The last thing many nonprofit leaders want to see is a media article that depicts their charity in a negative light. The vast majority of charities work hard to be in compliance at both the state and federal levels, as their nonprofit corporation and tax-exempt status is an integral piece of how they raise funds and operate. In addition, one of the primary goals of the Revised Form 990 is transparency. This includes shining a light on certain transactions between the charity and insiders or “interested persons”, as disclosures may be triggered on Schedule L of the Form 990. While these disclosures are not new, there were important changes to the 2014 Form 990 on who is considered an interested person that may catch organizations off guard.
New in 2014, the IRS streamlined the 2014 Schedule L definition of interested persons for Part II-IV, loans, grants and business transactions. Note, the Schedule L, Part I, Excess Business Transaction section remains unchanged. In many ways this is a considerable improvement, as prior to 2014 the definition for interested person had four different definitions, one for each part of Schedule L. This was confusing not only to the charities, but to the readers of the schedule trying to navigate the disclosures and the implications. Interested persons usually refers to current and former board members, officers, key employees and others with substantial influence over the organization, including those person’s family members and controlled businesses. See the Schedule L instructions for a complete definition. However, the two most notable expansions of the definition include creators and founders of the organization and substantial contributors reported on the Form 990, Schedule B, List of Contributors for the reporting year.
Substantial contributors and reasonable efforts.
Schedule L, Parts II – IV, requires a charity to perform “reasonable efforts” to determine if a disclosure is warranted. It often is difficult to ascertain who the organization’s interested persons are, let alone determine if transactions existed during the year. Therefore, the IRS instructions recommend that an organization send a questionnaire or survey to the known interested persons requesting information about potential transactions that need to be disclosed. The questionnaire should include the necessary questions along with a listing of all the known interested persons and a glossary of terms to help the recipient answer the questions accurately.
This can be a delicate situation with regard to substantial contributors, now considered interested persons. The questionnaire or survey could seem rather off-putting, intrusive, and overwhelming to a substantial contributor of the organization, thus compromising the relationship with the donor. In such case, rather than sending a full reasonable efforts questionnaire to the substantial contributors, a charity could consider a substitute letter. The letter would first thank the substantial contributor for their support and then ask three basic questions regarding if they, their family members, or 35% controlled business entities had any 1) loans outstanding to or from the reporting organization at year-end, 2) business transactions, or 3) grants or other assistance during the year with or from the organization. If the substantial contributor responds, then the organization can inquire further. The organization should include the full definition of the terms “family member” and “35% controlled entity” in the letter.
The primary reason for sending a substitute letter, besides being friendlier to the recipient, is that a concise reasonable efforts questionnaire includes the names of all the potential interested persons, thereby disclosing the list of substantial contributors to all that receive the questionnaire. Normally the list of substantial contributors is not open to public disclosure for most charities (it is open for private foundations and 527 political organizations). Thus, the questionnaire can create a confidentiality or donor relationship problem.
It appears the IRS did not consider the full ramifications for including a substantial contributor as part of the Schedule L definition of interested persons. To the point, it may in fact be “unreasonable” for an organization to fully distribute its substantial contributors list to determine its Schedule L disclosures. Regardless of which approach the Charity takes for its substantial contributors (either including them in a questionnaire or a substitute letter) the organization will need to document its tax position on the matter and the best efforts it undertook.
Schedule L disclosures.
The charity may have not violated any state or federal laws by having a transaction reported in Parts II-IV of Schedule. However, it may be important to understand the transaction and to have a response crafted if a particular disclosure is questioned. The statement should include the relevant policies and procedures, including the conflict of interest policy, that were used when approving the transaction.
Potential donors, the media and other interested parties to a charity use the Form 990 as an easy way to investigate the organization. Therefore, it is important for charities to understand the required Form 990 disclosures, including those disclosures that may raise eyebrows. Understanding how the sunshine disclosures on Schedule L apply to charities will equip leaders to make educated decisions about how the charity interacts with interested persons. Or, at the very least, the organization can be prepared to answer readers of the Form 990 if questions should arise.
Common Schedule L disclosures could include:
- A housing loan made to a new CEO to incentivize a relocation;
- A salary advance made to a key employee or officer;
- Family member of an interested person paid more than $10,000 during the year to work for the reporting organization or a related organization;
- The reporting organization has more than 35% of its board members sitting on an affiliated for- profit wholly-owned C corporation and there is a shared service or management agreement over the reporting dollar threshold;
- A board member’s family member is the recipient of a scholarship awarded by the reporting organization; or
- An interested person that controls more than a 35% interest (alone or with their family members) in a company that contracts with the reporting organization and the transactions meet the reporting dollar threshold.