Tax Questionnaire Season for Calendar Year Not-for-Profit Boards

Posted on Mar 27, 2018 in Not-for-Profit Boards

Not-for-profit boards have three fiduciary duties: the duty of 1) care, 2) loyalty and 3) obedience. Part of the duty of obedience is the duty to comply with tax laws. Federal tax law requires boards to annually prepare and file an accurate Form 990 for their organizations. As part of the preparation process, exempt organizations must exercise reasonable efforts to obtain from specific individuals information required to be disclosed on the 990. Some of this information is not readily available to the organization unless it simply queries the individuals. Three areas of the Form 990 where the instructions suggest that reasonable efforts include using a questionnaire are:

I. Part VI, Line 2 – Requesting information of those charged with management of the organization and listed on Part VII of the Form 990, whether they have either a family or business relationship with others on the same list. The intention of the inquiry is uncovering a lack of diversity in the management of the organization;

II. Part VII – Requesting information from those in charge of management of the organization and listed on Part VII of the Form 990, whether their family members and controlled businesses receive compensation from a related organization listed on Schedule R or in some cases unrelated organizations for services rendered to the reporting organization; and

III. Part L – Requesting information as to whether those in charge of management of the organization, including some additional individuals (including founders or creators, grant award committee members, and substantial contributors, all of these individuals’ family members or controlled businesses and in some cases their employees), are involved in lending transactions outstanding on the last day of the tax year, are recipients of charitable benefits, or are involved in certain business transactions over the filing thresholds with the reporting organization.

The instructions to the Form 990 state that an example of reasonable efforts includes distributing an annual questionnaire to the individuals from whom the organization must obtain the necessary information. However, to meet the reasonable efforts standard, the questionnaire must provide definitions and sufficient instruction so the individuals can provide the organization with the information needed to make the Form 990 disclosures.

This sounds simple. However, when organizations look into the details, it can quickly become complicated. This is why Clark Nuber partnered with Eve Borenstein to develop an on-line reasonable efforts questionnaire tool (the CN/EB questionnaire). The questionnaire tool is available to our clients for a flat fee of $35 and to others for $325. Upon request, we occasionally review a questionnaire an organization has developed for themselves. However, each questionnaire requires us to review for all of the required elements and thus, such a review is more costly than purchasing the already developed tool. An added benefit of the CN/EB questionnaire is it is cloud-based, and meets the reasonable efforts standards of the IRS. The CN/EB questionnaire assists you in:

Discerning of which individuals the organization must make inquiries;
Determining how much information is required to collect and disclose on the return; and
Whether the organization even has the type of transaction which might be covered.

To be clear, the instructions only state that each organization must exercise reasonable efforts. In order to make an assessment of what is reasonable, the organization, at a minimum, must understand of whom it should make inquiries for each year. This is undertaken by:

Completing Part VII of the Form 990 and identifying the individuals required to be listed, by category;
Determining if there were any potentially reportable loans outstanding on the last day of the year;
Determining if the organization is a grantmaking organization and if so, who is on the grant review and awards committee;
Determining if there were any business transactions over the dollar thresholds requiring inquiry for Schedule L, Part IV; and
Completing Schedule B and identifying all substantial contributors for the year.

Area I) and II) inquiries are required of all individuals on Part VII of the Form 990 each year. To do this efficiently, the organization must provide the individuals with the list of the other Part VII individuals, all related organizations (if there are any), and definitions of what is a “family member” and a “business transaction.” The organization must also provide the criteria for when compensation from an unrelated organization must be disclosed on the reporting organization’s Form 990. It is unusual, but it happens. These initial inquiries are usually fairly straightforward and do not cause too much trouble.

Area III) inquiry is where organizations may struggle with deciding of whom to make inquiries, what to inquire about and how to make the inquiries simple and non-intrusive; in short, how to put the “reasonable” in reasonable efforts. Organizations need to determine if an inquiry is even needed to complete required disclosures for preparation of Schedule L, Transactions with Interested Persons. Often the organization already has the information.

Schedule L has four parts. Parts II – IV are about sunlight and transparency, disclosing certain transactions with interested persons such as loans, grants and assistance, and business transactions. There is nothing necessarily improper about a transaction reported on any of these parts. However, because many of the interested persons for Parts II through IV are also disqualified persons for Part I, Excess Benefit Transactions, it must be determined if the transaction violates the prohibition on excess business transactions and therefore is to be reported on Part I of Schedule L, instead of Parts II – IV.

Loans – Were there any loans outstanding with interested persons on the last day of the year? Loans include salary advances, certain split-dollar life insurance arrangements, and other advances and receivables. There are exceptions. For example, pledges receivable, accrued compensation, and receivables created in the ordinary course of operations and under the same terms as offered to the general public, are not the sort of debts requiring disclosure. Most organizations know with whom they have debt arrangements. Part II of Schedule L often does not require any type of external inquiry as the reporting organization already has the information.

Assistance – Does the organization provide grants or assistance? If so, there is likely a need to distribute a questionnaire to the interested persons because it is hard to know about all of the connections. People to include are:

Current and former (within the last 5 years) officers, directors, trustees and key employees,
Organizational creator or founder,
Substantial contributors listed on Schedule B (see below),
Members of the organization’s grant selection committee,
Family members of those listed above,
A 35% controlled entity of one or more individuals and/or organizations described above.

The definition of substantial contributors in this case reaches beyond the individual to include the substantial contributor’s family members, employees and their children, entities owned more than 35% by such persons or employees, and children of employees of more than 35% controlled entities. Employees or their children are only included if they received the grant or assistance by the direction or advice of, or under a program funded by, the substantial contributor or by the direction or advice of the controlled entity.

Business Transactions – The last and broadest category of transaction has two primary dollar thresholds. If the organization has no single transaction over the greater of $10,000 or 1% of the organization’s total revenue for the tax year with a single vendor, or a group of transactions totaling more than $100,000 for the year with a single vendor, no additional inquiry is required as there is no Schedule L, Part IV reportable transaction. However, if the organization has many transactions exceeding these limits, it may use the questionnaire and limit the inquiry only to the relevant parts of Schedule L transactions. If there are only a few transactions meeting the reporting dollar thresholds, reasonable efforts may constitute documenting these few transactions and including the known vendors and their relationship with the organization or interested person. With large publicly traded businesses that have no relationship to an interested person of the reporting organization, no additional reasonable efforts are required.

What is sometimes an effective alternative to a reasonable efforts questionnaire?

Substantial Contributor Inquiries –Organizations with multiple potential transactions exceeding the reporting dollar thresholds of Schedule L – Part IV, or substantial contributors on Schedule B, and no way of knowing if a substantial contributor, their family member or 35% controlled business is a potential reportable vendor of an identified business transaction, must exercise reasonable efforts in their inquiry. The questionnaire discussed in the Form 990 instructions is only illustrative. A more effective inquiry for substantial contributors may be a negative confirmation letter. Clark Nuber has a sample letter available on its website. The letter identifies the addressee as a substantial contributor, explains the purpose of the letter, provides definitions of reportable transactions, family and 35% controlled businesses, and requests the substantial contributor contact a named individual at in a specified manner by a deadline if they know of a transaction requiring disclosure. If there is nothing to disclose, no action is required. The letter closes by thanking the donor for helping the organization to be a fully compliant tax exempt organization. Negative confirmation letters are well received by donors. Donors have asked why some organizations they would expect to hear from have not sent similar letters. One logical answer is the organization may not have transactions meeting the reporting dollar threshold.

Reasonable efforts for the first two areas is most easily accomplished with a simple questionnaire such as the one Clark Nuber has developed. The reasonable efforts for Schedule L, Area III, is best performed based upon the individual facts and circumstances of the reporting organization. Above all, the efforts should be customized, reasonable for the individual reporting organization, and well documented. Undertaking reasonable efforts to obtain information for completing the Form 990 is the responsibility of management. However, it is the fulfillment of the duty of obedience for the board members to answer completely and timely and to ensure all employees who are required to answer do so as well.

If you have questions, or would like assistance determining what is reasonable for your organization, please contact your Clark Nuber tax team members. Visit the Clark Nuber website to find our Reasonable Efforts Questionnaire.

This article or blog contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.