An Introduction to Financial Analysis of Selected Parts of the IRS Form 990 Schedule A
In addition to the Form 990 or 990-EZ, tax-exempt public charities are almost always also required to submit a completed IRS Form 990 Schedule A. This form must also be made publicly available, under the same conditions as the Form 990/990-EZ itself. The Form 990 Schedule A provides valuable information about tax-exempt organization's finances and operations. Although it is primarily devised to assist the IRS in determining if an organization qualifies as tax-exempt, it is also used to promote public accountability by exposing certain details of the organization's finances and operations for public inspection.
This text was written to help those without accounting expertise to use the Form 990 Schedule A to better understand the finances of tax-exempt organization. It is a companion to a seperate text on the subject of analysing the Form 990-EZ. The introduction to that text provides more discussion about the general validity of using tax-returns to evaluate an organization's finances. The author is neither a lawyer nor an accountant, but has developed expertise in understanding tax-exempt organization returns by having to complete them, as well as from educational resources published for accounting professionals and others.
NOTHING IN THIS TEXT SHOULD BE CONSTRUED AS LEGAL OR FINANCIAL ADVICE.
This text is not a complete analysis of the Form 990 Schedule A. In addition, it primarily addresses certain issues that arise with 501(c)(3) public charities, and not all organizations that file this form. There are many other kinds of tax-exempt organization that are required to submit the Form 990 Schedule A, and some must also complete special sections of the form that won't be covered in this discussion at all. Finally, this discussion only presents certain parts of the Form 990 Schedule A that are most commonly of interest to people doing a very basic financial analysis based on tax returns. For instance, no discussion of the form's section on lobbying expenditures is presented here, although this can be a very significant activity for some organizations and of great interest to those trying to learn more about the organization's activities. The two parts that are presented are the top salaries (Parts I and II of the form) and the support schedule (Part IV and IV-A of the form). These two parts the the ones most people interested in a financial analysis of a tax-exempt organization will want to examine most closely.
This text was prepared based on the 1997 IRS Form 990 Schedule A, Form 990 and 990-EZ, and associated tax code. It may not be completely accurate for later versions.
Parts I and II of the form present the top five salaries over $50,000 paid to the organization's employee and contract staff. The individual people and associated data must be given, and not just a summary that includes several people.
The names in this section may overlap with those from the Form 990 list of Officers, Directors, Trustees, and Key Employees (Part IV in Form 990-EZ and Part V in Form 990). In particular, the Executive Director (the person responsible for day-to-day operations, sometimes called the Chief Executive Officer) and other key employees are most likely to appear on both lists. Since Board of Trustees (also called Board of Directors) members are not typically also paid staff members, they won't commonly appear on the Form 990 Schedule A. Each person's title is given in both places, which will distinguish for you whether the person is a member of the Board or of the staff. It would be very unusual, and likely a cause of concern, if any member of the Board of Directors besides the Executive Director was paid more than $50,000 and therefore was listed on the Form 990 Schedule A. The Board of Directors is supposed to represent the general public and its interest in the organization, and there would be a serious conflict of interest if the person also received a significant salary from the organization. In addition, the IRS identifies various "disqualified individuals," such as the spouse of a Board member, whose appearance as a highly paid employee or contract could raise significant conflict of interest issues.
It is important to note that the IRS doesn't necessarily require that organizations avoid conflicts of interest, generally as long as no more than a fair market value is paid for services. However, public supporters and others concerned with accountability in tax-exempt organizations should definitely be concerned about conflicts of interest. Responsible organizations will have policy statements addressing conflict of interest either in their Bylaws or other Policy Guide, both of which should also be make publicly available (an organization's bylaws are sometimes available from the Secretary of State in the organization's state of incorporation).
With regard to the salary amounts, it is important to realize that the absolute number itself is not as important as the typical salaries being paid to others at different organizations with a similar job position and doing similar work. 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. More details of this consideration, including some sample salaries, are given in the document analysing the Form 990-EZ.
In the first section of Part IV of the Form 909 Schedule A, the organization specifies under which part of the Internal Revenue Code (IRC) it claims classification as tax-exempt. Independent 501(c)(3) public charities will typically check the box on either Line 11a, "An organization that normally receives a substantial part of its support from a governmental unit or from the general public. Section 170(b)(1)(A)(vi)," or line 12, "An organization that normally receives: (1) more than 33 1/3% of its support from contributions, membership fees, and gross receipts from activities related to its charitable, etc., functions—subject to certain exceptions, and (2) no more than 33 1/3% of its support from gross investment income and unrelated business taxable income (less section 511 tax) from businesses acquired by the organization after June 30, 1975. See section 509(a)(2)." An organization that checks the box on line 11a indicates that it is a "publicly-supported public charity" [it qualfies as tax-exempt under IRC 509(a)(1) and 170(b)(1)(A)(vi)] while one that checks Line 12 is typically supported by revenue from its exempt-purpose activities and services [and qualifies as tax-exempt under IRC 509(a)(2)].
This distinction is a critical part of understanding how an organization supports its activities. The publicly-supported charity depends on donations and/or grants, while the 509(a)(2) organization depends on selling services and performing other revenue-generating activities that advance its charitable mission. The latter organizations typically are at greater risk of losing their tax-exempt status due to reclassification as a commercial (and not charitable) organization. However, as long as such an organization stays restricts its activities primarily to those that advance its stated missions, and the IRS agrees that mission is charitable and not commercial, then such organizations generally qualify as tax-exempt. In short, a publicly-supported charity's most critical aspect for revenue is that it can attract public support in the form of donations and grants from people and granting agencies who agree with its goals and that it is successfully acheiving them. A 509(a)(2) organization, which depends more on revenue from services provided to those who find the services valuable and cost-effective, must in addition avoid competing with commercial businesses or risk being reclassified as a commercial business itself.
If an organization doesn't automatically qualify as tax-exempt (e.g. a church), then the IRS evaluates whether an organization qualifies as tax-exempt primarily by examining its finances, and secondarily by examining the facts and circumstances of its operation. Although a detailed discussion of how organizations can qualify as tax-exempt is beyond this discussion, it should be understood that an organization tht normally receives more than a third of its support from a governmental unit or from the general public automatically qualifies as tax-exempt. Otherwise, various other aspects of its operation are examined, still including their finances. Accordingly, the sources of revenue that the organization depends upon are typically the first characteristic both the IRS and the independent analyst will examine.
In addition, because the sources that the organization "normally" uses are evaluated, and not just those for the most recent tax period, a history of support sources is presented in Part IV-A. For instance, it is not unusual for an organization's sources of income to change somewhat from year to year, particularly for small organizations. Also, a new organization will commonly use different sources of support during their first few years than it does once it is established.
The various sources of support given in the table leading part IV-A are probably self-explanatory given the explanations presented above. The key items are: how much support comes directly or indirectly from the public as donations or grants (Line 15) or membership fees (Line 16), versus from services and activities that support the organization's charitable mission (Line 17), versus from interest, dividends, and related investment sources (Line 18), versus from unrelated business activities that don't promote the organization's charitable mission (Line 19) and other sources (Lines 20 to 22). The balance among these revenue sources determines if the organization automatically qualifies as tax-exempt, else which set of additional tests must be applied to determine its status.
Depending on its normal sources of revenue, an organization will choose to attempt to qualify as tax-exempt under some particular set of IRS rules. Only one such set of rules can be selected on the Form 990 Schedule A, and the tests that are used for that set of rules are given in subsequent sections of Part IV. An organization that has checked the box on Line 10a must demonstrate that it qualifies as a publicly-supported charity, while one that has checked the box on Line 12 must demonstrate it meets the tests given in IRC 509(a)(2).
The financial test for status as a publicly-supported charity are presented on Line 26. This test is met if either the organization receives more than one-third of its support from qualified public sources, as given in Line 26f, or at least 10% of its support from those sources and it additionally qualifies under certain facts and circumstances tests.
The financial test for tax-exempt status under IRC 509(a)(2) are presented on Line 27. This test is met if the organization receives at least one-third of its support from qualified exempt-purpose services and activities, as well as meeting other tests of both its finances, and the facts and circumstances of its operations.
The specific sources of revenue shown summarized in Part IV are not typically shown in the Form 990 Schedule A or the Form 990-EZ. An exception exists for "unusual grants" which must be described in an attachment associated with Line 28. Unusual grants receive special treatment because under certain tests for exempt status the organization may only treat a portion of the revenue as public support, while including the entire amount in total support. For this reason, a grant that is unusually large compared to the organization's usual support can significantly skew an organization's finances under the tax-exempt status tests, which would result in insufficient public-support and disqualification as a tax-exempt organization. The IRS therefore typically allows organizations receiving such unusual grants to omit them from the support test calculations.
Although the Form 990 and 990-EZ do include sections where the organization must reveal the primary activities that generate expenses (Part III), the only way to determine the exact sources of an organization's income is sometimes only its annual report. However, information about support from government grants is usually publicly available through the granting agency, as is support from some private grantmakers that publish detailed descriptions of their activities. Tax-exempt organizations are specifically not required to publicly release a detailed list of those contributing to the public support part of their revenue, although they may be required to release this information only to the IRS as an attachment to Form 990 or 990-EZ. It may be included in their publicly released tax-return at their option, although if it would reveal donors who have specifically asked to remain anonymous then the tax-exempt organization will usually omit this information about their sources of revenue.
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