related organizations and one organization provides fundraising services for the organizations in the group. If there is a legitimate reason for having no fundraising expenses while garnering virtually all revenue from contributions, the organization may check the box at the top of Part IX, Statement of Functional Expenses, and explain Schedule O. Again, this is not a required disclosure, but it would help meet the goal of transparency.
In each of the four years of KWF returns from 2013 – 2016, this is a visible issue. The organization shows $451K, $900K, $1.977M, and $3.736M in contributions between 2013 and 2016, with no fundraising expense reported. There is no supplemental explanation on the return so there is no way for a casual reader to know if there is a logical explanation.
The Role of the Practitioners in Oversight
To be clear, the IRS did not uncover the circumstances that have been reported in the news. Rather, the FBI uncovered the alleged fraud after conducting a thorough investigation. The tax preparer likely provided KWF management with an organizer and prepared a straight-forward return based upon those responses. The three issues above are a good starting point and should be addressed in the “reasonable efforts” questions the organization asks of those charged with management to ensure full disclosure on the Form 990.
According to news reports, Mr. Singer transferred part of his scheme to the nonprofit and what was once a pay-to-play through his company became a faux charitable contribution scheme to a nonprofit –and tax fraud. The allegations state the charity was issuing donor acknowledgment letters to parents stating no goods or services were provided in exchange for the contributions paid for the services Mr. Singer was providing. In addition, KWF was reporting no fundraising costs, zero in special events expenses, and offering no explanation of this apparent disconnect between the millions raised and the lack of expenses to garner this amount of revenue. This may simply be because Mr. Singer was providing these services as a volunteer to KWF. However, the FBI and the IRS appear to cast a different light on these transactions. The news reports and the Form 990 do not factually line up. But given Mr. Singer’s apparent unwillingness to be truthful and transparent in other areas, it is unsurprising the Form 990 is not completely in alignment with the later disclosed allegations.
What is the Future of the Form 990?
The function of the Form 990 is unchanged. It is still the most comprehensive and publicly available document tax exempt organizations produce each year. It is uniform and comparable between all organizations across the sector. It should be of little surprise a case such as KWF would occur, where some people formed a nonprofit and used it for non-exempt purposes, or that it existed for four years. If news reports are correct, the facts were not transparently reported on the Form 990, which was the responsibility of KWF’s management in a system of voluntary compliance.
Transparency, accountability, and compliance are still the hallmarks of a well-prepared Form 990. For donors and charities benchmarking performance with their peers, an accurate and well-prepared return compliant with the law and instructions is an invaluable source of data. We should continue to strive for a compliant, self-regulated, transparent, and accountable sector. We must not let a few bad actors tarnish the faith and trust in the entire sector.
© Clark Nuber PS, 2019. All Rights Reserved