An Introduction to Analyzing the IRS Form 990-EZ
The following text was written to aid those seeking to better understand the significance of information provided by the U.S. Internal Revenue Service's Form 990-EZ ("Short Form Return of Organization Exempt From Income Tax"), and to use that tax return form to help decipher the operations of tax-exempt organizations. It is directed toward the non-specialist wishing to analyze the tax return of a tax-exempt organization that submits this form annually. This is not a set of instructions for completing the Form 990-EZ. The author is neither an accountant nor lawyer, although this text was reviewed for accuracy and relevence by several accountants with tax-exempt organization experience. HOWEVER, NOTHING IN THIS TEXT SHOULD BE CONSTRUED AS LEGAL OR FINANCIAL ADVICE.
This text does not provide a complete list of items that must be evaluated to determine if a tax-exempt organization is fulfilling its charitable mission both efficiently and effectively. It only points out some items, almost entirely related to financial issues, that can be determined in at least an approximate fashion from a Form 990-EZ. Additional information can be obtained from the Form 990 Schedule A, which all 501(c)(3) organizations are also required to submit and to make publicly available. Further information can usually be obtained from an organization's annual report.
In some parts of this text, ratios and percentages may be used to illustrate typical values in order to aid the reader in identifying signs of unusual activity. However, such ratios and percentages are simply used to indicate when further investigation of the underlying source of the numbers must be performed, in order to understand their associated context. Such investigation often must go beyond the information provided in the Form 990-EZ or associated material. The IRS itself primarily uses tax returns to monitor for problems, and commonly asks for further explanation when appropriate. GuideStar has available a nice discussion of the use of ratios, along with a list of recommended representative calculations.
Finally, no tax-exempt organization should be evaluated strictly on the basis of its finances. Being fiscally sound and yet not at all fulfilling one's mission is failure. However, few organizations can successfully fulfill their mission without being fiscally sound. Furthermore, fiscal responsibility requires following certain legal and generally accepted professional principles and standards, but these standards may not always correspond to those held by the community served by the tax-exempt organization. The higher standards must be obeyed if a tax-exempt organization is to prosper.
This text was prepared based on the 1997 IRS Form 990-EZ and associated tax code. It may not be completely accurate for later versions.
Examine Part 1, Lines 1 through 8, and note which numbers are a significant portion of the total given in Line 9. Common activities include donations and grants (Line 1), program services performed for a fee or other charge that support the charitable mission (Line 2), membership dues (Line 3), and sales of inventory (line 7c). Sales of inventory includes items such as thrift store sales, and sales of fundraising merchandise that has significant value (versus that of very minor worth given as donation "rewards"). Note that although grants and donations are lumped together, they can imply very different activities for the organization, since grants are typically given to carry out specific activities that further the granting agency's mission. Further research, outside the Form 990-EZ, is required to distinguish between these two sources of revenue. Although the organization is required to provide an attachment listing the "major" contributors to the Line 1 sum, it is not required to release this information to the public, in order to protect donors who wish to remain anonymous.
Less common sources of revenue, which may nevertheless be significant, are investments (Line 4), sales of assets other than inventory (Line 5c), special events and activities (Line 6c), and any otherwise uncategorized revenue (Line 8). "Assets other than inventory" includes items such as buildings and office furniture, which aren't regularly sold as merchandise. "Special events and activities" is a somewhat complicated category, since some "events" are regularly carried out and serve the organization's mission (rather than simply being for fundraising) and therefore may be reported under program services (Line 2). Understanding the significance of special events revenue always requires more explanation, which is required as a publicly accessible attachment to the Form 990-EZ that provides details about the amount given on Line 6c.
Current tax-exempt organization accounting practice separates spending into three classes: 1) program services, which are activities that directly achieve or promote the organization's charitable mission, 2) fundraising, which is money spent in efforts to attract or process donations and grants, and 3) operations, which includes staff salaries, office maintenance, and other expenses that are incurred even in the absence of charitable activities. This is the broadest set of categories for "functional" expenses, as opposed to "object" expense categories (e.g. salaries or rent, summed without regard to the underlying function performed). The relative efficiency of tax-exempt organizations is often determined by comparing the proportion of total expenses that is spent on program services (which should be high), and the proportion spent on fundraising (which should be low), to those for other similar organizations.
Note that effectiveness is probably a more important measure of success than efficiency for a tax-exempt organization. Efficiency is reflected by how much of the organization's income goes to activities that directly achieve its mission, versus to only supporting activities. Effectiveness is primarily a function of how well the activities that the organization selects to achieve its mission actually succeed in doing so. Nevertheless, given two organizations with similar effectiveness, the one that is more efficient will better achieve its mission.
Part I, Lines 10 through 16, of the Form 990-EZ reports expenses by object, not function. Accordingly, the listing here does not generally tell you if the organization is spending its money in a manner that promotes its mission. However, program services expenses for the current year are identified (on Line 32, as discussed below), so the fraction of total expenses devoted to program service can be determined. There is no segregation given of fundraising from operations expenses if an organization files Form 990-EZ. This is significantly different from the full Form 990 (not EZ), where the year's expenses are segregated by function (program services, operations or fundraising) as well as by object. What many consider a key value, the amount spent specifically on fundraising, cannot be determined from the tax returns for an organization filing Form 990-EZ.
The Form 990-EZ does allow you to recognize an organization that primarily distributes funds to others who then perform activities that promote the organization's mission (i.e. gives grants), since such expenses are reported on Line 10. Also, organizations that primarily exist to serve their members, will have significant expenses reported on Line 11.
Part II of Form 990-EZ describes the organization's major activities and the total expenses for each. Here is where you can determine the proportion of its revenue that the organization spends on activities that directly promote its mission (i.e. program services), as well as identify the activities themselves. Be sure to note Line 32 ("Total program service expenses") as a percentage of Line 17 ("Total expenses"). This indicates the fraction of total expenses that was spent on programs that directly achieve or promote the organization's charitable mission, rather than on fundraising or operations activities.
The Council of Better Business Bureaus "Standards for Charitable Solicitations" states, "Reasonable use of funds requires that, a) at least 50% of total income from all sources be spent on programs and activities directly related to the organization's purposes; b) at least 50% of public contributions be spent on the programs and activities described in solicitations, in accordance with donor expectations; c) fund raising costs not exceed 35% of related contributions; and d) total fund raising and administrative costs not exceed 50% of total income."
Line 27 of the Form 990-EZ shows the balance of assets over liabilities, which is referred to as the "balance of funds" or "net assets." Although tax-exempt organizations are not allowed to function primarily for earning a profit, they must accumulate sufficient resources to carry on operations in the face of routine fluctuations in revenue. For this reason, all tax-exempt organizations should show a positive balance of funds. The size of this balance is generally proportional to the total expenses (around 3-4 month's worth, or 30%, is common), but may be larger for organizations that face a significant delay between when they typically incur expenses and when they receive income that will cover those expenses.
Also, organizations that perform disaster relief or other intermittent services will typically accumulate a much larger fund balance than average, in order to have sufficient reserves to pay for such activities when they occur. Furthermore, organizations that have large endowments (recognizable by their significant investment income, Line 4) will often show a particularly large balance of funds compared to unendowed organizations.
The National Charities Information Bureau (NCIB), "Standards in Philanthropy" states that the organization should "have net assets available for use in the following fiscal year not usually more than twice the current year's expenses or twice the next year's budget, whichever is higher."
Note the balance of Line 22 ("Cash, savings, and investments ") over Line 26 ("Total liabilities") on the Form 990-EZ. A healthy organization will almost always have sufficient cash on hand to pay its current bills and other short-term liabilities. Note that long-term liabilities, such as morgages, must be subtracted from Line 26 to determine the short-term liabilities. Organizations that submit the Form 990-EZ generally will not have major long-term liabilities besides morgages. In some cases, a large non-morgage liability may be justifiably offset with the value of land, buildings, or other assets (Lines 23-25), but comprehension of such cases always required further research beyond the tax return.
Part IV ("List of Officers, Directors, Trustees, and Key Employees") of the Form 990-EZ lists both the members of the organization's Board and any "key employees," and also shows if they received salaries or other compensation from the organization.
First, note that Officers, Directors, and Trustees (i.e. Board members) are not generally compensated in tax-exempt organizations, other than the chief executive in charge of day-to-day operations, who may be called the Director, Chief Executive Officer (CEO), or some other title. The Board represents the community whom the tax-exempt organization serves, usually the general public. Accordingly, to avoid any conflict of interest Board members are usually paid only to reimburse them for expenses incurred in attending meetings. However, it is not at all unusual for Board members in smaller organization to also participate in some staff functions (i.e. a "working board"), and therefore some Board members may receive compensation for this activity. Organizations are typically proscribed from paying their Board members for their duties as Board members, but not for other tasks they may perform. Generally, significant compensation to Board members for performing staff activities is not encouraged, as it weakens the Board's ability to function as an impartial representative of the general public. This becomes more critical as the organization grows. In particular, the Board's Chair (sometimes called President) and Treasurer are often singled out as being in sensitive positions with powerful roles in providing oversight and protecting the public interest.
Part IV also lists the salaries of "key employees," who are defined as those having powers similar to that of Officers, Directors, and Trustees. Note that Form 990 Schedule A provides further information on compensation, requiring the names and amounts paid to the top five staff members receiving $50,000 or more annually. Those names may include some key employees listed also in the Form 990-EZ.
The primary determinant of salary for key employees is not how much they deserve given their tasks. Instead, the critical value is how much people performing similar duties at other organizations are getting paid, since this determines the ability of the organization to attract competent staff. Although some skilled people are willing to serve an organization for less than they might earn elsewhere, they are rare, and an organization that pays significantly less than others will not typically attract the most talented people. However, skilled staff members that work for tax-exempt organizations usually do not expect to be paid as much as their counterparts at commercial businesses. Part of their "compensation" comes from serving the public good. The extent to which this is valued varies greatly. Nevertheless, tax-exempt organizations do compete for skilled staff members with commercial businesses, and offering salaries dramatically below what such workers can find elsewhere can hurt the organization's ability to fulfill its mission.
Accordingly, the only way to determine if a salary is reasonable is to compare it with the salary of people with similar responsibilities at other tax-exempt organizations of comparable size (usually measured by total revenue). The particular mission and operation of the organization, and geographical location, can also have an impact, providing a basis for significant differences between types of tax-exempt organization. To provide an idea of the amount of normal variation you may find, some median salaries for the top executive officer in different classes of nonprofit organizations are given in the table below. The data is from a 1997 survey by Towers Perrin of 376 nonprofit organizations. The number of organization in a given class is shown in parenthesis.
By Organization Type Trade Associations (81) $ 200,000 Educational Organizations (78) $ 142,600 Health & Social Welfare Organizations (48) $ 141,200 By Organization Budget Less than $1,000,000 (16) $ 78,500 $ 2,000,000 - $ 4,900,000 (73) $ 116,300 $ 10,000,000 - $ 19,900,000 (66) $ 180,000 More than $ 49,000,000 (41) $ 238,900 By Range of Survey Results Lowest reported $ 48,000 25%-ile $ 116,400 Mean $ 190,600 Median $ 165,000 75%-ile $ 226,300 Highest reported $ 716,500
Part V of the Form 990-EZ presents various questions and places for entering dollar amounts associated with unusual or special activities that the IRS considers in evaluating an organization's ongoing tax-exempt status. These include expenses for political activism such as influencing legislation (i.e. lobbying), in which tax-exempt organization may participate only in restricted ways. Most of the items are described clearly on the form itself, but there are a few items referred to only by tax code number, and these are described briefly below.
For reference, "influencing legislation" is defined in Section 4911 of the Internal Revenue Code (IRC), as "(A) any attempt to influence any legislation through an attempt to affect the opinions of the general public or any segment thereof, and (B) any attempt to influence any legislation through communication with any member or employee of a legislative body, or with any government official or employee who may participate in the formulation of the legislation."
Section 4911 (Line 40a) - Excess lobbying expenditures
Tax-exempt organization that have elected to be covered by under certain special IRS rules regulating lobbying [IRC 501(h); see IRS Form 5768] are permitted only a limited amount of lobbying expenditures, and must pay an excise tax on any amount spent beyond that.
Section 4912 (Line 40a) - Disqualifying lobbying expenditures
If tax-exempt organizations have not elected to be covered under the special IRS rules referred to in the paragraph above regarding IRC Section 4911, then an excise tax is generally imposed on the organization (and its managers!) if they incur any lobbying expenses whatsoever.
Section 4955 (Line 40a) - Political expenditures
Most tax-exempt organizations are specifically restricted from political expenditures, and must pay an excise tax on any such amounts. The term "political expenditure" means any amount paid or incurred by a section 501(c)(3) organization for any participation in, or intervention in (including the publication or distribution of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. Broadly speaking, lobbying expenditures are incurred to support or oppose issues and/or legislation, while political expenditures are incurred to support or oppose politicians.
Section 4958 (Line 40b) - Excess benefit transactions
Certain financial expenditures associated with payments to Board members, key staff members, or their relatives may constitute "excess benefits" under IRS rules. Such expenditures must be reported, and the organization may be required to pay an excise tax on those amounts.
home | 5 reasons | annual returns | exempt status applications | federal rules | online publishing | other sites | comments
|Last modified 16Jan99
Copyright © 1998-1999 Eric Mercer. All rights reserved.
The U.S. Nonprofit Organization's Public Disclosure Regulations Site