Form 990: What the Watchdogs are Watching

March 26, 2014

Several years have passed since the IRS revamped Form 990, Return of Organization Exempt From Income Tax, to its current lengthy core form, which also often needs numerous additional schedules.

Nonprofit entities and tax preparers seem to be getting a handle on the new form, introduced for the 2008 tax year, despite annual IRS modifications and clarifications. They are also becoming more comfortable with the document being publicly available, both upon request from the organization and published on the websites of various “watchdog” groups. The detail required by the revamped form, along with increased availability, has placed greater emphasis on completing the Form 990 properly and understanding what the Form 990 says about an organization – to the IRS, state regulatory agencies, watchdog groups and the general public.

While there has always been the potential for the IRS to examine these returns, the revamped form contains much more detailed information about an organization’s activities, policies and procedures, which may lead to more focused inquiries by the IRS. Many state regulatory agencies are also examining the Forms 990 in connection with charitable solicitation registrations. Additionally, watchdog agencies are reviewing Forms 990 so they can rate charities – and these rating reports are gaining popularity with donors and grant-making foundations alike.

Finally, because of the relative ease of accessing an organization’s Form 990, donors and the media are also looking at the forms. Accordingly, nonprofits and their advisers may want to take a second look at their Forms 990 to make sure they are presenting the information in as favorable a light as possible.

As for the watchdog groups, there are a variety of them and most make their reports available on their websites. These sites often have in-depth search capabilities. Some of the more popular groups include Charity Watch, Charity Navigator, Guidestar and JustGive.

Charity Navigator’s stated mission is “to advance a more efficient and responsive philanthropic marketplace.” They do so by evaluating the “Financial Health” and “Accountability & Transparency” of more than 7,000 of America’s charities. Charity Watch is a “charity rating and evaluation service dedicated to helping donors make informed giving decisions.”

Traffic to these sites is on the rise, and they often experience large spikes during times of philanthropic crises, such as natural disasters. The rating of a nonprofit could influence a potential donor’s decision to contribute to that particular nonprofit.

Being aware of the rating criteria employed by these watchdog groups may help favorably improve a nonprofit’s overall ratings and increase the likelihood of potential donors making contributions to the organization.

What are some of the criteria watchdog groups use in their evaluations of charities? Most relate to financial health, transparency or governance, and much of the information is derived from an organization’s Form 990 filings. Obviously, accurate financial statements and reporting are important for financial health metrics.

Watchdog groups are also looking at revenue and expense growth from year to year, working capital ratios, and years of available assets. In addition, one of the most significant financial metrics is the percentages of expenses allocated to the programmatic, administration and fundraising functions. Nonprofit organizations should carefully review their methodologies for allocating these functional expenses and make sure they are accurate and reasonable.

Nonprofits may have a greater opportunity to improve watchdog ratings of their organization under the transparency and governance metrics. Part VI of Form 990 has a series of governance questions that must be answered either “yes” or “no.” For most of these questions, ”yes” answers are a sign of “good governance” and will reflect positively in the ratings. These questions and other questions through the core form cover such governance areas as:

• Conflict of interest policy, which is renewed annually
• Whistle-blower policy
• Record retention and destruction policy
• Donor privacy policy
• Documentation of board and board committee minutes
• Provision of Form 990 to the governing body in advance of filing
• Audit of financial statements and establishment of an audit oversight committee
• Process for reviewing Form 990

Accordingly, for both effective board oversight and improving an organization’s rating, it is important to implement those policies and procedures that result in affirmative answers to these questions.

A nonprofit should also review its Form 990 to ensure that required salary disclosures are provided. The salaries of the organization’s chief executive and top financial person are required to be disclosed, regardless of the amount. Therefore, a reliable process for determining the top management officials’ and other key officers’ salaries is very important.

In addition to Form 990, watchdogs are reviewing nonprofits’ websites for transparency. Best practices include current listings of board members and key staff, published audited financial statements and Form 990, and a donor privacy policy disclosure. Including these items on the nonprofit’s website could help improve its scoring for transparency metrics with little additional effort from the nonprofit.

In summary, nonprofit organizations should be highly cognizant of charity watchdog groups and their rating criteria. The most important first step for a nonprofit should be to review its current ratings from the watchdog agencies. If the scores are high, take advantage and publicize them. If they are low, determine what areas are contributing to these low ratings and take steps, where possible, to improve on these metrics.