Form 990: A Detailed Examination
an expanded version of NPCC’s
How to Read the IRS Form 990
& Find out What it Means
Peter Swords
Copyright © 2003 Nonprofit Coordinating Committee of New York, Inc.
1350 Broadway, #1801, New York, NY 10018
www.npccny.org
Table of Contents
Introduction ................................................................................................................................1
Chapter 1: Regulatory Information
Introduction ..............................................................................................................8
Section I: Improper Payments to Individuals......................................................................8
Subsection 1: Excessive or Unreasonable Compensation ..........................................15
Subsection 2: Other Self-Dealing and Improper Transfers.........................................21
Subsection 3: Miscellaneous Provisions .....................................................................27
Subsection 4: Transactions with Related Organizations .............................................32
Section II: Other Regulatory Concerns Covered by the Form 990 ...................................34
Subsection 1: Unrelated Business Income ..................................................................34
Subsection 2: Private Foundation or Non-Private Foundation Status ........................38
Subsection 3: Lobbying Activity ................................................................................41
Chapter 2: Financial Information
Introduction ............................................................................................................46
Section I: Form 990 Part I: Revenue, Expenses, and Changes in
Net Assets or Fund Balances (Introduction) ............................................................49
Revenue .......................................................................................................................50
Expenses ……………………………………………………………… .....................63
Net Assets ……………………………………………………………. ......................66
Section II: Form 990 Part II: Statement of Functional Expenses ……. ..........................70
Section III: Form 990 Part III: Statement of Program Service Accomplishments ..........76
Section IV: Form 990 Part IV: Balance Sheets ...............................................................77
Subsection 1: Net Assets and the Financial Capacity Question ................................82
Subsection 2: The Adequacy of Reserves Question ...................................................99
Appendix A: Analysis of Net Assets: Some Examples
i
Introduction
This paper offers detailed suggestions on how to read the IRS Form 990 so that one can
make useful judgments about the organization whose Form 990 is being read. It
supplements our shorter essay on the same topic—“How to Read the IRS Form 990”-and has been prepared for those who wish to learn about understanding the Form 990 in
depth. The shorter essay may be accessed through the website of the Nonprofit
Coordinating Committee of New York, Inc. at www.npccny.org.
The Form 990, entitled “Return of Organization Exempt From Income Tax,” is a report
that must be filed each year with the Internal Revenue Service (IRS) by most
organizations exempt from federal income tax under section 501 of the Internal Revenue
Code of 1986, as amended (the “Code”), whose annual receipts are normally more than
$25,000 a year. Charitable organizations, those exempt from taxation under section
501(c)(3) of the Code, that are required to file the Form 990 itself, must also file
Schedule A to Form 990. (Schedule A need not be filed by most other organizations
exempt under section 501, such as trade associations, social clubs and the like.)
Generally, organizations are exempt under section 501(c)(3) if they pursue charitable,
educational or religious purposes. They are the focus of this paper. An organization
normally receives more than $25,000 a year if its gross receipts for the immediately
preceding three tax years average more than $25,000 per year. Organizations with gross
receipts for a year of less than $100,000 and assets at year-end of less than $250,000 may
file a short-form Form 990, called Form 990-EZ, for that year. Organizations that are
classified as private foundations (generally organizations that receive funding from a very
few sources) are required to file a Form 990-PF. Generally churches are not required to
file a Form 990 (although some churches file voluntarily).
Today the Form 990 is the basic component of the annual report that, in addition to being
filed with the IRS, must be filed with a large number of states that regulate charitable
solicitation. Many states require supplemental reports as well as the Form 990. A few
states require annual reports not only from charities that solicit within their borders but
1
also from those that are merely located there (and do not solicit there). Today about 35
states make the Form 990 the central part of their annual report.
In brief, the Form 990 is a six page form (and Schedule A is another six pages) which
elicits a great deal of regulatory and financial information about the reporting
organization, asks a number of questions that can be answered “yes” or “no,” and elicits
some descriptive information as well as the names and addresses of the organization’s
directors and key employees. In addition to completing the form, the filer must append a
number of schedules and attachments.
The Form 990 serves two essential purposes. First, it provides information that helps
government agencies (the IRS and state charity regulators) enforce their laws. For
example, both the IRS and state regulators enforce what has been called the
“nondistribution constraint.” This is a rule that holds that money and assets may not be
transferred from the filing organization to those who control the organization (other than
transfers for which the organization receives services or goods whose value is equal to
the transfers). Payments of excessive compensation and self-dealing transactions are
examples of impermissible distributions. Many believe that the nondistribution
constraint is the hallmark of a charitable organization. The current version of Form 990
has been so finely developed that most violations of the nondistribution constraint that
occur during the period being accounted for will, if the return has been filled out
honestly, be reported.
In addition, the IRS is charged with insuring that charities do not engage in improper
political activity or conduct too much lobbying, and the Form 990 elicits information on
these activities. Information about unrelated business activities is also elicited by the
Form 990 to aid the IRS in applying the unrelated business income tax to these activities.
Of particular interest to the states, the Form 990 elicits certain information about
fundraising. Chapter 1 of this paper covers those parts of the Form 990 that elicit
information needed by government regulatory agencies to carry out their oversight
function. Of course, this kind of information, which may suggest serious accountability
2
lapses, may be of as much interest to those considering providing support to a nonprofit
or using its services as it is to regulators.
Second, the Form 990 elicits a great deal of financial information about the filing
organization that enables the reader to learn about the organization’s financial condition,
make judgments about its financial strength or weakness and find out such things as the
sources of its income.
Chapter 2 of this paper helps readers understand how to read those sections of the Form
990 that provide financial information. Here the principal focus is on whether the filer
will be able as a financial matter to continue to provide the services it was set up to
provide and whether its managers are discharging their stewardship responsibilities
adequately. This information is obviously important to potential resource providers such
as funders, potential board directors and volunteers.
The Form 990 is a very public document and it is becoming more public. Today an
organization’s Forms 990 for the past three years must be shown to anyone who wants to
see them. In addition, copies of these forms must be given to anyone who requests them
(either by person or in writing) and who pays a reasonable fee -- $1 for the first page and
15 cents for every page thereafter and postage, if applicable. (Copies of the
organization’s Form 1023 “Application for Exemption from Taxation” including any
supplemental correspondence with the IRS must also be provided if requested.)
Furthermore, most Forms 990 beginning with the year 1997 are being posted on the
Internet by the National Center for Charitable Statistics and Guidestar, two nonprofit
groups in the Washington D.C., area (see www.guidestar.org). Finally, it is only a matter
of time before all charities will be required to file their Forms 990 electronically. Today,
for example, all Securities & Exchange Commission (SEC) and Federal Election
Commission (FEC) filings must be made electronically.
Thus, virtually every Form 990 is or soon will be accessible by anyone in the world.
Those who work for or are served by nonprofits as well as those who are thinking of
3
providing resources to them may have questions about these organizations. Now that
access to these organizations’ Forms 990 is readily available, those having questions may
find some answers on these returns but only if they know how to read them. Some may
have cause to suspect that a nonprofit in which they are interested may be abusing its
nonprofit status by, for example, improperly siphoning its funds into private hands. An
examination of the Form 990 may shed some light on these suspicions. Obviously those
who are considering supporting nonprofits, whether by contributing financial support or
by volunteering for them or in some other way, may find important information in such
organizations’ Forms 990. Furthermore, given the extremely public nature of the Form
990, it behooves those who are associated with these groups to know and understand
what is in their Forms 990, since anyone at any time might decide to examine them. For
example, in view of the Form 990’s very public nature, it is desirable that board members
know and understand what is in the Forms 990 of the organizations on whose boards they
sit. However, any of these persons will only find this information useful if they can
interpret the Form 990.
The Form 990 was first required in 1943 by Treasury Decision 5125 (dated March 5,
1942). Today it is mandated by section 6033 of the Code. In its early years Form 990
was primarily a regulatory tool for the IRS to help it monitor exempt organizations to
assure that they were still eligible for exemption. In the late 1970s and early 1980s, the
Form 990 was expanded to elicit general financial information about nonprofit
organizations. This expansion came in response to suggestions by the Commission on
Private Philanthropy and Public Needs (often referred to as the Filer Commission after its
chairman John Filer). A paper prepared by the Commission's Accounting Advisory
Committee began by observing that in view of the fact that section 501(c)(3)
organizations are public institutions, "their financial activities should be conducted in the
full light of public scrutiny" and then noted that the then existing Form 990 "is not
financial-statement oriented but is directed to regulatory needs" and suggested that the
Form 990 be amended to better reflect financial information. (See Volume V of the
Commission's papers.) The expansion of the Form 990 also came in response to state
charity officials who wanted to be able to use it as a public disclosure instrument so that
4
their constituents could better evaluate an organization's fundraising expenses and the
like.
In recognition of the Form 990's value to the public, not too long after the Form 990 was
first mandated, Congress enacted a law that requires the Secretary of the Treasury to have
Forms 990 made available to the public by the government. In the mid-1980s, the
disclosure law was expanded to require exempt organizations themselves to show their
last three Forms 990 to those who come in and ask to see them. More recently, as
mentioned above, the law has been further expanded to require section 501(c)(3) groups
to give copies of their Forms 990 (in person or by mail) to those who ask for them.
Groups do not need to comply with this last-mentioned requirement if they post their
Forms 990 on the World Wide Web. Recently the Joint Committee on Taxation has
called for accelerated mandatory electronic filing of the Form 990. When Forms 990 are
electronically filed they will be in a format that will enable automated reviews to be made
of them.1 As a result these forms will receive a degree of attention that is not now
possible given the current level of personnel and resources provided today to the sector's
government regulatory agencies. (The Joint Committee, made up of representatives from
the Senate Finance Committee and the House Ways and Means Committee, is the most
powerful tax writing committee in Congress.)
As indicated above, this paper aims to provide the reader of the Form 990 with help in
interpreting what the Form 990 means. What can you learn about an organization by
studying its Form 990? Much of the information found in the Form 990 is financial
information and so we will be looking at numbers and at things like amounts and types of
income and expenses. And we will be asking what these numbers might mean. We will
find they might mean a number of things and so all we can do is to suggest the kinds of
1
Software programs will almost certainly be developed so that when a Form 990 is submitted
electronically, a program will take the file and do such things as search it to make sure it is complete.
These programs will also be able to detect other errors that appear on the face of the document, such as
columns that are added up incorrectly or lines that should be identical but do not match (e.g., Line 13 and
Line 44, column (B)). In cases where there have been omissions or facial errors, a program will be able to
generate a letter to the filer informing it of the omissions and errors and requesting that it submit a
completed and corrected form. All of this will be done by an automated system without the need of
personnel.
5
inferences that may be reasonably drawn. Obviously not all of the many possible inferences
will be suggested here, and some of those offered may be more or less apt for particular
Forms 990. The suggestions offered below should be taken as prompts to more reflective
thinking about a Form 990 rather than as sure guides to interpretation. Ultimately, each
Form 990 tells the unique story of the organization that files it, and only by looking at the
whole Form 990 and determining how one part or line helps you understand other parts and
lines can you begin to piece together what the whole document or any part of it means. In
many cases the reader may want to compare a filer’s current Form 990 to its prior Forms
990 or to Forms 990 of other organizations or may want to go to sources outside of the Form
990 to get clear answers to questions that it may raise.
This paper has been written with section 501(c)(3) nonprofits in mind, namely, those
charitable, educational and religious groups described under that Code section. It should
be kept in mind, however, that the Form 990 is to be filed by a wide variety of nonprofits
in addition to section 501(c)(3) groups.
In reading the Form 990 it is helpful to refer to the IRS’s Instructions (Instructions for
Form 990 and Form 990-EZ).
These instructions explain in very clear and easily
understandable prose exactly what is expected by each line and what the various terms
used in the Form mean. They also provide a great deal of useful context information
about the Form 990. Those who created the Instructions have developed them with much
care and thoughtfulness over a number of years.
They are an authoritative and high
quality piece of work. The most recent versions of the Form 990, Schedule A, and their
instructions
can
be
accessed
and
downloaded
from
the
IRS’s
website—
http://www.irs.gov—or are available at any public library.
Most readers of the Form 990 will, of course, have competed copies before them. In this
connection, as indicated above, the Forms 990 of most charitable organizations are now
easily accessible on the Internet. They are presented in a format that permits them to be
downloaded and printed out. As also suggested, in a few years these forms will be
electronically filed by each organization required to submit the Form 990 and copies of
6
organizations’ last three Forms 990 will be available. The reader will be able to access
not only the Form 990 proper but also the many schedules and attachments that must be
attached to it. A great deal of important information can be found in these attachments
and in many cases a Form 990 cannot really be understood unless the attachments are
studied. As we go through the lines of the Form 990 in the sections below we note where
there is a requirement that a schedule or explanation be attached. As will be emphasized
below, a reader of a Form 990 can find out much more about the organization she is
examining if she has copies covering several years of activities. As has been noted,
groups are required to make available their last three Forms 990.
Finally, please note that this paper does not cover all parts of the Form 990 or Schedule
A. For example, nothing is said about Part IV-A in the Form 990 and every line in Part
VI is not covered. In addition, no comments are offered on certain other parts of the
Form 990 (e.g., the items at the top of page 1 and Part X). Similarly, our treatment of
Schedule A does not cover Part V. For information on what we have not covered, please
consult the Instructions. As suggested above, they contain reliable and clear information
on these matters
7
Chapter 1: REGULATORY INFORMATION
INTRODUCTION
This chapter of the paper covers the portions of the Form 990 containing information that
is important to government regulators in their efforts to assure that nonprofit groups
remain eligible for their nonprofit status (particularly that they remain eligible for tax
exemption) and are not harming the public. In Form 990’s early years2, these concerns
were the major reason for requiring nonprofit groups to file the Form. Our aim in this
part is to help readers of an organization’s Form 990 determine, from the Form,
whether the filer has contravened any of the rules under which it operates or has behaved
improperly. We also address those portions of the Form 990 dealing with regulatory
concerns that do not necessarily involve wrongdoing. (Below at the start of Section I we
address problems that may arise from what may appear to be an excessive emphasis on
wrongdoing.) Thus, we divide our attention between those parts of the Form 990 that
focus primarily on wrongdoing and improper behavior (Section I) and those parts that
focus on regulatory concerns that usually do not involve any wrongdoing (Section II).
Section I covers such topics as the payment of unreasonable or excessive compensation
and self-dealing. Section II covers such topics as unrelated business income and political
activity.
We will proceed by dealing with various regulatory topics as opposed to going through
the form section by section in the order presented.
SECTION I
IMPROPER PAYMENTS TO INDIVIDUALS
Introduction
A great deal of what follows in this section is negative in character. In many places it
will appear to assume some level of wrongdoing. Some may be offended by the tone and
2
As the Introduction to this paper points out, the Form 990 was first required in 1943. The Form has not
changed much in recent years. References in this paper are to Form 990 for 2002.
8
approach of this section. Since only a very few of the hundreds of thousands of
nonprofits engage in wrongdoing, and then only rarely, it may seem inappropriate to
focus so much attention on possible misbehavior. Some may believe that in doing so we
suggest that the nonprofit sector is infected by a degree of wrongdoing that is much larger
than in fact is the case. We, of course, do not mean to suggest this. We believe that most
nonprofits do not engage in any of the improper transactions we will be discussing. But,
of course, some do, and it is precisely to help inhibit and detect the occurrences of such
wrongdoing that the portions of the Form 990 we discuss in this section were put into the
Form. We cannot adequately explain these portions of the Form 990 without assuming
wrongdoing and thus cannot adequately cover these portions of the Form 990 without
sounding negative. But keep clearly in mind that we are not suggesting that the nonprofit
sector is crowded with malefactors; we are only trying to explain important portions of
the Form 990. Frequently in what follows we suppose a reader of the Form 990 who
appears to be looking for wrongdoing. This may be the rare reader and some may believe
that the mistrustful and suspicious attitude that such a reading suggests is inappropriate.
It should be kept in mind, however, that this is how regulators will read the form and
understanding regulators’ perspectives on the Form 990 is central to understanding these
provisions.
Much of what we cover in this section involves the improper siphoning off of
organizational funds into private hands. Why might a reader of the Form 990 be
interested in this type of negative information? To begin with, this information is
certainly relevant for those thinking of supporting the organization whose Form 990 they
are examining. For example, one would not likely contribute funds to an organization
that had made improper payments to its officers. In addition to those considering
whether or not to support an organization, in some cases there may be those who suspect,
or have information, that an organization has behaved improperly. They may want to
take steps to expose or stop such behavior. For example, as we will see, if the improper
behavior involved the transfers of money or assets to individuals, the transactions in all
likelihood should have been disclosed on the organization’s Form 990. If, as is likely,
such transfers are not disclosed, it is also probable that the filer made intentional
9
misrepresentations when it filed its Form 990. Readers of the organization’s Form 990,
such as those we are supposing, might have an interest in seeing that the organization is
held accountable for its behavior. Such readers would include board members who are
not part of a controlling group that has been acting improperly. These reader-board
members may want to help move the organization back into full compliance with the
laws and standards of ethical behavior. Disaffected employees might be similarly
interested. If a reader discovers information on the Form 990 that might suggest
improper behavior, she might report it to those in the management whose integrity she
relies upon. At a more radical extreme, she might report her discoveries to state charity
or IRS officials.3
The prohibition against improperly benefiting private individuals lies at the heart of what
we mean by a nonprofit organization.4 Money and wealth transferred to nonprofits must
be used to advance the nonprofit’s mission and not for the purpose of furthering
individual private interests. This rule applies to all sorts of nonprofits including
charitable nonprofits exempt under section 501(c)(3).
For section 501(c)(3) groups, there are two aspects of the general rule that no improper
payments may be made to individuals. First, section 501(c)(3) provides that an
organization will be eligible for tax-exemption if it pursues a charitable purpose and no
part of its net earnings inures to the benefit of any individual.5 We shall refer to this
prohibition as the “no inurement rule.” Second, there is a less specific version of the
general rule that provides that to be eligible for exemption an organization may not have
a purpose to benefit private individuals. The difference between these two versions of
the rule is that the no-inurement prohibition refers to improper transfers to certain defined
individuals6 while the “no private benefit” rule applies to any private individual or
3
As we move into an era when all Forms 990 are going to be easily accessible by anyone on the Internet,
filers may become reluctant about making misrepresentations and this may in turn deter untoward behavior.
4
This prohibition has come to be called the nondistribution constraint.
5
Section 501(c)(3) provides in relevant part that an organization will be eligible for tax exemption if it
pursues an exempt purpose and “... no part of the net earnings of which inures to the benefit of any private
shareholder or individual ...” Eligibility for tax-exemption also turns on the organization not engaging in
too much lobbying or in any partisan electioneering. See subsection 4 below.
6
We will refer to these individuals as “insiders.”
10
entity.7 Most violations of the general rule that no improper payments may be made to
individuals involve the no-inurement prohibition and, as we shall see, the Form 990 over
the years has evolved so that today it is almost impossible for an organization to violate
this rule and complete its Form 990 accurately without reporting the violation. On the
other hand, the Form 990 is not suited to pick up transgressions of the no-private-benefit
rule.8
We shall now concentrate on the no-inurement rule since, as just noted, it is breaches of
that prohibition that the Form 990 is particularly effective at addressing. To begin with,
it is only improper payments to “private individuals”9 that trigger the no inurement rule.
Who are private individuals for these purposes? They are people such as officers and
members of the board of directors and people with similar responsibilities and powers.
Roughly speaking they are persons with enough control over the nonprofit organization
to enable these persons to cause money or assets to be transferred to them or for their
7
This prohibition is primarily a judicial creation. Briefly, it provides that an organization must not be run
for the benefit of private interests. However, this private benefit prohibition applies to all kinds of persons
and groups, not just to those “insiders” subject to the more strict no-inurement proscription. There is
another major difference between these two aspects of the general rule — no inurement and serving private
interests — and that is that any payment or transfer of value, no matter how small, to an insider will
constitute a violation of the no-inurement prohibition whereas to violate the serving private interests
prohibition, the payments to private interests must be fairly substantial. Here is how a General Counsel
Memorandum (GCM) of the Internal Revenue Service has explained the prohibition:
In [an earlier GCM], this Office explained the standard used in balancing private benefit against
public benefit. Any private benefit arising from a particular activity must be “incidental” in both a
qualitative and quantitative sense to the overall public benefit achieved by the activity of the
organization if the organization is to remain exempt. To be qualitatively incidental, a private
benefit must occur as a necessary concomitant of the activity that benefits the public at large; in
other words, the benefit to the public cannot be achieved without necessarily benefiting private
individuals. Such benefits might also be characterized as indirect or unintentional. To be
quantitatively incidental, a benefit must be insubstantial when viewed in relation to the public
benefit conferred by the activity.
8
The improper benefit under the “no-private-benefit rule” can be to a broad class of people and does not
necessarily involve payments. For example, in one case the beneficiary of the improper benefit was the
entire Republican Party and the benefit involved was providing campaign aid to Republican candidates. It
would be nearly impossible to frame a data request or question for the Form 990 that would adequately
pick up such activities.
9
As noted above, the statute reads “... no part of the net earnings of which inures to the benefit of any
private shareholder or individual.” Since virtually no section 501(c)(3) nonprofits have shareholders, the
term “private shareholder” is an anachronism, and so, for determining who the individuals are to whom no
improper payments can be made without violating the no inurement prohibition, we are left with
interpreting the term “private individual.”
11
benefit. They have come to be called “insiders.”10 There is no specific definition of an
insider that can be mechanically applied to discover whether a particular individual
would be an insider. It depends on the facts and circumstances and the context of each
case.
Since the mid-1990s, a rule aimed at a similar problem to that addressed by the noinurement rule has been in effect. This rule, prescribed under section 4958 of the Code,11
imposes a tax on “disqualified persons” on the “excess benefit” they have received from
an “excess benefit transaction.”12 An excess business transaction is one in which a
disqualified person receives more from a section 501(c)(3) organization than she provides
in return to the organization.13 The term “disqualified persons” is defined to include
persons who are in a position to exercise substantial control over the affairs of the
organization.14 The Treasury Regulations under section 4958 define disqualified persons
as including (1) board members, (2) presidents, chief executive officers or chief operating
10
An Audit Guidelines for Hospitals issued by the Internal Revenue Service (IRS) provides the following
helpful description of insiders: “individuals whose relationship with an organization offers them an
opportunity to make use of the organization’s income or assets for personal gain”. Ann. 92-83, 1992-22
I.R.B. 59, section 333.2(2).
11
This rule is sometimes referred to as the “intermediate sanctions” rule. Before this rule, about the only
sanction the Internal Revenue Service had when a section 501(c)(3) organization violated the no inurement
prohibition was to revoke its exemption. In many cases this was believed to be too extreme. The new rule
provides a sanction between doing nothing and revoking an organization’s exemption. The rule applies
only to section 501(c)(3) organizations that are not private foundations under section 509(a), and to section
501(c)(4) organizations.
12
A tax is also imposed upon board members who approved the transaction knowing it was an excess
benefit transaction.
13
The Code defines an excess benefit transaction as follows: “The term ‘excess benefit transaction’ means
any transaction in which an economic benefit is provided by an applicable tax-exempt organization directly
or indirectly to or for the use of any disqualified person if the value of the economic benefit provided
exceeds the value of the consideration (including performance for services) received for providing such
benefit.” section 4958(c)(1)(A). Here is an example. Suppose a section 501(c)(3) organization pays its
executive director $500,000 when the compensation for persons in comparable positions in the same
geographical area is $300,000. The executive director would be a disqualified person who received an
excess benefit of $200,000. A tax of 25% would be imposed on the excess benefit (viz., $50,000). If the
executive director did not return the $200,000 to her organization before she was notified of the tax, she
would be subject to a second tier tax of 200% (viz., $400,000). Each board member who approved the
compensation knowing it was an excess business transaction would be subject to a tax of 10% ($20,000).
There would be no second tier tax on board members.
14
The statute reads in relevant part as follows: “The term ‘disqualified person’ means, with respect to any
transaction any person who was, at any time during the 5-year period ending on the date of such
transaction, in a position to exercise substantial control over the affairs of the organization.” Section
4958(f)(1)(A). The statute also defines the term “disqualified person” to mean, with respect to any
transaction “(B) a member of the family of an individual described in (A), and (C) a 35-percent controlled
12
officers,15(3) treasurers and chief financial officers,16 and (4) those who facts and
circumstances tend to show have substantial influence over the affairs of the
organization.17 Disqualified persons for section 4958 purposes are obviously similar to
insiders for purposes of the no-inurement rule, but the term “disqualified person” may
have a broader application than the term “insiders.”18 As will be seen below, some of the
entity. Section 4958(f)(1)(B) and (C). A 35-percent controlled generally means a corporation, partnership
or trust in which persons described in section 4958(f)(1)(A) have more than a 35% interest.
15
The Treasury Regulations amplify on this definition as follows: “This category includes any person who,
regardless of title, has ultimate responsibility for implementing the decisions of the governing body or for
supervising the management, administration, or operation of the organization. A person who serves as
president, chief executive officer, or chief operating officer has this ultimate responsibility unless the
person demonstrates otherwise. If this ultimate responsibility resides with two or more individuals (e.g.,
co-presidents), who may exercise such responsibility in concert or individually, then each individual is in a
position to exercise substantial influence over the affairs of the organization.” Treas. Regs. § 53.49583(c)(2).
16
The Treasury Regulations amplify on this definition as follows: “This category includes any individual
who, regardless of title, has ultimate responsibility for managing the finances of the organization. A person
who serves as treasurer or chief financial officer has this ultimate responsibility unless the person
demonstrates otherwise. If this ultimate responsibility resides with two or more individuals who may
exercise the responsibility in concert or individually, then each individual is in a position to exercise
substantial influence over the affairs of the organization.” Treas. Regs. § 53.4858-3(c)(3).
17
In amplifying on the “facts and circumstances test” the Treasury Regulations provide: “Facts and
circumstances tending to show that a person has substantial influence over the affairs of an organization
include, but are not limited to, the following – (i) The person founded the organization; (ii) The person is a
substantial contributor to the organization (within the meaning of section 507(d)(2)(A) taking into account
only contributions received by the organization during its current taxable year and the four preceding
years); (iii) The person’s compensation is primarily based on revenues derived from activities of the
organization, or of a particular department of function of the organization, that the person controls; (iv) The
person has or shares authority to control or determine a significant portion of the organization’s capital
expenditures, operating budget, or compensation for employees; (v) The person manages a discrete
segment or activity of the organization that represents a substantial portion of the activities, assets, income,
or expenses of the organization, as compared to the organization as a whole; (vi) The person owns a
controlling interest (measured by either vote or value) in a corporation, partnership or trust that is a
disqualified person; or (vii) The person is a non-stock organization controlled, directly or indirectly, by one
of more disqualified persons.” Treas. Regs.. §53. 4958-3(e)(2).
The Treasury Regulations further provide: “Facts and circumstances tending to show that a person does
not have substantial influence over the affairs of an organization include, but are not limited to, the
following -- (i) The person has taken a bona fide vow of poverty as an employee, agent, or on behalf of a
religious organization; (ii) The person is a contractor ( such as an attorney, accountant, or investment
manager or advisor) whose sole relationship to the organization is providing professional advice (without
having decision-making authority) with respect to transactions from which the contractor will not
economically benefit either directly or indirectly (aside from customary fees received for the professional
advice rendered); (iii) The direct supervisor of the individual is not a disqualified person; (iv) The person
does not participate in any management decisions affecting the organization as a whole or a discrete
segment or activity of the organization that represents a substantial portion of the activities, assets, income,
or expenses of the organization, as compared to the organization as a whole; or (v) Any preferential
treatment a person receives based on the size of that person’s contribution is also offered to all other donors
making a comparable contribution as part of a solicitation intended to attract a substantial number of
contributions.” Treas. Regs. § 53.4958-3(e)(3).
18
The term “disqualified person” may well have a broader application than the term “insiders” with respect
to those family members or 35% controlled entities that are defined as disqualified person under section
13
provisions of the section 4958 rule may be relevant when someone examining a Form
990 wants to find out more about a possible excess compensation or self-dealing issue.
The Form 990 has been drafted in such a way that many payments to insiders that violate
the no-inurement prohibition must be reported if the Form is to be completed accurately.
It is, of course, unlikely that such a violation would be reported. If an improper payment
to an individual has been made, information revealing it might be omitted or the filer
might supply data that would constitute an intentional misrepresentation. This obviously
could not be told from merely examining the Form 990, but some reader might know
about the payment and notice that the Form 990 did not report it or falsely reported it. It
may be that such a reader might wish to report the problem.19
There are two major categories of violations of the no-inurement prohibition: (1)
payments of excessive compensation to insiders and (2) other self-dealing between an
insider and the filer. We shall first cover excessive compensation.
4958(f)(1)(B)and (C). These persons will be disqualified persons if they are related in certain ways to a
person who is a disqualified person under section 4958(f)(1)(A) (i.e., someone who is in a position to
exercise substantial control over the affairs of the organization). Because such family members or
controlled entities may not exercise substantial influence, they may not be insiders for purposes of the noinurement rule (although disqualified persons under section 4958). However, with this exception aside,
since both terms turn on the question of whether the individual in question has substantial control or
influence, it would seem that in most other cases, they should be the same. But today there is very little
guidance as to what the term “insider” means for purposes of section 501(c)(3)’s no-inurement rule, while
on the other hand the Treasury Regulations provide a fair amount of specification as to the term
“disqualified person.” Consequently, for now it may be that individuals will be more likely to be found to
be disqualified persons under section 4958 than insiders under section 501(c)(3). Thus, today the following
persons may not be found to be insiders but may be disqualified persons because, depending on the facts
and circumstances, of being in a position to exercise substantial influence over the organization: a
substantial contributor to the organization; a person who manages a discrete segment or activity of the
organization that represents a substantial portion of the activities, assets, income or expenses of the
organization; a person whose compensation is primarily based on revenues derived from activities of the
organization which activities the person controls; and a person who founded the organization. This list is
not intended to be exhaustive. Because the question of who is and who is not an insider or disqualified
person in many cases is determined by the facts and circumstances of each case, at the edges the answer is
not clear. However, as the law develops in the future, with the exception noted, the two terms may come to
mean the same thing.
14
Subsection 1 – Excessive or Unreasonable Compensation
Part V of the Form 990 requires the filer to list the names, addresses and compensation of
all officers, directors, trustees and key employees.20 Part I of Schedule A requires the
filer to list the compensation of the five highest paid employees (who receive more than
$50,000) other than those listed at Part V of the Form 990 proper. We believe that in the
great majority of cases where excessive compensation constitutes a violation of the noinurement prohibition, the parties who received compensation would be included on
either Part V or Part I of Schedule A. Clearly officers and directors are insiders.21 Key
employees are also almost certainly insiders. Here is how the Instructions define the term
“key employee:”
A ”key employee” is any person having responsibilities or powers similar to
those of officers, directors, or trustees. The term includes the chief management
and administration officials of an organization (such as an executive director or
chancellor) but does not include the heads of separate departments or smaller
units within an organization.22
A chief financial officer and the officer in charge of administration or program
operations are both key employees if they have authority to control the
organization’s activities, its finances or both.23
19
As suggested in the Introduction to this section of the paper, this possibility may deter misreporting and
ultimately misbehavior. With Forms 990 available on the Internet, such a result becomes all the more
likely.
20
It also elicits each such person’s title and average hours per week devoted to the position.
21
While the Instructions do not define the terms officers and directors (or trustees), it is virtually certain
that they are meant to cover those persons that state nonprofit laws call the board of directors, and these
persons are insiders. The definition of “key employee” which follows above in the text notes that “a ‘key
employee’ is any person having responsibilities or powers similar to those of officers, directors, or trustees”
and this strongly suggests that the meaning of the terms directors, etc., are as just stated.
22
On the question of who constitutes a head of a separate department, here is what the Instructions say:
“The ‘heads of separate department’ reference applies to persons such as the head of the radiology
department or coronary care unit of a hospital or the head of the chemistry, history, or English department
at a college. These persons are managers within their specific areas but not for the organization as a whole
and, therefore, are not key employees.” Note, however, as suggested above, they may be disqualified
persons under section 4958.
23
As suggested, at the edges there may be some persons whose relationship with an organization offers
them an opportunity to make use of the organization’s income or assets for personal gain and who would
thus be insiders for purpose of the no-inurement prohibition but who are not key employees. For example,
15
In most cases it will only be key employees, officers or directors that would be in a
position to direct their organization to make improper payments (including awarding
excessive compensation) to themselves.24 If one adds the next five highest paid
employees to the list of officers, directors and key employees, in most cases the net will
have been cast wide enough to pick up all possible insiders.
Let us recall for a moment that we are considering the problem of excessive
compensation. Below we shall discuss what constitutes excessive compensation. As a
preliminary note, a reader of the Form 990 may be interested in the amount of salary of
the highest paid employees even if the those salaries do not rise to the level of being
excessive compensation. Such a reader may be interested in finding out what people are
being paid in positions similar to ones she may be interested in.25 Or more generally, the
reader may have views on what she believes to be appropriate compensation levels for
organizations like the filer, and learning what the filer actually pays its top employees
may be relevant to her in forming an opinion about the filer. For example, the reader
may have opinions on how much charities should pay their staff and may believe that the
salaries paid by a particular charity are inappropriate. These concerns do not inherently
raise regulatory issues or questions of improper behavior, the main focus of this section,
but as we are considering compensation, they are mentioned here. This subject is
discussed below at Chapter 2.
Part V of the Form 990 and Part I of Schedule A require that the full compensation be set
forth for each individual listed. For both Part V and Part I, column (C) calls for an
in some circumstances a substantial contributor to the filer may be an insider. As also suggested, the term
"disqualified person” for section 4958 purposes may have a broader application that the term “insider” and
therefore a broader application than the term “key employee.” (Perhaps, over time, IRS guidance will
move towards having all these terms mean the same thing. If this develops, the persons to be listed at Part
V will be greatly expanded.) What is clear, however, is that the key employees are insiders and
disqualified persons, and in this latter regard, the provisions of section 4958 will apply to them if they are
parties to an excess benefit transaction.
24
As suggested above, it is by virtue of this power that they become insiders.
25
For example, the reader might be a board member of an organization similar to the filer’s that is in the
process of deciding what to pay its executive director. The compensation of the filer’s executive director
will be listed at Part V.
16
individual’s basic compensation26; column (D) for deferred compensation and employee
benefits;27 and column (E) for expense account and other allowances.28 It is all there. If
there are questions about a person being paid too much, and, if the form has been
completed correctly, it is likely that all the amounts paid will be picked up by Part V and
Part I of Schedule A. It is not uncommon to encounter a Form 990 that lists payments
only under the compensation column, column (C), and reports nothing under column (D)
(employee benefits, etc.) or column (E) (expense account and other allowances). Only a
few nonprofits pay compensation that must be reported under column (E), but many
provide their employees with employee benefits reportable at column (D). It may, of
course, be that the individuals listed have not received any employee benefits, etc., but it
may also be that the filer is hiding part of one or more individual’s total compensation
package. A careful reader will be alerted. Frequently filers do not report compensation
on Part V but rather attach a schedule and report the information on the schedule. This is
usually the case where the filer has a relatively large board. There is only space to report
ten names on Part V. It is also not uncommon for a filer to list only board members and
fail to list key employees. This may simply be the result of not understanding what Part
V requires but again it might be intentional and a careful reader will be alerted.
The Instructions provide for column (C): “For each person listed, report salary, fees, bonuses, and
severance payments paid. Include current-year payments of amounts reported or reportable as deferred
compensation in any prior year.”
27
The Instructions provide for column (D): “ Include in this column all forms of deferred compensation
and future severance payments (whether funded or not funded; whether or not vested; and whether or not
the deferred compensation plan is qualified under section 401(a)). Include also payments to welfare benefit
plans on behalf of officers, etc. Such plans provide benefits such as medical, dental, life insurance
severance, disability, etc. Reasonable estimates may be used if precise figures are not readily available.
Unless the amounts were reported in column (C), report, as deferred compensation in column (D), salaries
and other compensation earned during the period covered by the return but not yet paid by the date the
organization files its return.”
28
The Instructions provide for column (E): “Enter both taxable and nontaxable fringe benefits (other than
de minimis fringe benefits described in section 132(e)). Include expense allowances or reimbursements that
the recipients must report as income on their separate income tax returns. Examples include amounts for
which the recipient did not account to the organization or allowances that were more than the payee spent
on serving the organization. Include payments made under indemnification arrangements, the value of the
personal housing, automobiles, or other assets owned or leased by the organization (or provided for the
organization’s use without charge), as well as any other taxable and nontaxable fringe benefits. See Pub.
525 for more information.” The complexities of expense account and allowance payments are beyond the
scope of this document. For information on this subject, see, P. Swords, The Form 990 as an
Accountability Tool for 501(c)(3) Nonprofits, 51 The Tax Lawyer, 571, 588-591 (1998).
26
17
What constitutes excessive or unreasonable compensation? We believe that what is
meant by excessive or unreasonable compensation for purposes of the no-inurement rule
is the same as what is meant by those terms under section 4958.29 Here is what the
Treasury Regulations under section 4958 say about reasonable compensation:
The value of services is the amount that would be ordinarily be paid for like
services by like enterprises (whether taxable or tax-exempt) under like
circumstances (i.e., reasonable compensation). Treas. Regs. §53.4958 –
4(b)(1)(ii)
Thus, generally speaking, to determine whether someone’s compensation is reasonable, a
comparison should be made of the compensation being paid to persons doing similar jobs
in similar enterprises in the same geographical area. In many cases, if the reader knows
about such organizations, she may review their Forms 990 to ascertain what they are
paying to individuals holding similar positions to the one that she is considering. (This
has become an easy task now that organizations’ Forms 990 are available on the
Internet.)
If compensation listed at Part V appears to a reader to be so high as to raise some
questions as to whether it might be excessive, as will be explained in a moment, it is
likely that the filer may have developed some documentation supporting the
compensation’s reasonableness in order to comply with safe-harbor provisions of the
section 4958 regulations. A reader could request to see this documentation. It is unlikely
that the organization would comply with her request. It would not be legally required to.
But such failure to comply in itself may be significant to the reader.
We will now briefly explain the safe-harbor provisions. Under the section 4958
Treasury Regulations, compensation arrangements between an organization and a
disqualified person are presumed to be reasonable if the following conditions are
29
This follows since, as noted above, section 4958 was introduced in large part to provide the Internal
Revenue Service with an alternative remedy to revoking an organization’s tax exemption in cases where
there has been improper inurement.
18
satisfied. First, the board or a committee of the board has approved the compensation.
Second, the governing body awarding the compensation relied upon data as to
comparable salaries. And third, the board adequately documented the basis for its
compensation award. 30 Thus, as suggested, documentation supporting the
compensation’s reasonableness may be available.
As noted above, a reader of the Form 990 may be interested in compensation information
generally and not only to determine whether a filer has paid anyone excessively. For
example, a reader may be canvassing a number of similar organizations to learn what
they are paying their executive directors. If any one or more of these organizations had
prepared the documentation just described and were willing to share it with others, that
would be very helpful for this inquiry.
At the bottom of Part V there appears Line 75, asking the following question:
Did any officer, director, trustee, or key employee receive aggregate
compensation of more than $100,000 from your organization and all related
organizations, of which more than $10,000 was provided by the related
organization? If “Yes” attach schedule.
Without this question, if, for example, a key employee’s compensation were generously
supplemented with payments from related organizations which the filer influenced or
controlled, the existence of such an arrangement would not be disclosed on the filer’s
Form 990. Indeed, what was reported on the Form 990 might suggest that the key
employee was being compensated at a modest level that may not have been the case if the
compensation from related organizations31 was taken into account. Line 75 would
Treas. Regs. section 53.4958-6(a) provides in part: “Payments under a compensation arrangement are
presumed to be reasonable, and a transfer of property, or the right to use property, is presumed to be at fair
market value, if the following conditions are satisfied -- (1)The compensation arrangement or the terms of
the property transfer are approved in advance by an authorized body of the applicable tax-exempt
organization ... composed entirely of individuals who do not have a conflict of interest ... with respect to
the compensation arrangement or property transfer ... ; (2) The authorized body obtained and relied upon
appropriate data as to comparability prior to making its determination ... ;and (3) The authorized body
adequately documented the basis for its determination concurrently with making that determination ... .”
31The Instructions are quite specific about the definition of a "related organization."
"A 'related
organization' is any entity (whether tax-exempt or taxable) that the filing organization directly or indirectly
30
19
disclose such an arrangement. If the question is answered “Yes,” a schedule must be
attached listing the names of each officer, key employee, etc., receiving such
compensation, the name of each related organization that provided the compensation and
the amount of compensation each provided (using the same format required by columns
(C) through (E) of Part V). Such disclosure will provide no indication of whether the key
employee was receiving compensation from related organizations essentially for the
services s/he was providing to the related organization or for services s/he performed for
the filing organization. Consequently, more information would have to be known about
all these payments before it could be concluded that anything improper had occurred.
However, the mere disclosure of the payments and their amounts may raise questions.32
Payments of compensation are also listed at Schedule A’s Part II (Compensation of the
Five Highest Paid Independent Contractors for Professional Services). Here, according
owns or controls, or that directly or indirectly owns or controls the filing organization. For example, if
Organization A owns 90% of B, and B owns 80% of C, then A would directly own 90% of B and indirectly
own 72% (90% of 80%) of C.
”Owns” means holding (directly or indirectly) 50% or more of the voting membership rights, voting stock,
profits, interest, or beneficial interest.
”Control” means that:
1. Fifty percent (50%) or more of the filing organization's officers, directors, trustees, or key employees are
also officers, directors, trustees, or key employees of the second organization being tested for control;
2. The filing organization appoints 50% or more of the officers, directors, trustees, or key employees of the
second organization being tested; or
3. Fifty percent (50%) or more of the filing organization's officers, directors, or key employees are
appointed by the second organization.''
Control exists if the 50% test is met by any one group of persons even if collectively the 50% test is not
met.
Whether or not any elements of ownership or control are present, a related organization also includes;
* A supporting organization operated in connection with the filing organization where one of the purposes
of the supporting organization is to benefit or further the purposes of the filing organization; and
* A supported organization operated in connection with the filing organization where one of the purposes
of the filing organization is to benefit or further the purposes of the supported organization.
32 In those instances where the compensation received from related organizations is wholly justified (e.g.,
the key employee performed services for the related organization that were in addition to those he
performed for the filing organization and such services were wholly unrelated to what he did for the filing
organization), it is very likely that the filing organization will fully reveal all the material elements of the
various compensation payments in order to remove any suggestion of impropriety. The absence of such
full disclosure may further fuel suspicions.
There may be elements of tax fraud if an officer or employee of an exempt organization received some or
all of his compensation from a taxable subsidiary for which he performed few or no services. Without Line
75, compensation paid by the taxable subsidiary would not be disclosed to the public since its tax return
would not be open to public inspection. Even if the related organizations paying compensation are taxexempt, Line 75 is invaluable because a Form 990 reader would otherwise have to inspect the returns of all
20
to the instructions, a filer must list the five highest paid independent contractors (whether
individuals or firms) who received over $50,000 for the year. The Instructions state:
“Examples of such contractors include attorneys, accountants and doctors.” Independent
fundraisers would also be included here. Independent contractors will very rarely be
insiders, so Part II will probably not disclose violations of the no-inurement rule.
Nevertheless, a reader might be interested if some of the payments listed there seem very
high. She may want to know, for example, why attorney fees seemed unusually high. Or
she may be influenced by large fees paid to fundraisers. These questions may not be
questions regarding the filer’s compliance with the law, but they could reflect on the
management of the filer. They are discussed at Chapter 2 below. At the extreme,
however, they may raise a question about the filer’s eligibility for tax exemption. It has
been suggested that if a section 501(c)(3) organization has been so irresponsibly
managed as to in effect give away the store to an outside party, it could be argued that it
was operated to a significant degree for the private benefit of that outside party and thus
breached the no-private-benefit rule.33
Subsection 2 – Other Self-Dealing and Improper Transfers
We next consider payments to individuals that violate the rule against improperly
benefiting individuals in ways other than paying excessive or unreasonable
compensation. These payments will either be the result of some self-dealing transaction
or simply the improper transfer of a filer’s assets to individuals for no apparent reason
(e.g., looting or quasi-looting). The sale by a board member of property in excess of its
fair market value would be an example of an improper self-dealing transaction. The
sheer siphoning off of filer funds to an executive director without anyone knowing about
it would be an example of the second category of improper transfer. Many of these
transactions will be excess benefit transactions under section 4958 of the Code that would
give rise to tax liability.
related organizations to find additional compensation, assuming s/he could identify all the related
organizations.
33
See, United Cancer Council, Inc. v. Commissioner, 165 F. 3d 1173 (1999).
21
If these payments are made to certain individuals (e.g., board members or key
employees), they must be reported at Schedule A, Part III, Line 2.34 Line 2 is set out
immediately below:
During the year, has the organization, either directly or indirectly, engaged in any of
the following acts with any of its trustees, directors, officers, creators, key employees,
or members of their families, or with any taxable organization with which such person
is affiliated as an officer, director, trustee, majority owner, or principal beneficiary:
[a] Sale, exchange, or leasing of property?
[b] Lending of money or other extension of credit?
[c] Furnishing of goods of services or facilities?
[d] Payment of compensation (or payment or reimbursement of expense if more than
$1,000)?
[e] Transfer of any part of its income or assets?
If the answer to any question is “Yes,” attach a detailed statement explaining the
transactions.
On the face of it, this would be the place where the deepest searching for evidence of
improper transfers should be made, self-dealing being perhaps the paradigmatic instance
of such abuses.35 This question appears to pick up all and any transfers of value to board
members, key employees, etc. Thus, all improper, as well as proper, transfers are
included. The parties to transactions with the filer that are listed in Line 2 (i.e., trustees,
officers, creators, key employees, or members of their families) will in most cases include
those individuals in a position to have directed the filer to make an improper transfer. In
most cases we believe that abusive transfers are made by key employees, such as the
executive director or chief financial officer or by board members.36 If the answer to any
34
As discussed below, it is, of course, not very likely that they will be reported if they were improper.
As noted below, transactions between listed persons (i.e., trustees, directors, key employees, etc.) that are
of benefit to the filer and in no way improper are also reported here.
36
In this respect, the theory of the listing is similar to the listing of persons for whom compensation must
be reported at Part V of the Form 990. But the net cast by Line 2 is broader than that cast by Part V. Line
2’s list includes creators and the members of the families of trustees, etc.
35
22
of the questions is "Yes," the question calls for the attachment of a detailed statement
explaining the transactions.37
Of course, if there were any improper self-dealing transactions or other improper
transfers made during the year covered, it is not very likely that the preparer of the form
would answer any part of Line 2 "Yes" and then attach a detailed statement explaining
the transactions. To do so would be in effect to confess to such things as prohibited
inurement or excess benefit transactions under section 4958 of the Code. Therefore,
where improper self-dealing transactions have occurred, the answers to these questions
may very likely be "No," and this will frustrate any search for wrongdoing. However, as
suggested above, there is always the possibility that someone examining the Form 990
will know of some act of self-dealing that occurred during the period covered and will
then know that Line 2 was improperly filled out and that it is likely that this was done so
intentionally. This would give rise to the possibility of further action.38
Let us now consider some of the principal ways that abusive transfers may be made
between what we will call a “Line-2 party”39 and the filer. First, a Line-2 party may have
sold or leased property to the filer at a price above its fair market value40 or the filer may
have sold or leased property to a Line-2 party at a price below fair market value. In any
of these cases, the filer would be required to answer Line 2a, “Yes” and attach a detailed
statement explaining the transactions.
37
Neither the form itself nor the Instructions to Line 2 call for the reporting of names. It may be, however,
that to furnish an attachment providing a “detailed statement explaining the transactions” without naming
the parties to the transactions would be to file an incomplete return.
As will be explained below, there are many self-dealing transactions that are made for the benefit of the
filer and are not in any ways abusive. They must also be disclosed on Line 2, but in the attached statement
their benign nature will be revealed.
38
In addition, those who are in control of preparing the Form 990 will know that persons may examine it
who know about an act of self-dealing (and that such persons may examine it on the Internet without those
in control of preparing the Form 990 knowing about the examination), and this knowledge may deter some
improper behavior.
39
A Line-2 party will be a trustee, director, officer, creator, key employee, or a member of their families.
40
The example usually given of self-dealing involves a board member selling a building she owns to the
nonprofit organization on whose board she sits for a price considerably in excess of the building’s fair
market value. If, for example, the building is worth $750,000 and it is sold for $1,000,000, the $250,000
23
Second, the filer may have lent money to a Line-2 party at an interest rate below the
market rate or on some other favorable conditions, or a Line-2 party may have made a
loan to the filer at an interest rate above the market or on some other unfavorable
conditions.41 In any of these cases, the filer would be required to answer Line 2b, “Yes”
and attach a detailed statement explaining the transactions.
Third, the filer may have hired a Line-2 party to perform services for it for consideration
above what the market would bear or on some other favorable conditions. For example,
the filer may engage a board member to place its liability insurance at a brokerage rate in
excess of what would normally be paid and the engagement may have been made without
canvassing other brokers to ascertain whether they might perform superior services at a
lower price.42 Another example would involve the filer making its facilities available to a
Line-2 party for some private reason of the Line-2 party (e.g., his daughter’s wedding)
either without the Line 2 party compensating the filer for the use of the facilities or
compensating the filer at a rate below that at which the filer usually makes available the
excess above fair market value that she received constitutes in effect the improper siphoning off of assets
that belong to the filer into the hands of the board member.
41 Lending money to a Line 2 party, as suggested, may give pause. An article in a publication prepared by
the IRS for its agents that work with tax-exempt organizations has this to say about loans to key employees:
A loan between an EO [Exempt Organization] and another person associated with the EO invites
close scrutiny by the Service, particularly if the terms of the loan by an EO to an
employee/independent contractor are more favorable than terms from unrelated lenders (e.g.,
lower interest rate, less security). Even if the loan terms are similar to those available from
unrelated lenders, the mere existence of a “private” source of loan credit available to executives
or highly compensated employees/independent contractors which is not available to rank-andfile employees or other members of the general public may be viewed as a form of inurement.
Thomas and Bloom, Reporting Compensation on Form 990, 1995 (for FY 1996) Exempt
Organizations Continuing Professional Education Technical Instruction Program Textbook, 195
at 206.
If the loan is below market, the foregone interest may well give rise to income to the borrower under
section 7872 of the Code and be treated as a compensation-related fringe benefit that would require that it
be listed as part of the key employee's compensation on the organization's Form 990 (Column (E) of Part
V). Such amounts would have to be taken into account in determining whether the total compensation paid
to the key employee was reasonable and not excessive for purposes of section 4958 of the Code.
Under the laws of some states, loans to members of nonprofit boards are prohibited. See N.Y. Not-ForProfit Corp. Law section 716 (McKinney 1997).
42
If the transaction in question involved a board member furnishing a service to her organization for which
she received a fee as an independent contractor and the fee was for more than $50,000 and she was one of
the five highest paid independent contractors, she would be listed in Part II of Schedule A. It would seem
also that she should be listed here. The Instructions for Line 2d, covering compensation, provide that if the
compensation is already listed in Part V of the form 990 proper, it need not be listed at Line 24. No such
instruction is given for payments to independent contractors.
24
facilities.43 Allowing a Line-2 party to use an automobile belonging to the filer for his
private use for more than a de minimis amount of time would be another example of an
abusive transfer. Or a Line-2 party may have furnished goods, etc., to the filer at price
above that which would be considered reasonable. In any of these cases, the filer would
be required to answer Line 2c, “Yes” and attach a detailed statement explaining the
transactions.
Finally, the filer may have transferred funds or other assets to a Line-2 party for no
reason other than to shift assets of the filer improperly into the private hands of the Line2 party, that is, to loot the filer. This may involve the mere transfer of cash or it may
involve paying bills of the Line-2 party where such payments are not treated as reportable
compensation. These payments might include defraying a Line-2 party’s children's
tuition or club dues and expenses in circumstances where the club was not used by the
Line-2 party to advance the exempt organization's exempt purposes or the furnishing of a
home to live in, the value of which would not be excluded from the key employee's gross
income under section 119 of the Code.44 Gifts45 and transfers of income or other assets
not treated as compensation (such as flat-out looting) would be reported here. In any of
these cases, the filer would be required to answer Line 2e, “Yes” and attach a detailed
statement explaining the transactions. It is barely conceivable that this question would be
answered "Yes," but again if someone knew of such transfers and had access to the Form
990 that answered the question "No," further action might be suggested.
It should be realized that the transactions covered by Line 2 in many cases might be of
benefit to the filer and the farthest thing from an improper act. For example, a board
member might have sold the filer some property at a price below market value. Or a
43
The converse would also constitute an example of an abusive transfer. Here the Line-2 party would have
made available facilities she owned or controlled for a price in excess of what the market would usually
bear. The abusive transfer would be the payment to the Line-2 party by the filer for the use of the facilities.
44
Briefly, section 119 of the Code excludes the value of lodging provided to an employee if the employee
is required to accept such lodging on the premises of his employer as a condition of her employment.
45
Under section 102(c) of the Code, a gift to an employee is not excluded from gross income and therefore
should be reported as taxable compensation to the employee unless it is de minimis.
25
board member might have made a loan to the filer to help it through a bad period.46 In
these cases, the filer would also answer the relevant Line 2 question “Yes.” These
transactions would be described in the attached statement where it would be explained
that they were made for the benefit of the filer and not the key employee. Indeed, if the
filer answers any of the Lines 2a through 2e “Yes” and does not attach a statement
explaining the transaction, a reader might suppose that the filer was not disclosing aspects
of the transactions that it believed would embarrass it. In these circumstances a
determined reader might inquire of the filer why no statement was attached.
Line 2d asks for the payment of compensation (or payment or reimbursement of
expenses if more than $1,000) to any Line-2 party. The Instructions make clear that: "If
the only compensation or payment relates to amounts reported in Part V of Form 990, or
Part IV of Form 990-EZ, check ‘Yes’ and write ‘See Part V, Form 990,’ or ‘See Part IV
of Form 990-EZ,’ on the dotted line to the left of the entry space." Here is where an
organization would list compensation in excess of $1,000 paid to members of the families
of officers, directors, key employees, etc. Such payments may give pause.
As suggested above, many transactions reported at Line 2 may be potential excess benefit
transactions under section 4958.47 Consequently, the filer may have developed
documentation in support of the transaction to take advantage of the safe-harbor
provisions described above.48 If after reading the statement explaining the transaction,
questions still remain about its propriety, a request might be made of the filer to see such
documentation. As noted above, the filer would not be required to comply with this
request, but its failure to do so may itself have some significance.
Of course, as suggested above, if any of these payments or transactions were “innocent,”
it is likely that they would be fully explained in the attached detailed statement describing
Such a loan might reflect on the filer’s financial condition and this may be of interest to the reader, but it
would not seem to indicate any improper behavior.
47
Most Line-2 parties will be disqualified persons.
48
See text at notes 30-32.
46
26
them. If they were not “innocent,” it is unlikely the question would be answered “Yes,”
but as suggested above, this might trigger further examination.
Note, Line 2 asks whether "the organization, either directly or indirectly, engaged in any
of the following acts...” The word "indirectly" covers the situation where the sale or loan,
etc., was made to or by an affiliate of the filing organization, although the Instructions do
not make this clear and there is no indication of how "related" the second, affiliated
organization needs be to have the transaction listed here.49
It should be noted that there is one kind of self-dealing transaction that will not be picked
up by the Form 990, namely, what is sometimes called appropriation of a corporate
opportunity. For example, if a board member learns of an opportunity of interest to the
nonprofit through his service on the nonprofit’s board and takes advantage of the
opportunity for himself,50 this may not be a strictly self-dealing transaction but it would
be a clear conflict of interest and improper. The Form 990 would not pick it up.
Subsection 3 – Miscellaneous Provisions
There are several other lines on the Form 990 that a reader may want to examine to find
out whether there might be some suggestion of misbehavior.
To begin, Part II (Statement of Functional Expenses), reports payments for expenses and
in some cases the amounts of these payments may raise some misgivings. If big numbers
appear at Line 30 (Professional fundraising fees) one may question whether the filer’s
assets are being transferred improperly to fundraisers. For example, one may question
49
Because the preamble to Line 2 ends with the phrase "or with any taxable organization with which such
person is affiliated as an officer, director, trustee, majority owner, or principal beneficiary...” it may suggest
that only transactions between key employees and taxable organizations need to be listed here and that
transactions between key employees and affiliated 501(c)(3)s need not be listed. This would surely be an
incorrect reading, but perhaps the instructions under Line 2 ought to be expanded to eliminate the
possibility of such a reading.
50
For example, a board member purchases a building that the nonprofit would like to buy at a favorable
price because she has learned in her capacity as a board member that the building is on the market.
27
whether the filer has been so poorly managed that it might be found that it was operated
to a significant degree for the private benefit of that outside party and thus breached the
no-private benefit rule.51 There may be an inconsistency between amounts shown here
and amounts shown elsewhere on the return. For example, as suggested above in our
examination of Part II of Schedule A, if large amounts are listed at Line 30 but little is
shown at Part II of Schedule A, some pause may be taken.52 It should also be noted that
better information on potential problems having to do with professional fundraisers may
be found on reports filed with state charities offices, many of which require that contracts
with professional fundraisers (PFRs) be filed.53
If big numbers are reported at Line 31 (Accounting fees), the amounts may be suspicious,
conceivably suggesting friends being paid or cover up work requiring high fees, etc. Big
numbers at Line 32 (Legal fees) may also raise questions for the same reasons.
High travel and conference expenses at Lines 39 (Travel) and 40 (Conferences,
conventions and meetings) might be cause for alarm. As will be noted below in Chapter
2, here is where an organization would list the aggregate of payments to individuals for
potentially extravagant and lavish expense account advances and reimbursements.
Line 43 (Other expenses) is where the filer reports investment counseling and other
professional fees. Big numbers may be suspicious: friends being paid, etc. As noted
below in Chapter 2, some informed Form 990 observers believe that it is not uncommon
for a filer that wants to hide certain payments (say to fundraisers) to list them at Line 43.
Here also is where penalties, fines and judgments are listed which may be grist for those
with reservations about the filer.
51
See, United Cancer Council, inc. v. Commissioner, 165 F. 3d 1173 (1999) and the text at Note 35 above.
Of course, if all fundraising is done in-house and outside fundraising independent contractors are not
used, that could explain the discrepancy.
53 Some states require supplemental information designed to give a much clearer picture of fundraising
expenses than the Form 990 provides. For example, some require a breakdown of each solicitation
campaign showing gross proceeds, outside fundraiser fees, other expenses, and net proceeds to the exempt
organization.
52
28
Part VI (Other Information) bears some attention. Part VI is comprised of over 25
questions that call for a Yes or No answer.54 Line 76 asks whether the filer engaged in
any activity not previously reported to the IRS and if the filer answers the question
“Yes,” it is to attach a detailed description of each activity. Line 77 asks whether any
changes were made in the filer’s organizing or governing documents but not reported to
the IRS. If the answer is “Yes,” a conformed copy of the changes must be attached. If
either of these questions is answered “Yes,” quite apart from whether any of the changes
reflect untoward activities, a determined reader will want to examine the attachments to
find out more about the filer. They may, however, suggest changes that might raise some
misgivings.
Line 81 directs the filer to enter the amount of political expenditures it made during the
year. A political expenditure is one made to advance or hamper the election of anyone to
a political office.55 Section 501(c)(3) organizations are prohibited from making such
expenditures, and if they do so they may have their tax-exemption revoked. If an
organization has made such an expenditure, it is not likely that it will report it. It may be,
however, that the reader of its Form 990 knows that such an expenditure was made and
this may be significant to the reader if she observes that the filer left Line 81a blank.
Note that section 501(c)(4) organizations may make limited political expenditures and
that this line is provided mostly to elicit information from such section 501(c)(4)
organizations. (As noted in the Introduction, section 501(c)(4) organizations are also
required to file the Form 990.) The subject of political activity is explored further below
in Section II, subsection 4.
Line 83 asks whether the filer complied with the public inspection requirements for
returns and exemption applications. This line relates to the requirement that 501(c)(3)
54
A number of these questions do not relate to section 501(c)(3) organizations and so are not discussed
here.
55 Here is how the Instructions define the term: “A political expenditure is one intended to influence the
selection, nomination, election or appointment of anyone to a Federal, state, or local public office, or office
in a political organization, or the election of Presidential or Vice Presidential electors. It does not matter
whether the attempt succeeds.”
An expenditure includes a payment, distribution, loan, advance, deposit, or gift of money, promise, or
agreement to make an expenditure, whether or not legally enforceable.”
29
organizations must show or send their Forms 990 for the past three years and their Form
1023 to anyone who comes to their office or writes and asks to see them. It is hard to
imagine that an organization would answer this question "No." Thus, if someone knew
that the organization in fact did not comply with the inspection requirements, which
would ordinarily include anyone who asked to see an organization's Form 990 and was
rebuffed,56 suspicions may be aroused.
Line 89a directs the filer to report the amount of tax imposed on the filer during the year
under sections 4911, 4912 and 4955. Section 4911 relates to filers who have elected
under section 501(h) to have the question of whether they have engaged in too much
lobbying measured by the amount of their lobbying expenditures. As explained below in
Section II, subsection 4, groups who have made the election under section 501(h) and
have made over a specified amount of lobbying expenditures must pay a tax on the
excess. If taxes are imposed under section 4911 during the year, they must be reported
on Line 89a. If such amounts are reported on Line 89a it may suggest to the reader that
the filer is aggressive in its lobbying efforts. The tax imposed under section 4912 is on
the lobbying expenditures of groups that have not made the election and have had their
tax-exemption revoked on account of engaging in too much lobbying.57 We believe that
a reader of such an organization’s Form 990, having learned that its tax-exemption has
been revoked, will have little interest in finding out anything else about it. Taxes are
imposed on political expenditures under section 4955. Political expenditures generally
are those made to influence someone’s election to public office. As explained above, if a
section 501(c)(3) makes these expenditures, it may loose its tax-exemption. In cases
where a section 501(c)(3) has made a relatively small amount of political expenditures
and revocation of its tax-exemption seems too harsh to the IRS, a tax under section 4955
may act as an intermediate sanction.
56
There is evidence that this happens often.
This tax was imposed to address the problem of a section 501(c)(3) organization being set up and taking
tax-deductible dollars and then using these dollars to engage in excess lobbying while expecting all the
while that its section 501(c)(3) exemption would consequently be revoked and planning when this
happened to just cease operations. Because the tax is imposed also on the managers of the organization,
these schemes have presumably been deterred or stopped.
57
30
Line 89b asks whether the filer engaged in any section 4958 excess benefit transactions
during the year or whether it became aware of excess benefit transactions from a prior
year. If the filer answers the question “Yes,” it must attach a statement explaining each
transaction. A “Yes” answer with a detailed explanation would be of obvious concern to
a reader interested in finding out whether the filer engaged in any questionable activities.
If the filer answered the question “No,” and the reader knew of such a transaction or
transactions, that in itself would be revealing.
Line 89c directs the filer to report the amount of taxes imposed on the filer’s managers or
disqualified persons during the year under sections 4912, 4955 and 4958. In addition to
taxes being imposed upon the filer (see comments above on Line 89a), taxes may also be
imposed under section 4912 on a filer’s managers who approved the lobbying
expenditures giving rise to the tax on the filer under section 4912 knowing they were
lobbying expenditures. Similarly, taxes may also be imposed under section 4955 on a
filer’s managers who approved the political expenditures giving rise to the tax on the filer
under section 4955 (see comments above on Line 89a) knowing they were political
expenditures. In the case of taxes under section 4912, which would be imposed in
circumstances where the filer had lost its tax exemption, as suggested above, it is hard to
see how the reader of the filer’s Form 990 would be interested in pursuing its
examination of the filer. Where taxes have been imposed under section 4955 (and the
filer’s tax- exemption has not been revoked), a reader of the filer’s Form 990 may want to
find out more about the filer’s political activity.
As indicated above, if the filer has entered into an excess benefit transaction with a
disqualified person, a tax will be imposed on the disqualified person and on managers of
the filer who approved the transaction knowing it was an excess benefit transaction. The
amount of such taxes imposed during the year should be included in the amounts reported
at Line 89c. As excess benefit transactions are one of the primary ways that section
501(c)(3) organizations abuse their nonprofit status, the presence and amount of these
taxes will be of obvious interest to the reader of the filer’s Form 990.
31
Subsection 4 – Transactions with Related Organizations
An important frontier for potential abuse is the use of related organizations to make
improper transfers to private individuals of income or assets of a section 501(c)(3)
organization that should otherwise have been spent to advance the transferor
organization's exempt purpose. This problem was very well illustrated in the United Way
of America (UWA) situation of some years ago which, among other things, involved
UWA setting up spin-off corporations, in which UWA officers had an interest, to which
loans were made. The spin-off corporations that then took actions that benefited William
Aramony, the Chief Executive Officer of United Way of America, and his family and
friends.
The relevant sections of the Form 990 for this problem are Lines 75, 80, 88 and Part IX
of the Form 990, and Line 2 of Part III and Part VII of Schedule A.
Part V Line 75 asks: “Did any officer, director, trustee, or key employee receive
aggregate compensation of more than $100,000 from your organization and all related
organizations, of which more than $10,000 was provided by the related organizations? If
"Yes," attach schedule.” This question as it relates to compensation has been discussed
above in subsection 1. While the definition in the Instructions covering the meaning of
"related" is very good, this question (restricting itself as it does to "compensation") would
seem to leave out the following transfers to officers, etc., of the filing organization by a
related organization:
1. Loans to officers, etc.
2. Payments that would not be compensation to officers, etc.
3. Providing to officers, etc., the use of assets (residences, cars, etc.) that are not
compensation.
4. All manner of non-compensatory payments and transfers to family members and
friends of officers, etc.
32
These items should be picked up by Schedule A's self-dealing question (Part III, Line 2).
But, as suggested in the discussion above on that question, it may not be clear to all the
preparers of the Form 990 that the word "indirectly''58 includes sales and loans, etc., from
all related organizations, as the clause "with any taxable organization" may suggest that
only sales or loans, etc., from taxable organizations should be listed here; thus, such
transactions with affiliated 501(c)(3) organizations might not be included. As a result,
non-compensation transfers to key employees by related organizations would be left out
of the Form 990.
Line 80 asks: “Is the organization related (other than by association with a statewide or
nationwide organization) through common membership, governing bodies, trustees,
officers etc., to any other exempt or nonexempt organization?” All the filer has to do is
answer "Yes" or "No" and if "Yes," indicate whether the related organization is exempt
or nonexempt. There is no need to disclose any use of the related organization, nefarious
or otherwise. One may suppose that where there is a related organization, and some
suspicion that the filing organization may be inclined to use the second organization for
improper purposes, that the mere disclosure of a related organization will give a
determined sleuth something to go after, but this seems pretty slim.
Line 88 asks: “At any time during the year, did the organization own a 50% or greater
interest in a taxable corporation or partnership, or an entity disregarded as separate from
the organization under Treasury Regulations sections 301.7701-2 and 301.7701-3? If
‘Yes,’ complete Part IX”. Part IX is entitled “Information Regarding Taxable
Subsidiaries and Disregarded Entities.” Part IX column (A) asks for the name, address
and employer identification number of the corporation, or disregarded entity59 in which
the filer held a 50% or greater interest at any time during the year. Column (B) asks for
58
Question 2 reads as follows: "During the year has the organization, either directly or indirectly, engaged
in any of the following acts with any of its trustees, directors, officers, creators, key employees, or
members of their families, or with any taxable organization with which any such person is affiliated as an
officer, director, trustee, majority owner, or principal beneficiary: (a) Sale, exchange, or leasing of
property? (b) Lending of money or other extension of credit?" etc.
59
Treasury Regulations section 301.7701-1(a)(4) reads as follows: “(4) Single owner organizations. Under
sections 301.7701-2 and 301.7701-3, certain organizations that have a single owner can choose to be
recognized or disregarded as entities separate from their owners.”
33
the percentage of ownership interest. Column (C) asks for the nature of the activities of
those organizations listed in column (A). Columns (D) and (E) call for the total income
and end-of-year total assets respectively of the entities listed at column (A) as reported on
their Federal tax return for the year ending within the year covered by the filer’s Form
990.60 Like Line 80, there appears to be no need to disclose any particular uses of the
related organization. However, also like Line 80, in cases where the filer owns more than
a 50% interest in a taxable corporation, etc., a determined reader may wish to find out
more about the relationship.
SECTION II
Other Regulatory Concerns Covered by the Form 990
Introduction
In this section we consider various parts of the Form 990 where information is elicited to
help government regulators enforce the law; this information is not usually relevant to
wrongdoing.
Subsection 1 –Unrelated Business Income
Nonprofits exempt under section 501(c)(3) are permitted to engage in unrelated
businesses so long as they are not organized and operated for the primary purpose of
carrying on an unrelated trade or business61. An unrelated business is an activity that is
unrelated to the filer’s exempt purpose (aside from the filer’s need for income to carry
out its exempt purpose). For example, if a nonprofit organization publishes a journal and
advertises products in the journal that are not related to the organization’s exempt
The Instructions for disregarded entities provide as follows for columns (D) and (E): “Since the financial
information of a disregarded entity is reported on its parent organization’s return, enter in Column (D) the
amount on line 12, Total revenue, that is attributable to the disregarded entity. Enter in Column (E) the
amount on line 59, Total assets, Column (B), that is attributable to the disregarded entity.”
60
34
purpose, selling the advertising would be an unrelated business. If such organizations
have $1,000 or more in gross unrelated business income, they must file a Form 990-T
(which is not a public document) and pay a tax on their unrelated business income. Thus,
the IRS is interested in knowing whether nonprofits conduct any unrelated businesses, the
extent of such activities and whether they should be paying any taxes. The Form 990
elicits information about a filer’s unrelated business activity and this subsection is
designed to help the Form 990 reader find out where such information is reported and
interpret it. Such information rarely raises any questions about impropriety and the
material is included here as this Part covers concerns of primary interest to regulators.
To begin with, Line 78a in Part VI (Other Information) asks whether the filer had
unrelated gross income of $1,000 or more during the year covered by the Form 990.62
Line 78b asks, if the answer to Line 78a is “Yes,” whether the filer filed a Form 990-T
for the year.
Unrelated business income is reported at Lines 2 through 11 at Part I and at Part VII
(Analysis of Income Producing Activities). Line 93 of Part VII has five blank lines
(Lines 93(a) through (e)) for program service revenue. Program service revenue includes
revenue earned from carrying out the activities that form the basis of a filer’s exemption
(e.g., tuition revenue received by a section 501(c)(3) school) as well as revenues received
from conducting an unrelated business activity. The filer is required to list its program
service revenue on these four lines including its revenue from its unrelated business
activities. The Instructions offer no guidance regarding what should be listed on these
lines. Presumably a short descriptor such as “tuition income” or “advertising revenue”
will do. There are five columns (columns (A) through (E)) to the right of these lines.
The first four columns (columns (A) through (D)) elicit information about unrelated
business income. The fifth (column (E), Related or exempt function income) asks for the
amount of income derived from carrying out the filer’s exempt function.
61
62
See Treasury Regulations section1.501(c)(3)-1(e).
Recall that the information elicited at Part VI calls for Yes or No answers.
35
Most nonprofits do not generate unrelated business income so that the only program
service revenue they will list on Line 93 will be from program activities that form the
basis of its exemption. If, for example, the filer were a school and it lists “tuition
income” on Line 93a, it would leave columns (A) through (D) blank and report the
amount of tuition income it received on column (E). (See discussion of Part VIII below
on the need to explain how each activity for which income is reported in column (E)
furthered the filer’s exempt purposes.)
Some nonprofits also conduct unrelated trades or businesses. A school, for example, as
well as offering an educational program might also operate a restaurant for its students
and faculty and publish a journal in which it runs unrelated advertising. The latter two
activities would constitute an unrelated business. The school would be required to list
these two program activities on two of the lines offered by Line 93. It would then have to
report the information required by columns (A) and (B) and in some cases by columns
(C) and (D).
Column (A) asks for the business code of the unrelated business. These codes are not
found in the Instructions to the Form 990 but rather in the Instructions to the Form 990T.63 On the last page of the Instructions for Form 990-T there are listed, under the title
“Codes for Unrelated Business Activity,” over 200 codes covering various activities (e.g.,
code 522130 credit unions or code 445100 Grocery stores). In our example of a school
restaurant, the school would list code 722210 (Limited-service eating places) for its
restaurant and code 541800 (Advertising and related services) for the advertising activity
of its journal.64
Column (B) asks for the amount of income received from the unrelated business. Here
the school in our example would enter the amount of gross income it received from
These instructions can be accessed and downloaded from the IRS’s Forms and Publications Website
whose URL address is: http://www.irs.gov/formspubs/
64
If the journal was sold and if its purpose was related to the school’s educational mission, the revenue
from its sale would be from a related activity and included at column (E).
63
36
selling advertising in its journal. (In a moment we will explain why the income from the
restaurant would not be reported at column (B))
Column (C) asks for the exclusion code for certain kinds of income and column (D) asks
for the amount of income to which the exclusion code applies. This requires a brief
explanation. Income from certain kinds of business activities is excluded from taxation.
For example, if the activity is not regularly carried on, its income is excluded from the
unrelated business income tax under section 512(a)(1) of the Code. The Instructions
provide a sheet that lists all the various exclusions from the unrelated business income tax
and assigns a code to them. If the filer has received income from a business that is
excluded from the unrelated business income tax, it would list the exclusion code in
column (C) and the amount of such income in column (D).65 Returning to our example
of the school’s restaurant, since all or most of this income will not be taxable because of a
special exclusion66, the filer would enter the exclusion code in column (C), which in this
case would be “03.”67 (If the restaurant were also used to sell meals to patrons that were
unconnected to the school, the income from that activity would be subject to the
unrelated business income tax.68)
The unrelated business income tax is a vast subject and is beyond the scope of this
document. More detailed information on the subject can be found in the IRS’s
Instructions for Form 990-T.69 Reference is made to unrelated business income and Part
VII above in this document’s Chapter 2, Section 1.
65
It would have listed the business activity on one of the lines provided at Line 93a through e and assigned
it a business code in column (A).
66
Section 513(a)(2) provides in relevant part that the term “unrelated trade or business” does not include
any trade or business that is carried on by the filer “primarily for the convenience of its members, students,
patients, officers, or employees.”
67
Code 03 reads “Section 501(c)(3) organization – Income from an activity carried on primarily for the
convenience of the organization’s members students, patients, officers, or employees (hospital parking lot
or museum cafeteria, for example) (section 513(a)(2).”
68
In this latter case, the amount of such income would be reported at column (B).
69
As noted above, these instructions can be accessed and downloaded form the IRS’s Forms and
Publications Website whose URL address is: http://www.irs.gov/formspubs/
37
In cases where the filer reports income on Line 93 from a program service activity which
is part of its exempt mission (e.g., tuition charged by a school), as indicated above, it
reports the amount of such income in column (E). Part VIII requires that an explanation
be provided of how each activity for which income reported in column (E) of Part VII
contributed importantly to the accomplishment of the organization’s exempt purposes.
Here the filer will list the line number of each such activity (e.g., Line 93c) and then give
a brief explanation of how the activity was needed to attain the filer’s exempt goals. In
the ordinary cases, such as tuition received by a school, the explanation will be fairly
obvious. There may be some cases where the connection between the business activity
and the filer’s exempt purposes are not as self-evident. For example, a drug rehabilitation
agency may conduct a woodworking shop that sells its products. If the primary purpose
of the shop is to teach recovering drug addicts skills and good work habits, it would be
related to the exempt purposes of the filer. A reader of the Form 990 would find this
explained at part VIII.
Subsection 2 – Private Foundation or Non-Private Foundation Status
By reason of section 509 of the Code, section 501(c)(3) organizations are classified as
either private foundations or non-private foundations. The term “private foundation” is
given a very special definition by section 509 and related provisions of the Code.70 Very
generally, it refers to a section 501(c)(3) organization that receives its income from a
relatively small number of sources. Equally generally, non-private foundations are those
section 501(c)(3) organizations that receive their income from a relatively large number
of different public sources. Private foundations are subject to somewhat restrictive
provisions.71 The distinction between private foundations and non-private foundations was
introduced into the Code by Congress in 1969 after hearings had suggested that there were a
growing number of section 501(c)(3) organizations that had received all their funds from
one family which controlled them. It was claimed that these groups were not using their
70
The term does not, for instance, refer solely to private grant-making philanthropies, as it does in common
usage. Human services or arts groups that make no grants might, under certain circumstances, be private
foundations for purposes of section 509 of the Code.
71
These provisions are set forth at sections 4940-4946 of the Code.
38
funds for public purposes and in some cases were improperly using their funds to benefit
their creators. The 1969 provisions added to the Code make it impossible for private
foundations (i.e., section 501(c)(3) groups which received their funds from only a few
sources) to hoard funds. This is done by requiring private foundations to distribute a portion
of their assets to the public for charitable purposes. Other restrictions are imposed upon
private foundations, including those that make it less likely that other private foundations
will make grants to them, that prohibit self-dealing of any sort, and that impose certain limits
on the deductibility of contributions to them. In addition private foundations must pay a
small excise tax under these rules.72
If a section 501(c)(3) filer is not a private foundation, Part IV of Schedule A is where it
asserts this fact and reports information to substantiate its claim. A reader of the Form 990
who wants to know whether the filer is a non-private foundation should refer to this part.
Lines 5 through 13 of Part IV describe the various reasons why a filer may not be a private
foundation and provide boxes, one of which the filer must check to indicate which reason
applies to it. For example, churches (Line 5), and schools and hospitals (Lines 6-7) if they
are organized in certain ways, are not private foundations.
There are two categories of section 501(c)(3) organizations (other than the per se nonprivate foundations categories just mentioned) that qualify for non-private foundation status
because they receive their support from a fairly wide range of different sources. The rules
governing eligibility for these categories are detailed and complicated and beyond the scope
of this document. Only a summary explanation will be made of them. Both categories use
what is referred to as the public support fraction in which receipts from public sources are
put in the numerator and total support in the denominator. If the fraction is large enough,
the filer qualifies for non-private foundation status. The first such category (Line 11a) are
those organizations that normally receive a substantial part of their support from
governmental units or from the general public or both.73 In determining the public support
72
In addition there are rules that prohibit private foundations from having large percentage holdings in
companies and from making grants to individuals without maintaining careful accountability of how the
grants are used. See sections 4943 & 4945 of the Code.
73
See section 170(b)(1)(A)(vi) of the Code.
39
fraction under this first category, exempt function income74 is excluded from both the
numerator and denominator. If the fraction works out to 33 1/3% or more, the filer will
qualify under this category.75 The second category (Line 12) is generally similar to the first
except that it includes exempt function income.76 As suggested, the rules are much more
complicated than this simple explanation might suggest, but we believe enough has been
provided to suggest the general idea that fairly wide public support is needed to qualify
under these two categories.
The rule for both categories is that the filer normally receives the required amount of public
support. This generally means that the filer must qualify on the basis of the average of its
receipts over a four-year period. Part IV-A of Schedule A sets out a support schedule where
the filer reports the receipts of various types of income (e.g., gifts and contributions (Line
15), membership fees (Line16), etc.) for the four years preceding the year that the return
covers.77
As mentioned, a reader of the Form 990 may wish to learn whether the filer is a private
foundation or not, and, if not, by what category it qualifies as a non-private foundation. This
can be found out by examining Part IV of Schedule A. It might, for instance, be of interest
to the reader to know that the filer received its support from a fairly wide range of sources as
this may suggest it is not controlled by just a few individuals and this may be significant for
the reader. The reader may also find it significant that it received support from a number of
sources insofar as this reflects on the filer’s capacity to receive support in the future.
For filers that establish their non-private foundation status on the basis of receiving receipts
from a broad range of public sources (namely, those filers which check the boxes at either
Line 11a or 12), a reader may find out the various categories of support the filer received
74
Exempt function income is income the filer receives for carrying out its exempt function (e.g., tuition
received by a school).
75
If the public support fraction is at least 10% and the filer meets in addition what is called the facts and
circumstances test, it will also qualify under this category
76
See section 509(a)(2) of the Code. Here also the qualifying fraction is 33 1/3% but there is not a 10%
facts and circumstances test under section 509(a)(2).
77
If the filer qualifies on the basis of its average receipts for four years, it will ordinarily be considered to
be a non-private foundation for the next two years.
40
during the last four years by examining Part IV-A (Support Schedule). The reader may also
find out by what fraction the filer qualified for non-private foundation status (Line 26f or
Line 27f). Line 26f is of particular interest as it is where the filer reports its pubic support
percentage for the year. A high public support percentage means, as suggested, that the filer
obtains support from a wide variety of sources and a low percentage means that it obtains
support from a relatively few sources. This may be quite relevant to a reader of the Form
990. There is a great deal of other information reported at Part IV-A that bears on the filer’s
non-private foundation status but we do not believe it reveals that much of interest78. What
seems to us important is simply knowing whether the filer is a private foundation or a nonprivate foundation.
Subsection 3 – Lobbying Activity
For an organization to remain eligible for tax-exempt status under section 501(c)(3), it
must not engage in too much lobbying activity.79 Generally, lobbying refers to efforts to
persuade federal, state or local legislators to act favorably or unfavorably upon some
proposed legislation. Section 501(c)(3) provides in relevant part that an organization
shall be eligible for tax-exemption so long as “ ... no substantial part of the activities of
which is carrying on propaganda, or otherwise attempting, to influence legislation (except
as otherwise provided in subsection (h))...”. Since, under the “no substantial part” test,
there is very little guidance to help section 501(c)(3) organizations know what is too
much lobbying80, in 1976 the Congress added subsection (h) to section 501, which
generally allows section 501(c)(3) organizations to elect to have the question of whether
they are engaging in too much lobbying decided on the basis of how much money they
spend on lobbying, i.e., the level of their lobbying expenditures. We will refer to this
78
We do not believe that the relatively small amount of significant insight into the filer (beyond the fact of
its non-foundation status) that might be derived from examining Schedule-A justifies the effort that such an
examination would take.
79
Thus, for an organization to be eligible for tax-exempt status under section 501(c)(3), it must (1) pursue a
charitable purpose, (2) make no improper payments to insiders (i.e., it may not breach the no-inurement
prohibition) and (3) not engage in too much lobbying. In addition, it must not engage in any political
campaigning, that is, efforts to have someone elected or not elected to public office. See our discussion of
Lines 81 and 89n above in Section I, subsection 3.
80
Neither the statute nor the regulations promulgated thereunder, nor the cases and rulings, provide any
help in determining what is too much lobbying for purposes of interpreting the “no substantial part” test.
41
election as the “(h) election.” Generally, section 501(c)(3) organizations are permitted
under the (h) election to spend up to 20% of the first $500,000 of their budget on
lobbying and reduced percentages of budget amounts above $500,000 with an overall cap
of $1 million. Of the permissible amounts, only 25% may be spent on grass roots
lobbying. Generally grass roots lobbying involves contacting members of the general
public and in turn urging them to contact legislators to urge them to act favorably or
unfavorably on some proposed legislation.81
Line 1 of Part III (Statement of Activities) of Schedule A asks the filer whether it
engaged in any lobbying during the year. If the filer answers “Yes,” it must enter the
total expenses it incurred in connection with the lobbying activities and complete Part VIA if it made the (h) election. If it did not make the (h) election, it must complete Part VIB and attach a statement giving a detailed description of the lobbying activities. Thus, if
a reader of the Form 990 of a filer is interested in learning whether the filer has engaged
in lobbying activities, she should look at Line 1 of Part III of Schedule A and to learn
more about those activities, she should inspect the filer’s Part VI-A or Part VI-B of
Schedule A.
As indicated, if a filer has made the (h) election, it must complete Part VI-A (Lobbying
Expenditures by Electing Public Charities). By examining this part a reader can learn the
total amount of the filer’s grass roots lobbying (Line 36) and direct lobbying (Line 37)
81
More specifically, electing organizations may spend on lobbying various percentages of their total
exempt purpose expenditures, namely 20% of the first $500,000 of exempt purposes expenditures, 15% of
the next $500,000, 10% of the next $500,000 and 5% of the excess over $1,500,000. There is a cap,
however, of $1,000,000 that is reached when an organization has annual exempt purposes expenditures of
$17 million. See section 4911(c)(2) of the Code. Exempt purpose expenditures include all the amounts
spent by the organization during the year to accomplish its exempt purposes, less capital expenditures,
investment management expenses and the expenses of a separate fundraising unit. See section 4911(e)(1)
of the Code. Of the total amount of allowable lobbying expenditures, only 25% may be spent on grass
roots lobbying. As indicated in the text, generally grass roots lobbying involves contacting members of the
general public and in turn urging them to contact legislators to urge them to act favorably or unfavorably on
some proposed legislation. The remainder of the amount that an organization may spend on lobbying is
limited to direct lobbying expenditures. Direct lobbying consists of the organization directly contacting
legislators and urging them to act upon proposed legislation. Thus, an organization with $500,000 of
exempt purpose expenditures could make grass roots lobbying expenditures of 5% of total exempt purposes
expenditures (viz., $25,000) and direct lobbying expenditures of 20% of total exempt purposes
expenditures (viz., $100,000) less the amount spent on grass roots lobbying.
42
expenditures and the total amount of its exempt purpose expenditures (Line 40).82 If a
filer makes lobbying expenditures in excess of the permissible amount, it must pay an
excise tax of 25% on the excess.83 If the filer normally spends more than 150% of the
allowable amounts, it will likely lose its tax exemption. As with the private foundation
rules, “normally” means the average of expenditures over a four-year period. Part VI-A
provides a schedule similar to that at Part IV on which the filer reports its varying
amounts of lobbying and grass roots lobbying expenditures for the last four years. Thus,
by examining a filer’s Schedule A, a reader of the Form 990 may find out, among other
things the following:
1. Whether it engaged in lobbying (Line 1, Part III);
2. The total expenses incurred in connection with its lobbying activities (Line1, Part
III);
3. Whether it made the (h) election (Part VI-A);
4. If it made the (h) election, the amount of its grass roots, direct lobbying and
exempt purpose expenditures (Lines 36, 37 and 39 respectively); and
5. The amounts of its total lobbying and grass roots lobbying expenditures for the
last four years.
It may be observed that if a filer has made the (h) election, generally all that a reader of
the Form 990 can find out about its lobbying activities is how much it spent on them and
how the expenditures were divided between direct and grass roots lobbying. In contrast
to those who have not made the election, the filer is not required to supply any
description of its lobbying activities.
If a filer has not made the (h) election and has engaged in any lobbying activity, it must
complete Part VI-B (Lobbying Activity by Nonelecting Charities). By examining this
82
As indicated, filers who have made the (h) election can make direct and grass roots lobbying
expenditures equal to some percent of their exempt purposes expenditures. This amount is called the
“lobbying nontaxable amount” and the “grass roots nontaxable amount.” These amounts can also be
learned from examining Part VI-A. Line 41 is where the lobbying nontaxable amount is reported. Line 42
is where the grass roots lobbying amount is entered.
83
If there is an excess of grass roots lobbying expenditures, it can be found at Line 43. If there is an excess
of total lobbying expenditures, it can be found at Line 44.
43
part a reader can learn a fair amount about this activity, including information that goes
beyond mere expenditure amounts. To begin with, the filer must report, by answering
“Yes” or “No,” whether it used (a) volunteers and/or (b) paid staff or management to
carry out its lobbying efforts. Further, it must report whether it used for these purposes:
c. Media advertisements and the amount spent on such advertisements;
d. Mailings for members, legislators, or the public and the amount spent on such
mailings;
e. Publications, or published or broadcast statements, and the amount spent on such
efforts;
f. Grants to other organizations for lobbying purposes and the amount spent on such
grants;
g. Direct contact with legislators, their staffs, government officials or a legislative
body and the amount spent on such efforts; and
h. Rallies, demonstrations, seminars, conventions, speeches, lectures, or any other
means and the amount spent on such efforts.
The report of the amounts spent at lines c through h should include the compensation for
the staff reported at line b. The total of lobbying expenditures (the sum of lines c thought
h) must be reported at line i.
Finally, if the filer answered any of the lines a though h “Yes,” it must attach a statement
giving a detailed description of the lobbying activities. The Instructions note that “[t]he
detailed description of lobbying activities should include all lobbying activities, whether
expenses are incurred or not (e.g., even lobbying activities carried out by unreimbursed
volunteers).”
There are several reasons why a reader may be interested in learning whether a filer has
engaged in lobbying activity. The reader may think, for example, that groups like the
filer ought not only to help people but in addition should advocate for changes that will
address the problems that caused its clients to need help. Or a reader might believe that
groups such as the filer ought not to engage in lobbying activity. In some cases a filer
44
may be a group that advocates for a position or positions that the reader disagrees with.
She may then want to know the extent of its lobbying activity.
Finally, in many cases Part VI is left blank or incomplete or is incorrectly completed even
though the filer indicated at Line 1 of Part III that it did engage in lobbying. A reader
may infer from this that the filer may be trying to hide something, or that the filer does
not know how to complete Part VI or did not make the effort required to complete it
accurately. She may make whatever inferences and draw whatever conclusions she
thinks appropriate from any of these finding
45
Chapter 2: FINANCIAL INFORMATION
INTRODUCTION
This part covers those parts of the Form 990 that contain financial information. Our aim
is to help readers of the Form 990 assess a filer’s financial viability and performance and
how its managers have discharged their stewardship responsibilities.
We believe those who read the financial parts of the Form 990 may have several different
interests in mind. Perhaps the most common will be to help inform their judgments about
whether or not to contribute to a particular filer. In addition, those who use or are
thinking of using the services of a filer may also be interested in its financial condition.84
In all these cases a major question will be whether or not the organization being
considered will be able in the future as a financial matter to continue to provide its
services.
There are, of course, other aspects about an organization that will be important to those
who are interested in supporting or using it. Certainly of high importance is the question
of whether or not it does good work -- is it effective and is it run efficiently and what are
the results or outcomes of its program? One may also be interested in the quality and
experience of an organization’s staff as well as of its board of directors. To answer these
and similar questions, the financial parts of the Form 990 provide relatively limited
information.85
84
Examples of this last category would include children choosing among caregivers for their parents or
parents choosing among nonprofit schools for their children.
85
Here is what the Financial Accounting Standards Board (FASB) has said about financial reporting by
nonbusiness organizations: “The information provided by financial reporting is primarily financial in
nature: It is generally quantified and expressed in terms of units of money. Information that is to be
incorporated formally in financial statements must be quantifiable in terms of units of money. Other
information can be disclosed in financial statements (including notes) or by other means, but financial
statements involve adding, subtracting, multiplying, and dividing numbers that depict economic things and
events and require a common denominator. … Financial reporting by nonbusiness organizations, however,
is limited in its ability to provide direct measures of the quality of goods and services provided in the
absence of market-determined exchange prices or the degree to which they satisfy the needs of service
beneficiaries and other consumers.” See FASB, Statement of Financial Accounting Concepts No.4 –
Objectives of Financial Reporting by Nonbusiness Organizations, paragraph 23, pp. 12-13 (1980). This
46
It is a truism that the financial information furnished by financial statements, such as the
Form 990, only provides information about a filer’s past financial performance. On the
basis of a filer’s past financial performance, however, cautious judgments may be made
about its future financial performance, and these judgments in turn may serve the basis
for making further judgments about the filer’s future financial ability to continue to
provide services. Of critical importance to this evaluation will be assessments of the
filer’s ability to obtain resources in the future from contributors, grantors, service
beneficiaries, government agencies, volunteers and other resources providers. Also of
interest is how much the filer receives from each source of revenue and whether it may be
expected to continue to receive income at such levels. In much of what follows we
suggest how to read the Form 990 to make such assessments.
Central to evaluating a filer’s ability to financially continue its operations is knowing
what level of expense the filer has incurred in conducting its program, since it may be
reasonably expected that it will continue to operate at about the same level. Knowing
how much the filer will need to spend in the future indicates how much the filer needs to
raise to continue its activities. And, as suggested, having some indication of whether the
filer can raise this amount in the future is a key conclusion to be reached from studying a
filer’s financial information.
A filer’s net worth is relevant to determining the filer’s ability to carry on in the near term
in the event the filer experiences temporary difficulties in obtaining resources. We also
spend some time discussing how to assess a filer’s net worth.
Financial information also may indicate how the filer’s managers have discharged their
stewardship responsibilities. Financial stewardship responsibilities include the custody
and safekeeping of the filer’s resources, whether the filer’s resources available for
investment have been invested in an efficient, effective and prudent manner and whether
statement applies fairly well to the financial parts of the Form 990, except that the Form 990 does not have
notes, as do financial statements.
47
generally the filer’s financial resources have been used efficiently and effectively to
achieve its goals. We believe that it is difficult to learn from financial statements,
including the Form 990, whether the filer has established and maintained adequate
controls to assure the custody of its assets. Some indication of how well the filer has
invested its assets may be garnered from comparing income flows and assets, and this is
touched upon in what follows. More generally, if a series of statements reveals that the
filer has been running regular and perhaps increasing deficits and if its net resources are
diminishing, this might suggest inadequate stewardship.86
We proceed by going through those parts of the Form 990 that contain financial
information in the order in which they appear on the form (e.g., Part I (Revenue,
Expenses and Changes in Net Assets), Part II (Statement of Functional Expenses) etc.).
Our ultimate aim is to assist the reader in determining what the information means. Does
it mean that the filer is financially healthy and has been managing its assets adequately?
Or does it mean something less positive? What cannot be over-emphasized, as suggested
in the Introduction, is that this kind of interpretation is difficult and often can only
approach a rough conjecture. This is true when a reader has one or more completed
Forms 990 at hand. It is even truer when, as here, we are commenting on what particular
lines might be taken to mean and refer to the lines just by themselves and out of the
context of the whole Form 990. From time to time we do suggest what such lines might
mean, but it should always be remembered that our interpretations are tentative and there
may be other equally plausible interpretations. All we can do here is to suggest ways that
you can begin to examine and think about Forms 990 and help you begin the difficult
process of developing a facility for interpreting these forms. Time and effort are needed
to understand and use information on the form and one must be willing to study the
information with reasonable diligence. This is undeniably a cost, but for those who want
to learn about a particular nonprofit or several nonprofits or even the sector at large, we
believe the cost is worthwhile.
86
But of course, it might not. Among other things, it could mean that the filer had embarked on an
ambitious expansion of its activities, the financing of which it believed would soon be worked out, or that
resources traditionally available to the filer had been withdrawn.
48
One should also bear in mind that the information provided by the financial parts of the
Form 990 is often based on estimates that are merely approximate so that the illusion of
precision created by the statement of information in seemingly precise monetary units
must be understood to be just that – somewhat of an illusion.87
SECTION I
FORM 990 PART I -- REVENUE, EXPENSES, AND CHANGES IN NET ASSETS
OR FUND BALANCES
Introduction – Part I, which makes up the first page of the Form 990, is divided into three
sections: Revenue (12 lines)88, Expenses (5 lines) and Net Assets (4 lines). Expenses and
Net Assets are summary sections. For Expenses, totals are transferred from Part II
(Statement of Functional Expenses) on page 2.
It may be that the reader will want to examine Line 12 (Total revenue) and the summary
sections first. Line 12 reports total revenues for the year and this may provide the reader
with a quick and rough idea of the filer’s capacity to generate income. Line 17 (Total
expenses) reports the filer’s total expenses for the year being reported on. This is a good
indication of the size of a filer’s activities.89. Total expenses may be a better indicator of
the size of a filer’s operations than total revenue since total revenue, as we will see
below, might include receipts that are restricted so that, for example, only the income
from such receipts may be used for supporting the filer’s current activities. Total
expenses, as suggested above, also provides a fair indication of how much the filer needs
Here is what FASB says on this topic: “The information provided by financial reporting often results
from approximate, rather than exact measures. The measures commonly involve numerous estimates,
classifications, summarizations, judgments, and allocations. Thus, despite the aura of precision that may
seem to surround financial reporting in general and financial statements in particular, with few exceptions
the measures are approximations that may be based on rules and conventions rather than exact amounts.
See FASB, Statement of Financial Accounting Concepts No.4 – Objectives of Financial Reporting by
Nonbusiness Organizations, paragraph 25, p. 13 (1980).
88
When sub-lines are counted, there are 25 lines in the Revenue section. For example, line 1 consists of
Lines 1a, 1b, 1c and 1d.
89
As mentioned below, a reader of the Form 990 may also want to look at Line 90b in Part VI on page 5
which shows the size of the filer’s staff.
87
49
to raise in the future to be able to continue its program. The Expenses section breaks
down total expenses into the three categories: program service, management and general,
and fundraising. Some may find the relative amounts of these aggregates significant.
Line 18 reports on whether the filer had a surplus or a deficit for the year. This
information may be taken as roughly indicating the filer’s overall fiscal performance for
the year being reported on. Similarly, Line 21, which reports on the filer’s net assets at
the end of the year, indicates the extent of the filer’s net resources from which inferences
may be made about the filer’s future financial strength.
Revenue -- There are two important questions about an organization, the answers to
which may be suggested by examining the Revenue section of Part I. First, is it likely
that the organization will continue to receive financial support in the future and thus
remain financially strong? Second, are there persons and agencies that have concluded
that the organization's activities and purposes merit support? The two themes suggested
by these questions are sounded throughout what follows.
Before going through each line of the Revenue section, you might want to go directly to
Line 12 which indicates the total amount of income or revenue the organization received in
the course of the year covered by the return. As suggested, this information, along with total
expenses reported at Line 17, gives you some idea of an organization's size as well as of its
ability to generate income. (You might also want to look at Line 90b near the bottom of
page 5 to see how many people the organization employs.) This is obviously an important
piece of context information.90 A large organization does not just emerge one day as a large
organization. It must have generated considerable support over time to reach its current
position.
90
As noted below, Lines 1 through 11 provide information about amounts and different sources of income
the group received. This information may indicate that the organization has been successful in developing
multiple funding sources, but it can only be confidently interpreted after taking into account the amount of
an organization’s total revenue.
50
Before proceeding, the obvious point should be made that a great deal more can be found
out by examining several years of an organization's Forms 990 than by looking at just one.
(It will be recalled that groups are required to make available their last three Forms 990.)
For example, if a source of income is reported at about the same level for three years
running, there is a fair likelihood that it will continue coming in at this level. This inference
could not be made with the same level of confidence on the basis of the information in one
Form 990.
Line 1 elicits data about contributions. These are gifts and similar transfers for which the
donor gets nothing back in return from the filing organization. Line 1 is broken down into
three sub-lines. Line 1a (direct public support) includes such transfers as contributions from
individuals and foundation grants. It also includes dues from members where the members
receive nothing or little of value back from the filer for their payments but rather make these
contributions (dues payments) simply to support the filer.
Line 1b (indirect public support) includes contributions received from a federated
fundraising agency, such as the United Way. One way of thinking about the differences
between Line 1a and Line 1b is to notice that Line 1a elicits information about contributions
received as a result of the organization's own efforts while Line 1b relates to contributions
received as the results of another organization's efforts (viz., the fundraising agency).
Line 1c (government grants) includes transfers from government agencies for which the
agencies receive nothing in return. In that respect they are like grants from foundations and
are quite different from many government contracts. The usual government contract, which
is included on Line 2, involves the receipt of payments from a government agency for work
performed by the organization for the agency.
As noted above, support from any source suggests that there are some who thought well of
the group. If the return shows a good deal of revenue at Line 1a from direct public support
(individual gifts and foundation grants, etc.), it may be inferred that many think well of it.
There are, however, several cautionary points you should keep in mind. First, you may want
51
to check fundraising expenses at Line 15, as significant amounts of those expenses might
suggest that the gift revenue can be explained as much by money spent on fundraising
efforts as by how well the organization is thought of by the public. On the other hand, if
several years of Forms 990 show strong direct public support and relatively high fundraising
expenses, it may also be concluded that the organization has developed a solid means of
supporting itself.
As another point of caution, Line 1a might include a foundation grant that is to be used over
several years. Thus, only a part of the grant is properly attributable to the year being
reported on, and looking at the amounts included on Line 1a without knowing the size or the
multi-year nature of the grant might lead one to believe that the organization's income
generating efforts to support activities for that year being reported on were more successful
than one would conclude if the multi-year nature of the grant was known about91. This
problem is reviewed in more detail at the end of this discussion of revenue. Similarly if the
organization received a large bequest during the year being reported on, it may be that Line
1a shows a healthier amount of contributions than is usually the case, but there is no way of
knowing from looking at Line 1a whether this was the case. In addition, the filer may have
received a gift for an endowment with a direction that only the income generated from the
endowment’s principal be used.92 Or the gift might have been a building or funds to be used
in erecting a building. There is no way for a reader of Line 1 to tell whether any or all of
these possibilities was the case. These observations emphasize, as noted above, the
importance of looking at the organization's Forms 990 for several years. For example, a
large increase in Line 1 gifts for one year may suggest a special, one-time gift.
Finally, Line 1a includes those amounts received from fundraising events for which the
contributor received nothing of value in return from the organization. (Here is an example:
Contributors to a fundraising benefit pay $250 for a ticket to the event for which they
91
As will be explained below and in subsection 2 of Section IV, it may be significant for evaluating the
filer’s future ability to raise general support to know whether the grant or grants were for general purposes
or for special programs.
92
The gift may direct that the income be used for a special purpose (e.g., to provide scholarship funds to
students from Vermont) or for the filer’s general purposes. There would be no way from looking at Line 1
52
receive a dinner that is worth $85 to them. $165 would be included on Line 1a and $85 on
Line 9 (see below)). In some cases, organizations have regular fundraising events so that
this source of income may be expected to recur. In other cases, fundraising events are held
relatively infrequently and so should not be expected to be a recurring source of income.
What in fact is the case cannot be told from examining Line 1a.
Amounts listed at Line 1b as receipts from a federated fundraising agency might reasonably
be expected to be a reliable source of future income and suggest that the fundraising agency
thinks well of the filer. On the other hand, if after contributions have been listed on Line 1b
for a couple of years, in the third year they are omitted, it may mean that the federated
agency knows something about the filer which is not evident from the group’s Form 990.
For most groups, government grants (as distinguished from government contracts) are pretty
rare, so it may be sensibly supposed that amounts included on Line 1c may not be recurring.
It may be noted that Line 1d (Total) requires the filer to attach a schedule of contributors.93
This schedule of the Form 990 is not open to public inspection and so will not be available
to the reader.94
Before discussing Lines 2 through 11, it may be helpful to observe that the Form 990 may
be read as dividing revenues into two general categories: contributions (Line 1) and revenue
from income-producing activities (Lines 2 through 11). Income-producing revenue may in
turn be divided into income received from activities related to the filer’s exempt purposes
and income derived from activities unrelated to the filer’s exempt purposes (unrelated
business activities).
to know how the income was spent (or even as suggested in the text, that the gift was for an endowment).
These problems are also discussed below.
93
The schedule must report contributors who gave the filer money, securities or other property worth
$5,000 or more during the year.
94
Groups need not show this schedule to those who visit their offices and ask to see their Forms 990 nor
will it be posted on the Internet.
53
Line 2 (Program Services revenue including government fees and contracts) includes
amounts received by an organization for charging for its services, such as tuition charged
by a school or amounts received by a performing arts company from ticket sales.
Furthermore, as suggested above, some nonprofits receive fees for performing services
for government agencies. Included in this latter group are some organizations that
receive nearly all of their revenue from government contracts. Their Forms 990 will
show significant amounts at Line 2. However, to ascertain whether the amounts
appearing on Line 2 are from government contracts, it will be necessary to look at Line
93 under Part VII on page 6. Line 93 breaks down program service revenue among fees,
for example, charged to individual clients (Line 93a-e), Medicare or Medicaid payments
(Line 93f) and revenues from government contracts (Line 93g column (e)). In
understanding the nature of an organization, it may be considered significant that it
receives nearly all of its revenue from a contract (or contracts) with a government agency
(or agencies).
Unrelated business income may be included on Line 2. Indeed, the most usual type of
unrelated business income involves those revenues derived from activities that are
unrelated business activities. Some organizations engage in unrelated business activities,
that is, activities that have nothing to do with achieving the organization’s exempt
purpose and are conducted for the most part merely to raise funds to support the
organization’s exempt activities. An example would be a nonprofit that published a
journal that ran advertising for products having nothing to do with the nonprofit’s exempt
purpose. In some cases income received from an unrelated activity will be subject to the
unrelated business income tax.95 An organization with unrelated business income must
file a Form 990-T and may have to pay an unrelated business income tax on such income
if it has unrelated gross income of $1,000 or more. Part VII of the Form 990 elicits
information that analyzes the income reported at Lines 2 through 11 to show whether it is
derived from an exempt or unrelated activity. Part VII has been discussed above at Chapter
1, Section II, Subsection 1. Mention is made here of Part VII since a reader of the Form 990
95
There are some kinds of income that are received from unrelated activities on which no tax need be paid.
For example, interest and dividend income and much rental income are excluded from the tax on unrelated
income. See section 513(b) of the Code.
54
may want to learn whether income from a particular source, say sales of goods, is derived
from a related or unrelated activity. A reader of the Form 990 may conclude that income
from an unrelated business activity may be a reliable source of future income, especially if
the activity has been carried on for some time.96 If the filer reports significant amounts of
unrelated business income, it is, of course, likely that it engages in a significant amount of
unrelated business activities and this may be relevant to a reader’s assessment of a filer.
Line 3 (Membership dues and assessments) includes amounts received by an organization
from its members from charging for services it provides to them. Note that the amounts
included at Line 3 are payments for which the members receive more or less full
consideration in services for their dues and not payments that are primarily ways of
contributing support to an organization. These latter payments, as noted above, would be
included on line 1a. Relatively few charities have income on Line 3.97 If it can be
determined that a filer’s members believe it is important to maintain their membership98,
then it may be assumed that membership dues will be a fairly stable source of income.
Furthermore, indications of a growing number of members (as might be discovered from
examining Forms 990 covering several years) may suggest that this source of income will
grow in importance and can be considered stable. Such a pattern may also reflect that a
growing number of people approve of the filer. On the other hand, if membership dues
decrease over time, it may be that the filer is losing its hold on its members and that dues
cannot be looked to in the future as a steady source of income. In addition, a pattern of
decreasing dues may suggest that those who may be considered to know best about the
filer are beginning to think less well of it.99
Lines 4 (Interest on savings and temporary cash investments), 5 ((Dividends and interest
from securities), 6 (Rent), 7 (Other investment income) and 8 (Gross amount from sales
96
An examination of the filer's Forms 990 for several years may suggest that the activity has been carried
out for some time.
97
Trade organizations exempt under section 501(c)(6) typically receive this kind of income.
98
For example, members may receive important information as a result of their membership in the filer or
they may have exposure to people and organizations that are in a position to help them or they may believe
that they receive recognition or prestige as a result of their membership.
99
Income from membership dues and assessments will virtually always be related income and reported at
column (E) on Part VII.
55
of assets other than inventory), e.g., securities, real estate, etc., cover what might be
called “passive” income from investments. Groups with large endowments will receive
substantial amounts of interest and dividend income which will be shown on Lines 4 and
5.100 Amounts on Line 6 (Rent) suggest the ownership of real property held for rental
income. Line 7 (Other investment income) usually involves royalty income.101 Line 8
for the most part will be receipts from the sales of securities.102 Given the nature of the
underlying holdings that produce these kinds of income, many of them recur each year at
about the same levels. It may be concluded that income that is generated on assets that
may have been given in the past does not reflect on how the filer is considered as of the
time it filed the Form 990 being examined. In most cases the income shown on these
lines will not be subject to the unrelated business income tax. However, generally if the
property that produced the income had been acquired with the proceeds from a loan and
is held to produce income, instead of for exempt purposes, some or all of the income may
be subject to the unrelated business income tax. A reader of the Form 990 would be able
to tell this by examining Part VII.103
It may be of interest to know whether the performance of a filer’s passive investments
has been successful or not. Some very rough answer to this line of inquiry may be
gleaned from comparing Part IV (Balance Sheets) information with Part I information.
For example, Part I’s Line 4 reports interest on savings and temporary cash investments
and Part IV’s Line 46 reports the value of the filer’s holdings in savings and temporary
cash investments. By comparing the two amounts, an approximation may be made of
whether the filer has invested its short-term savings productively. The same kind of
100
Below in Section IV, we consider the relationship between a balance sheet line that reports securities as
an asset and the level of income reported at Lines 4 and 5 as perhaps reflecting on how well the filer is
managing its investments.
101
The filer is required to describe such investment income either in the short space provided on the form
itself or in an attachment. Consequently the reader will be able to find out the nature of its income.
102
The filer is required to attach a schedule giving a considerable amount of information on the sale or
exchange of each asset that is a nonpublicly traded security and the sale or other disposition of an asset that
is not inventory. Publicly traded securities may be reported in the aggregate on the schedule.
103
The point made in the text has to do with what is called unrelated debt-financed income under section
514 of the Code. This is a very complicated subject and is beyond the scope of this document. More
detailed information on the subject can be found in the IRS’s Instructions for Form 990-T. These
instructions can be accessed and downloaded from the IRS’s Forms and Publications Website whose URL
address is: http://www.irs.gov/formspubs/
56
conclusions many be drawn by comparing Part I’s Line 5, which reports dividends and
interest from securities, with Part IV’s Line 55, which reports the value of the filer’s
holdings in security investments; and Part I’s Line 6, which reports rental income, with
Part IV’s Line 55, which reports the value of the filer’s investments in land and buildings.
Extreme care must be given to making these kinds of assessments since there may be
many good reasons why a particular investment is not particularly productive in
generating income.104
Line 9 includes income from special fundraising events (but only that part of income
received for such events for which the contributor gets full value back for his or her
payment -- see comments and example accompanying the explanation of Line 1a
above.105) Line 9 calls for the gross revenue106 from such receipts (Line 9a), the
fundraising expenses incurred in generating such amounts (Line 9b) and the net income
received (Line 9c). If the net amounts at Line 9c are large and recurring, it may suggest
that the organization spends a considerable amount of time and money producing events
like trade fairs where a good deal of selling for value goes on. This may be relevant to
the reader of a Form 990. (In the example given above in discussing Line 1a, we
supposed an event for which each contributor paid $250 for attending and received in
return a dinner worth $85. Assume 100 people attended the event and that each dinner
cost the organization $55. Line 9a would show $8,500; Line 9b would show $5,500; and
Line 9c would show $3,000.107) If a filer reports Line 9 income, it must attach a schedule
listing the three largest special events conducted and provide financial information about
For example, investments may be in “growth” stocks that pay low dividends. Or real estate investments
may be in non-income producing realty that the filer intends to use in the future for its exempt activities.
105
In the part of Line 9a that is in parentheses and reads (“not including $_________”), the filer is to report
the amounts received from special events that are reported on Line 1a as contributions.
106
Gross receipts – contributions (included on Line 1) = gross revenue.
107
In the parentheses on Line 9a, the filer would report $16,500. Note that usually there are other expenses
incurred in connection with putting on special events in addition to the direct expenses for the goods or
services “sold” to those who attend the event (the dinner in the above example). These costs would include
the costs of mailing invitations and other fundraising costs attributable to producing the contributions (the
$165 in the above example). These costs are to be reported in column (D), Fundraising, Part II, and not on
Line 9b. Thus, the contribution amount for an event is ordinarily more than the net amount derived by the
nonprofit from the event.
104
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these events.108 In almost all cases the income reported on Line 9 will not be income
subject to the unrelated business income tax. While the underlying activity of the special
event may be in the nature of a business not related to the filer’s exempt purpose (other
than its need for income to conduct its exempt activities), for income from an unrelated
business to be taxed, the business must be ”regularly carried on,” and most of the events
that give rise to the income reported at Line 9 are not ”regularly carried on.”109
Line 10 includes income from the sale of inventory. This, while a significant source of
income for some kinds of nonprofits, is not likely to be a big item for charitable
organizations. If a filer reports Line 10 income, it must attach a schedule.110 In some
cases the income reported at Line 10 will constitute unrelated business income111 and
whether this is so can be found out by examining Part VII.
Line 11 (Other revenue) includes items of income of a type that are not includable at
Lines 1 through 10. Just what kinds of income are being included here is revealed at Line
103 of Part VII.112
We have analyzed each line. It is now time to comment on what might reasonably be
concluded by comparing the relative amounts included on the various lines on the
Revenue section of Part I. To help do this a continuum is posited with groups that rely on
donations for nearly all of their money at one end and those which receive most of their
Here, in part, is what the Instructions provide: “Attach a schedule listing the three largest special events
conducted, as measured by gross receipts. Describe each of these events and show for each event: the gross
receipts; the amount of contributions included in gross receipts (see instruction above); gross revenue
(gross receipts less contributions); the direct expenses; and the net income (or loss) (gross revenue less
direct expenses).
Include the same information, in total figures, for all other special events held that were not among the
three largest. Indicate the type and number of the events not listed individually (e.g., three dances and two
raffles).”
109
Whether income from special events reported at Line 9 constitutes unrelated business income may be
found out by examining Part VII.
110
Here is what the Instructions provide: “In an attached schedule, give a breakdown of items sold; (e.g.,
sales of food, souvenirs, electronic equipment, uniforms, or educational publications).”
111
For example, the filer might operate a retail store that has nothing to do with its exempt purposes.
Income produced by the store, including income from the sale of its inventory, would be unrelated business
income.
112
By examining Line 103 the reader would also be able to find out how much of this income is unrelated
business income.
108
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money from the sale of goods and services at the other end. The groups at the left end
may be called “donative” groups, and, since they engage in little commercial activity and
rely heavily on contributions, they might be thought of by some as truly charitable.
Those at the other end that receive most of their income from charging for their services
may be called “entrepreneurial” or “commercial,” although these terms should be
understood in the limited sense that fees are charged for services rendered and not in the
ordinary sense of “commercial” which might suggest for-profit enterprises.113
Groups with relatively large amounts on Line 1 (contributions) and relatively small sums
on other lines, as suggested by the continuum posited above, may on the one hand be
considered to be truly charitable but, given the somewhat fickle nature of charitable
giving, may on the other hand be thought to exist on a relatively unstable source of
funding.
Groups with relatively large amounts on Line 2 (Program service revenue) and relatively
small sums on other lines may be groups, such as nonprofit theatres, that derive much of
their income from ticket sales. Or they may be groups that derive most of their money
from government contracts. Here it would be useful to have some idea of what it is the
group does. (See discussion of Part III of Form 990 below.) This source of income can
be stable, although government funding may not be a stable source. In any event, if it is
the case that these groups receive little income from contributions, it may be concluded
that their character is quite different from those that do get most of their income from
contributions.
Groups with relatively large amounts on Line 3 (Membership dues and assessments), and
relatively small sums on other lines, are likely to be nonprofits which finance themselves
by providing services to their members and may not be of a “charitable” nature. In many
cases this will be a steady source of income. If this amount shows a steady increase as
113
Examples of fee-for-services income include the tuition that schools and universities receive, the
proceeds from ticket sales that performing arts groups receive and charges for services provided by health
care groups. In cases like these, where the income is received on account of the filer carrying out its
59
years go by, this probably indicates that the filer is retaining its members and new ones
are joining. This may be thought to reflect positively on what the filer is doing.
Groups with large amounts of income listed on any or all of Lines 4 through 8, which
indicate essentially investment–type income (or what has been referred to above as
“passive” income), may be thought to have a fairly stable flow of income from these
sources in the future. It might, however, as noted, be fairly concluded that the assets that
produce this “passive” income were given to the organization in the past and the income
generated from them does not indicate present support from outside sources for the
organization.
A final point on sources of revenue. Many believe that it is desirable for an organization
to receive income from a wide variety of sources.114 Whether an organization has been
able to do this or not may be inferred from examining all the lines, i.e., Lines 1 through
11.
In our introduction above to our consideration of Part I of Form 990, we observed that a
key objective in examining the revenue section of Part I is to be able to forecast the filer’s
ability to generate sufficient income in the future to meet its expenses. On the face of it,
the amount of income a filer received in the year being reported on may be a reasonable
measure of the amount of income it will receive during the next year or so. But this is not
always the case, and before ending our discussion of the revenue section of Part I, we
want to raise one or two complications we have alluded to above.
As a preliminary matter, we need to make clear two assumptions. First, in referring to
expenses, we mean near-term expenses, that is, those expenses the filer will incur in the
next period or so. For example, if a filer receives funds with a restriction that they are not
to be used for some time or that only the income from such funds may be used, these
exempt activities, the income is called “exempt purpose income.” If the income is generated as the result
of the filer conducting an unrelated business, the income is called “unrelated business income.’
114
This belief is, of course, an example of the kind of generalization that may or my not be valid for a
particular filer.
60
funds would not be available to meet a filer’s near-term expenses. It is probable,
however, that such funds would be available in the longer run. For example, if in the
future the filer’s financial circumstances deteriorated to such an extent that it was unable
to pay its bills, these funds would likely be reachable by its creditors.
Second, we believe that there is a significant difference between a filer’s core program
and special programs it may conduct. For our purposes, a filer’s core program is its
general mission, that which it was principally set up to accomplish. A filer's core
program consists of those mission-related programs and services that the filer can
conduct within its “core budget” and available unrestricted revenue. In contrast, a special
program is one that, while consistent with the filer’s general mission, is not part of its
ordinary activities. As we are using the term, a special program is supported by
contributions that restrict the use of their funds to support the particular special program
for which the funds were contributed, which special program is not part of the filer’s core
program. In most cases when the funds for a special program run out, the special
program is terminated but, of course, the filer continues its core program. In sum, the
special programs or projects are, as suggested, mission related, but they are not conducted
with “core funding.” Financing for general support, as suggested, consists of income that
may be used for the filer’s core program in any way the filer wishes.
We are now ready to address the complications. To begin with, not all assets that a filer
receives during the year that are includable in income may be available for its program.
Some assets, such as a gift to an endowment, may be restricted so that only the income
from the gift may be used to meet the filer’s needs. However, the principal of the gift
would be included in income in the year that it is received and thus in Line 12.
Nevertheless, since this amount would not be available to meet a filer’s near-term needs,
it would seem reasonable not to include this amount in the revenue total for the year that
one is using to evaluate the filer’s ability to raise funds in the future.115
115
We want to be clear about what we are suggesting in the text. As noted, we believe it is reasonable to
provisionally assume that the amount of income that a filer receives during the year being reported on can
be taken as a measure of what it may receive in the next period or so. Consequently, it may be assumed
that the filer will have income at about this level to meet its near term-term needs. But this assumption
61
Second, the filer may have received a contribution that was restricted in such a way that a
good part of the contribution is to be spent in a future period. The total amount of such
contribution would be included in income in the year it was received and thus in Line 12.
However, as in the case just considered, since some of this amount may not be available
to meet a filer’s near-term needs, it would seem reasonable not to include this amount in
the revenue total for the year that one is using to evaluate the filer’s ability to raise funds
in the future.
Finally, the filer may have received a contribution that restricted its use to a special
program. The total amount of such contribution would be included in income in the year
it was received and thus in Line 12. However, if a reader of a filer’s Form 990 was
primarily interested in forecasting the filer’s ability to meet the expenses of its core
program, since this amount would not be available to meet such expenses, it is
appropriate not to include this amount in the revenue total for the year that one is using to
make the forecast.
In sum, we are suggesting that a careful reading of a Form 990 may require making a
distinction between two general classes of revenue that, if received, will be included in
income in the year being reported on: income that is available to meet the near-term
needs of the filer’s core program and income that is restricted in such a way that it is not
so available. In some cases a reader of the Form 990 will be able to learn about the
presence of income that falls into the latter category by examining Part IV (Balance
sheets) of the filer’s Form 990. These problems are discussed below in the Net Assets
segment of this section and in Section IV of this paper.
should only be a provisional one since there may receipts that are included in income that should not be
taken as reflecting on the filer’s ability to generate income in the future to meet near-term needs. In the
text, we cite a gift to establish a permanent endowment as an example. While this gift will certainly
produce income that will be available to meet near-term needs, the amount of the gift itself will not be so
available and thus should not be taken into account in determining the amount of income that the filer
raised during the year that may be taken as a measure of what it will raise in the near-term future.
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Expenses – An organization’s expenses are broken down into two sets of categories:
functional expenses and object expenses. (Object expenses are discussed below.) The
three functional expense categories are program services, management and general, and
fundraising. The Expenses section of Part I of the Form 990 gives the totals of an
organization’s functional expenses. These amounts are derived from Part II (Statement
of Functional Expenses) of the Form 990 on page 2. As we will see below, Part II
contains about 25 lines (rows) at which are listed an organization’s object expenses (e.g.,
salaries, supplies, etc.) and these amounts are allocated among three columns for
functional expenses, namely, Program services (column (B)), Management and general
(column (C)) and Fundraising (column (D)). Column (A) is where the totals of each of
the object expense lines are listed. Line 44 (Total functional expenses) is where the totals
of each functional expense column are entered. And it is these totals from Line 44 that
are carried back to the lines in the Expenses section of Part I. Thus, Line 44 column (B),
the total for Program services expenses, is carried back to Line 13; Line 44 column (C),
the total for Management and general expenses to Line 14; and Line 44 column (D), the
total for Fundraising expenses to Line 15. Line 17 (Total expenses) is where the total of
the totals is entered. For most filers, line 17 will equal the sum of Lines 13, 14 and 15
and will also be equal to line 44(A) on Part II. For very few filers Line 17 will equal the
sum of Lines 13, 14, 15 and 16.116 Line 16 (Payments to affiliates) is for certain
payments made by affiliates to their parents. These payments are extremely rare and the
reader is unlikely ever to encounter them.117
Program services expenses are those incurred to carry out the organization’s mission.
Thus, expenses incurred by a social services organization in paying its social workers for
delivering services to its clients would be program services expenses. By like token,
payments made by a performing arts organization to produce a play would be program
116
In this case Line 17 will equal Line 44 (A) plus Line 16.
Here, in part, is how the Instructions describe such payments: “Dues paid by the local charity to its
affiliated state or national (parent) organization are usually reported on line 16.” There is much more detail
in the Instructions for those who are interested. If amounts are reported here, the filer must attach a
schedule listing the name and address of each affiliate that received payments and specifying the amount
and purpose of the payments to each affiliate.
117
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services expenses. For a 501(c)(3) group, the activities which these expenses support are
usually the basis of the organization’s tax exemption.118
Management and general expenses are those incurred in connection with providing
overall administration to an organization. The Instructions note such things as preparing
for and holding board meetings, working on office management and personnel problems,
and accounting and investment activities. The Instructions also make clear that the
expenses incurred in carrying out activities involving the supervision of program services
or fundraising are not included under management and general. Thus, for example,
preparing for and attending a development committee meeting would not be part of this
category.119
Fundraising expenses are pretty much self-defining. The Instructions define this category
as “ … the total expenses incurred in soliciting contributions, gifts, grants, etc.”
It is not uncommon for a particular expense to present a problem regarding which
functional category it should be assigned to. A similar problem may arise because some
expenses may relate to more than one functional category (shared expenses). The subject
of expense categorization and allocation is an enormous one and far beyond the scope of
this paper. By the time a reader examines a Form 990, these decisions will have been
made, but a careful reader will be aware that there is at least as much art as science in
making them (and sometimes a little spin) and will keep this in mind as she interprets and
assesses the expense information contained in the Form 990 and particularly how object
expenses are allocated among the three functional categories.
For many it is conventional wisdom that it is preferable for a group to spend most of its
money on program and relatively little on management and general and fundraising.
Thus, ratios are sometimes used for assessment purposes. It may be asked: Of a group’s
118
Program services expenses also include expenses incurred in conducting an unrelated business activity.
For many small organizations with small staffs, it is likely that management and general expenses will
be small as most of management’s time of these groups is spent on supervising the program and fundraising
and relatively little is spent on overall management activities.
119
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total spending, how much was made up by each of the three functional categories? The
fundraising ratio, for example, would consist of fundraising expenses over total expenses.
This ratio can be developed from the information found in the Expenses section of Part I,
namely, the amounts found at Lines 15 (Fundraising) and 17 (Total expenses). For
example, if Line 15 is $80,000 and Line 17 is $400,000, the fundraising ratio would be
20% ($80,000/ $400,000 = 20%). Similarly, program services and management and
general ratios can be developed from the data on Lines 13 (Program services), 14
(Management and general) and 17 (Total expenses).
Returning to the point made above about conventional wisdom, a high program service
ratio and relatively low management and general and fundraising ratios might be thought
to be desirable. We, however, are bold to suggest that the wisdom is conventional and
not necessarily sound. For example, groups that are young or are advancing unpopular
causes may have to spend more on fundraising than well-established groups or those that
provide services that everyone agrees are important. Furthermore, we believe that
conventional wisdom is generally misinformed about the importance and realities of
fundraising. For example, we believe that those who have never worked in a nonprofit
organization have little idea of how hard fundraising can be or how much time and effort
are needed to do it successfully. Similar observations apply to management and general,
except that the management and general ratios are usually fairly low (in part because a lot
of what administrators do is fundraise). As a final point on this subject, we return to what
was said above about the “art” involved in allocating expenses among the three
categories of functional expenses and the caution that must be exercised in interpreting
these allocations. Furthermore, it should be kept in mind that the pressures of
conventional wisdom (e.g., that it is inappropriate to spend too much on fundraising),
may in some cases induce those who keep track of what an organization does to make
allocation decisions that tend to under-represent the amount of time and money actually
spent on fundraising. A corollary of this point is the fact that a group that is completely
honest in its reporting may be hurt in comparison with a less scrupulous group when
those who assess these groups follow the guidelines of conventional wisdom in
interpreting spending ratios and the like, and this seems unfair.
65
Net Assets – There are four lines contained in the Net Assets portion of Part I. Line 18
(Excess or (deficit)) is the difference between Line 12 (Total revenue) and Line 17 (Total
expenses) and shows whether the filer ended the year in the red or the black for that year
– a matter in itself of some interest. We return to Line 18 at the end of our consideration
of Net Assets.
Line 19 (Net assets or fund balances at beginning of the year) shows a figure taken from
Line 73 column (A) of Part IV (Balance Sheets) and generally represents the net worth of
the filer at the start of its accounting period. Line 20 (Other changes to net assets or fund
balances) is for certain adjustments that are explained below. In many cases it will be left
blank or the figure zero will be entered. Line 21 (Net Assets or fund balances at end of
year) shows a figure taken from Line 73 column (B) of Part IV (Balance Sheets) and
generally represents the net worth of the filer at the end of its accounting period. Where
Line 20 is zero (which is usually the case), Line 21 is the result of combining Line 18, the
organization's surplus or deficit for the year, and Line 19, the organization's net worth at
the start of the year. To take a very simple case, suppose an organization’s only assets at
the start of the year were $100 and it had no outstanding liabilities. In these
circumstances, Line 19 would show $100. If during the year it took in $200 and incurred
expenses of $175, it would have a surplus (excess) of $25 and Line 18 would show $25.
Combining Lines 18 and 19 would produce the amount of $125, which is the figure that
would be entered at Line 21 as the filer’s net assets (net worth) at the end of the year. (If
the organization incurred expenses of $ 210 for the year, Line 18 would show a deficit of
$10 and combining Lines 18 and 19 would result in a figure of $90 which would be
entered at Line 21.)
Thus, from a financial standpoint, these lines on the Net Assets section of Part I provide
information about the level of financial resources a filer has behind it. Do these reserves
furnish the filer with an ample cushion to help it through a difficult period? Or are they
meager and thus suggest that the filer must get by pretty much on what it brings in each
66
year with little in reserve? Information helping to answer these questions can start to be
developed from looking at the net worth lines (Lines 19 and 21).
Because of complications similar to those mentioned at the end of our analysis of
revenue, care must be taken in interpreting a filer’s net asset information. As in our
discussion above of these complications, the distinctions between near-term and longerterm expenses and between core program and special program expenses are important to
bear in mind.
Line 21, the net assets held by a filer at the end of the year being reported on, may be
taken as providing a rough estimate of how much the filer has in reserve to meet expenses
if, for example, it comes upon a period of diminishing income. Line 21, however, may
include net assets that are not available for meeting the near-term core program expenses
of a filer.
To begin with, Line 21 may include assets that are permanently restricted. An example
would be an endowment whose principal is permanently restricted and only the income
of which is available for current spending. Another example would be assets that are
temporarily restricted such as assets that are to be used in the future to support a special
program of the filer. Both of these kinds of assets would be included in Line 21 and both
of these kinds of assets probably should not be considered in determining the level of a
filer’s reserves to meet its near-term core program expenses. By turning to Part IV
(Balance sheets) of the filer’s Form 990, a reader can learn how much of a filer’s total net
assets (Lines 21 and 73(B)) are made up of permanently restricted and temporarily
restricted net assets. Permanently restricted net assets are reported at Line 69.
Temporarily restricted net assets are reported at Line 68. As suggested, these two
categories of net assets should probably not be considered in evaluating the amount of
reserves available to meet a filer’s near-term program needs. If permanently restricted
and temporarily restricted net assets are eliminated from total net assets, unrestricted net
assets are left (Line 73 – [Line 68 + Line 69] = Line 67). Line 67 reports a filer’s
67
unrestricted net assets and this amount does come closer to suggesting how much of a
filer’s total reserves are available for these needs.
Even Line 67, however, should be considered carefully. It may be that included in Line
67 are assets, such as a building that the filer uses to carry out its exempt purposes, that
cannot be readily liquidated without virtually destroying the filer’s ability to continue its
program. There may also be certain investment assets that would be very difficult to
liquidate. These assets should probably not be considered as being available to meet a
filer’s near-term program needs. Information about such assets can be found out by
examining the Assets section of Part IV. For example, Line 57 reports on the value of
buildings used by the filer to conduct its program. This subject is explored further below
in subsection 2 of Section IV of this paper.
A reader of a filer’s Form 990 may also be interested in the increase or decrease in net
assets from the beginning to the end of the year. If net assets are increasing, for example,
this may be because the filer’s ability to generate revenue is improving or because it is
better controlling its costs or generally that the relationship between the filer’s incomegenerating capacity and its ability to control costs suggests that its financial condition is
improving.120 One can find out whether a filer’s net assets have increased or decreased
by comparing Lines 19 and 21 and Lines 73(A) and 73(B).121 Here too, however, the
complications mentioned above must be considered. Thus, for example, if the increase in
net assets is a function in part of a gift to the filer’s endowment, this fact should be taken
into account in assessing the increase. Many of these complications are eliminated,
however, if one looks primarily at the changes in unrestricted net assets shown at Line
67. This subject is also explored further below, in subsection 1 of Section IV.
120
Of course, if net assets decrease from the beginning to the end of the year, less positive conclusions may
be drawn about the filer’s financial future. Note, that the focus here is a dynamic one. It looks to see
whether the filer’s income-generating capacity is changing for the better or the worse.
121
If Line 21 is greater than Line 19, net assets have increased. Similarly if Line 73(B) is greater than Line
73(A), net assets have increased. And, of course, if Line 21 is less than Line 19 and Line 73(B) is less than
Line 73(A), net assets have decreased. These lines refer to total net assets and, as suggested above, by
looking at Line 67 one can learn whether a filer’s unrestricted net assets have increased or decreased and
this will most likely be a better place to look before assessing a change in a filer’s net asset position as an
indication of whether its financial condition is improving or not. This subject is explored further below in
subsection 2 of Section IV of this paper.
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We return now to Line 18. As suggested above, it would be of interest in itself to know
whether the organization ended the year with a surplus (excess) or deficit for the year. Of
course, if the reader has available to her the filer's Forms 990 for the past three years, she
will be able to make more informed determinations about its financial position than if she
had only one year to look at. It means more if an organization has been running deficits
three years in a row, resulting in a constantly diminishing net worth, than if it only
showed one year of deficit and an increase in net worth over three years. For example, if
a reader of three consecutive Forms 990 of a filer observes that the filer had $750,000 of
net assets at the start of the period being examined and sustained deficits in the
neighborhood of $200,000 for each of the three years, so that the filer’s net assets had
diminished to about $150,000 at the end of the period being examined (Line 67(B) of the
last year’s Form 990), there would be reason for serious concern abut the filer’s future
financial health. On the other hand, if the deficits ran at about the level of $50,000 a
year, while this may be taken as an indication of some problems, they would clearly not
be as serious as in the first case.
The above analysis is appropriate only if the filer reports no amounts at Lines 68 or 69
for the three years being examined.122 But, as a predictor of its future financial
performance, a filer’s surplus or deficit reported at Line 18 may be misleading for
reasons similar to those discussed above regarding Line 12 and net assets. If the filer, for
example, received a large gift to its endowment during the year, that amount would be
reflected in Line 18, and consequently it may not be reasonable to suppose that the filer
will end the following period with a similar surplus.123 However, by looking at the
differences between Lines 67(A) and (B), one can determine whether the filer ended the
year with a core program surplus or deficit. As subsection 1 of Section IV below
explains, one may rely with some degree of assurance on the filer’s core program surplus
122
In this case the surpluses or deficits reported at Line 18 would be identical to the core program surpluses
or deficits as determined from examining the differences between Lines 67(A) and (B) for the three years.
123
In circumstances where a significant amount of a filer’s expenses have been defrayed during the year
with the release of funds from temporarily restricted assets on hand at the beginning of the year, the filer
may report a deficit even though from a common sense view it operated in balance or at a surplus for the
69
or deficit as a predictor of the filer’s future financial ability to generate sufficient
resources to continue its core program.
A note on Line 20 (Other changes in net assets or fund balances). In some instances,
there will be changes between an organization’s net assets at the start and end of the year
that cannot be accounted for by the amount on Line 18. They would include such items
as adjustments of earlier years’ activities and, not uncommonly for those groups that hold
securities as assets, unrealized gains or losses on investments carried at market value.
The net of these changes is entered at Line 20. If a filer reports on Line 20, it must attach
a schedule. Line 20 is discussed below at Section IV.
SECTION II
FORM 990 PART II -- STATEMENT OF FUNCTIONAL EXPENSES
Part II (Statement of Functional Expenses) is where most of an organization's expenses
are reported. As noted above, it is structured in accordance with two types of expenses:
object expenses and functional expenses. Object expenses include such things as
compensation paid to staff and amounts paid for telephone and travel.124 Functional
expenses divide expenses by activity: amounts spent on program services, management
and general, and fundraising expenses. We have discussed functional expenses above in
considering the Expenses section of Part I.125 This section concentrates for the most part
on what can be concluded from studying an organization’s object expenses.
As a preliminary point it should be noted that there are a number of expenses that do not
appear on page 2 Part II of Form 990 but rather, as noted above, are listed on page 1 of
the Form. Thus, expenditures incurred in connection with rental income received from
year, and it would not be reasonable to suppose it would run a deficit in the following period. This problem
is discussed in subsection 1 of Part IV of this paper.
124
Object expenses are also referred to as natural expenses.
70
investment property are recorded at Line 6b; sales expenses incurred in connection with
the sale of securities and the like at Line 8b; certain expenses incurred in connection with
special events at Line 9b; and the cost of goods sold in connection with the sale of
inventory at Line 10b. For the most part these expenses are incurred in connection with
the production of income raised simply to support the organization and not in connection
with any program of the filer. (Note, however, that the same could be said for general
fundraising expenses or expenses incurred in connection with the receipt of unrelated
business income, which are reported on page 2, Part II of Form 990.) It may be
significant to know how much is expended on the production of these types of revenue.
Knowing that an organization spends a substantial amount of money in producing rental
income or in connection with the sale of securities, rather then just the amount of net
income from these sources, may inform one’s understanding of the filer. To complete the
identification of non-page 2 expenses, certain kinds of payments made to affiliated
organizations, such as dues paid by a local charity solely to support its state or national
parent, are reported at Line 16. As noted above, this line is only rarely applicable and
usually shows zero.
We now look at the expenses listed on Part II. The various object expenses listed at
Lines 22-42 (salaries, postage, etc.) are pretty much self-defining, and explanatory
comment will be provided for only a few of them. (As suggested above, the Instructions
to the Form 990 are excellent in explaining these terms.) Line 22 (Grants and
allocations) are where grants made by the filer are listed. Many grant-making
organizations file Forms 990-PF, but there are some nonprofits that are not private
foundations that nevertheless make grants and who therefore file Forms 990. Here is
where such grants would be listed.126 Line 23 (Specific assistance to individuals) is for
direct payments to an organization’s clients or patients127 and Line 24 (Benefits paid to or
for members) is for payments to members such as hospitalization or disability benefits.
125
We will comment on the relationship between program services expenses as reported at Part II and Part
III in our discussion of Part III below.
126
If grants are made, the filer must attach a schedule showing the class of each activity (e.g., nursing
activity, fellowships, etc.), donee’s name and address and amount given and certain other information. The
Instructions relating to this schedule are fairly detailed.
71
(Line 24 usually applies to non-501(c)(3) organizations.) Note that so far as the
categorization of functional expenses goes, Lines 22-24 must be allocated to Program
services (column (B)) and so where questions are raised about whether an organization is
spending too much on management and general or fundraising, amounts listed on these
lines might be reassuring. (Of course, there is no assurance, for example, that the grants
were intelligently or carefully made or that they accomplished their purposes. See
generally our observations made below in discussing Part III on the utility of the Form
990 for making substantive evaluations of a filing organization.)
Lines 25-29 have to do with payment of compensation to staff and (where applicable)
board members. As there might be concern about salary levels (being too high or too
low), these lines could be of particular interest. Line 25 is for compensation paid to
officers, key employees and (if applicable) board members and should equal the sum of
the amounts listed at Part V (List of Officers, Directors, Trustees, and Key Employees).
In Chapter 1 above, we have discussed in detail Part V and how it may contain
information about a filer’s noncompliance with the no inurement prohibition. What
follows briefly repeats some of the points made there. Part V lists the total compensation
paid to directors and officers and each key employee. A key employee is defined as
someone with authority to control the activities or finances of the organization, and when
there is an issue of excessive compensation, it frequently involves employees with such
power. Thus, some close inspection may be paid to Part V. To avoid the disclosure of
particular compensation payments that may be thought to raise awkward questions,
unscrupulous organizations may hide these payments by including them at Line 26 (Other
salaries and wages).128 However, when the amounts listed at Line 26 are divided by the
total number of employees as listed at Line 90b, if the average seems high, suspicious
readers may want to probe deeper (particularly if they have information about
compensation independent of the Form 990). Furthermore, Line 29 (Payroll taxes)
includes amounts paid as the organization’s share of Social Security and Medicare taxes
and thus roughly reflects the level of its actual payments of compensation. As these
127
If payments are made, the filer must attach a schedule showing the total payments for each particular
activity, such as food, shelter, medical and hospital fees and direct cash assistance to indigents.
128
They may also be hidden by being reported at Line 43 (Other expenses). We discuss line 43 below.
72
amounts are reported to the IRS on other forms (e.g., Form 941) and to some extent can
be cross-checked against employees’ individual income tax returns, they are not likely to
be falsified. At the other end of the question about salary levels, dividing the amount
listed at Line 26 by the number of employees listed at Line 90b may suggest that some
salaries may be too low. A Form 990 reader may also be interested in the difference in
the compensation levels of the highest paid employees and the filer’s other employees.
Compensation received by the highest paid employees is listed at Part V and Part I of
Schedule A. A reader who combines this information with the filer’s average
compensation (Line 26 /Line 90b = average compensation) may gain some idea of the
differences between high paid employees and the compensation levels of the rest of the
staff. As noted above, salary and compensation matters which may raise questions about
excessive compensation or otherwise improper payments are covered in Chapter 1.
The only other specific lines on Part II that we will comment on are Line 30 (Professional
fundraising fees), Line 36 (Occupancy), Line 42 (Depreciation) and Line 43 (Other
expenses). Line 30 is where payments to outside fundraisers for solicitation campaigns
or for advising the organization on solicitation campaigns are put. It may be that some
groups do not want to disclose this kind of payment and choose instead to include it at
Line 43 (Other expenses) as “professional services” or some such thing. If the reader is
suspicious, a crosscheck might be made to Part II of Schedule A where there should be
listed the compensation paid to the five highest paid independent contractors for
professional services, who are paid more than $50,000. The instructions to Schedule A
make clear that professional fundraisers are to be included here. Column (a) of Schedule
A’s Part II requires the filer to list the names and addresses of each independent
contractor and column (b) requires that the type of service be noted. Thus, payments to
professional fundraisers may be disclosed at Part II of Schedule A if not on Line 30 of the
Form 990 proper. This is particularly the case as the filing organization must file a Form
1099 with the IRS for every payment it makes to an independent contractor of $600 or
73
more. Thus, the filer is likely to feel constrained to complete Part II of Schedule A
accurately. Part II of Schedule A is also discussed above in Chapter 1.129
We mention Line 36 (Occupancy) only to make clear what information it elicits. Here
should be put amounts paid for the use of space (rent), heat, light, power, outside
janitorial services, mortgage interest, property insurance and similar expenses (but not
amounts for depreciation – see next paragraph).
Line 42 (Depreciation) is where the filer records the depreciation expenses it incurred
during the year being reported on. Typically these expenses include depreciation
incurred on such fixed assets as buildings and equipment. As will be explained below in
Section IV, this is an important item for determining a filer’s cash flows for the year, and
depreciation and its relevance is explained in more detail there.130
Finally, a word about Line 43 (Other expenses) is merited. There are a large number of
expenses that are not included at Lines 22-42, such as payments for general liability and
D&O insurance, taxes for which the organization is not exempt, expenses incurred in
connection with the production of workshops, purchase of food, computer services and
on and on. These expenses are listed at Line 43. Where filers report amounts on line 43,
they are required to attach a schedule to their returns listing all these expenses. This
schedule is well worth looking at. As suggested above in discussing Line 30
(Professional fundraising fees), certain payments may be listed here in ways that obscure
their true nature.131
What generally can be said about Part II? In connection with the Expense section of Part
I on page 1, we have already discussed what might be made (or not made) of comparing
the relative amounts spent on the three functional categories, i.e., program services,
129
Line 31 (Accounting fees) and Line 32 (Legal fees) may very well involve payments to independent
contractors and thus a reader of the Form 990 might want to look at Part II of Schedule A to see whether
the amounts listed at the two places make sense. For example, if Line 32 shows a large amount for legal
fees but Part II of Schedule A shows no payments to attorneys, something may be amiss.
130
If the filer records depreciation, it must attach a schedule showing how depreciation was computed.
74
management and general, and fundraising expenses. So far as evaluation of what object
expenses might mean, perhaps some inferences might be drawn if the amounts listed on
certain lines seem large as compared to other expenses (e.g., a large amount spent on
legal fees or travel may raise questions), but we believe that extreme caution should be
exercised in arriving at any such conclusions. Generally a common-sense review of these
expenses may offer some insight into a filer’s activities (e.g., substantial amounts spent
on printing and publication are consistent with an organization that publishes journals and
reports while substantial amounts spent on travel are consistent with an organization that
provides services in different places).
Just below the listing of object expenses, there is a question that asks whether the filer
reported in column (B) (Program services) any joint costs from a combined educational
campaign and fundraising solicitation. For example, an organization may mail a
pamphlet to its potential supporters that informs the reader about the organization and the
importance of its cause and solicits contributions from the reader as well. The costs of
preparing and sending this pamphlet may be allocated between program services and
fundraising. In this case the organization would answer the question “Yes” and in the
space provided indicate the total amount of these joint costs and the amounts allocated to
program services and fundraising. In interpreting these figures the reader is advised to
keep in mind what was said above about the art involved in making joint cost allocations.
Perhaps the most relevant use that can be made of this segment of the Form 990 comes
up when the reader knows about activities to which it applies and finds that the filer has
answered the question “No.” In these circumstances, some doubts may be raised about
the accuracy of the filer’s reporting of fundraising expenses, but we would strongly
emphasize the words “may be raised” and suggest caution in making such an
interpretation. (In 1998 the American Institute of Certified Public Accountants issued a
Statement of Position on the subject of joint cost allocations that addresses this subject.
See SOP 98-2 "Accounting for Costs of Activities of Not-for-Profit Organizations and
131
It may be that some clue as to such evasive reporting may be gleaned from examining the schedule
attached to Line 43.
75
State and Local Government Entities That Include Fund Raising." New York, March 11,
1998.)
Section III
FORM 990 PART III—STATEMENT OF PROGRAM SERVICE
ACCOMPLISHMENTS
This part is where a filer can indicate what it does. The filer is supposed to state the
organization’s primary purpose (on a very short line) and then for each program describe
its purpose and state the outputs of the program, such as number of clients served,
publications issued, and students taught.132 The filer must then list the total of program
expenses for each such program, and the sum of all these expenses must be the same as
Line 44 (Total of functional expenses) total for Program services (column (B)). A
creative filer may be able to provide a fair idea of its activities, but we believe a careful
Here is what the Instructions provide about Part III: “ A program is a major (usually ongoing) objective
of an organization, such as adoptions, recreation for the elderly, rehabilitation, or publication of journals or
newsletters. [The Instructions then set up two columns one headed “ Step” (which list numbers) and one
“Action.” We shall collapse the columns in what follows.] 1. State the organization’s primary exempt
purposes. 2. All organizations must describe their exempt purpose achievements for each of their four
largest program services (as measured by total expenses incurred). If there were four or fewer of such
activities, describe each program service activity.
 Describe program service accomplishments through measurements such as clients served, days
of care, therapy sessions, or publications issued.
 Describe the activity’s objective, both for this time period and the longer-term goal, if the
output is intangible, such as in research activity.
 Give reasonable estimates for any statistical information if exact figures are not readily
available. Indicate that this information is estimated.
[3 has to do with grants the filer makes.] 4. Attach a schedule that lists the organization’s other program
services.
 The detailed information required for the four largest services is not necessary for this schedule.
 Section 501(c)(3) and (4) organizations, and section 4947(a)(1) nonexempt charitable trusts,
however, must show the expenses attributable to their program services.
5. The organization may show the amount of any donated services, or use of materials, equipment, or
facilities it received or utilized in connection with a specific program service.
*Disclose the applicable amounts of any donated services, etc., on the lines for narrative description
of the appropriate program service.
 Do not include these amounts in the expense column in part III.
 See the instructions for line 82.”
132
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reader should remain agnostic as to whether the filer is doing its work effectively and
efficiently or achieving satisfactory ultimate outcomes. It may in fact deserve high scores
on these points but many believe that you cannot find this out by reading descriptive text.
Rather, such things as site visits and interviews with those served are needed to make this
kind of assessment. In any event, we believe that this is a good place to start one’s
examination of a Form 990 since it is the only place that gives the reader an idea of the
activities that an organization engages in and thus provides an important context for
interpreting the rest of the Form 990.
SECTION IV
FORM 990 PART IV – Balance Sheets
Introduction
This section looks at Part IV of the Form 990 – the balance sheet. Part IV is as important
as any part of the Form 990, and a true comprehension of the filer’s financial position can
only be gained by understanding how to read it and what it means. For people who are
unfamiliar with the details of accounting theory, methods and conventions, this can be
difficult. This section is designed to help with this difficulty.133
As we have noted, among the most important things that one can learn from studying
financial statements, like the financial portions of the Form 990, is some idea of whether
the filer will have adequate resources in the future to enable it to continue its operations.
Two major questions may be asked to assess the filer’s financial potential for continuing
its operations. First, does the filer have the capacity to raise funds to meet its future
operating costs? Put another way, will the filer generate income in the next period
sufficient to cover the expenses it will incur during that time? Below we refer to this first
133
Indeed, as we will note below, much of what follows in this section has been prepared for those who are
unfamiliar with accounting principles and methods. We believe that many readers of the Form 990 may be
included in this category.
77
question as the “financial capacity question.” Second, will the filer have sufficient
reserves to be able to continue its operations in the future in the event it meets a
temporary lapse134 in its ability to generate income? Below we refer to this second
question as the “adequacy of reserves question.” We have discussed aspects of these
questions above in Sections I and II of this paper.135 In this section, we show how
understanding the balance sheet provides important additional information for assessing
the filer’s capacity to garner resources and for assessing the adequacy of its net worth if
the filer should experience hard times.
The financial capacity question asks whether the filer will be able to continue to raise
funds in the future to support its operations. In approaching this question we suggest that
what we call “the past-is-prologue-to-the-future assumption” be used. This assumption
supposes the filer may be expected to receive about the same amount of income and incur
about the same amount of expenses in the next period as it did in the one being reported
on. Consequently, if the filer in the period being reported on generated sufficient income
to cover its expenses, then we may assume that it will do so again in the next period. As
we have frequently noted, making projections about a filer’s financial future is hardly an
exact science. The year being reported on may have included some unusual financial
occurrences and the financial results of the year following the one being reported on may
be quite different than those reflected in the Form 990 under review. But again, a major
objective in reviewing a filer’s financial statements, including the financial statements
included in the Form 990, is to make guarded evaluations about the filer’s future financial
prospects and, to do this, assumptions need to be made, however provisional they might
be.
In this connection, we refer below to a “short,” or “temporary” or “brief” period of declining revenue or
revenue shortfall. If the filer entered upon a long period of revenue shortfall, due for instance to a
significant decline of interest in supporting the organization, it is likely that even a large reserve of net
assets would not save the filer from serious trouble.
135
Section I of this paper reviewed Part I of the Form 990 that contains information about the level and
sources of the filer’s income. Section II of this paper reviewed Part II that contains information about the
filer’s expenses.
134
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When a filer’s income exceeds its expenses, it ends the year with a surplus and its total
net assets increase from the beginning to the end of the year. Thus, if the filer reported a
surplus at Line 18 on page 1, it may be provisionally concluded that it will be able to
continue to raise funds in the future to support its operations. A contrary conclusion may
be drawn if the filer reported a deficit. But, as will be explained below in subsection 1, in
cases where a filer receives income with restrictions, which is not uncommon, it may be
misleading to evaluate a filer’s financial future on the basis of Line 18, and thus it may be
necessary to look at the change in unrestricted net assets at Line 67 to draw more reliable
conclusions about the filer’s future financial prospects.
The second major question asks whether the filer has sufficient assets to draw upon to
meet near-term needs if it should encounter a temporary period of declining revenue.136
Answering this question, unlike the first major question, for the most part does not
involve an attempt to predict how the filer will perform financially in the future. It
merely looks at the size or amount of net assets that are free to meet near-term needs. Of
course, the adequacy of reserves question assumes a situation that is not very likely to
occur, namely, that the filer will stop receiving income for a while. This possibility,
however, is always a possibility, and, while in some senses unrealistic, provides a good
viewpoint from which to assess the filer's net reserves and to determine, given what
might be considered a worst-case scenario, how long the filer would be able to continue
its operations. Keep in mind that in asking this second question, we ask whether there
will be sufficient resources to meet near-term expenses, that is, those expenses the filer
will incur in the next period.137
For answering both the financial capacity and the adequacy of reserves questions, it is
essential that Part IV of Form 990 be reviewed and understood. Here we reproduce Part
IV:
This refers to what we called above the adequacy of reserves question.
For example, if a filer receives funds with a restriction that they are not to be used for some time or
that only the income from such funds may be used, these funds would not be available to meet a filer’s
near-term expenses. Such funds would, however, be available in the longer run. For example, if in the
future the filer’s financial circumstances deteriorated to such an extent that it was unable to pay its bills,
these funds would likely be reachable by its creditors.
136
137
79
It will be noted that Part IV is divided into three sections: Assets, Liabilities, and Net
Assets. The assets and liabilities that are listed in the Assets and Liabilities sections of
80
Part IV may be divided into several categories: cash and cash equivalents,138 assets and
liabilities that occur because the filer is using the accrual method of accounting,139
financing assets (e.g., loans made to others) and liabilities (e.g., loans received from
others),140 investment assets141 and assets consisting of land, buildings and/or equipment
used in carrying out the filer’s activities.142 The Net Assets section is made up of eight
Lines. For our purposes we focus on four of those Lines: Line 67 -- unrestricted net
assets; Line 68 -- temporarily restricted net assets; Line 69 – permanently restricted net
asset and Line 73 – total net assets.
Below in subsection 1 we address the Net Assets section of Part IV. In subsection 2 we
analyze the Assets and Liabilities sections of Part IV explaining what each Line means
and what light it may shed for answering the financial capacity question and the adequacy
of reserves question. There is information in both subsections of Section IV that bears on
those two questions. However, to answer our first question -- does the filer have the
financial capacity to raise funds to meet its future operating costs143 -- we concentrate
mostly on the change in a filer’s net assets and focus on the Net Assets section. 144 And
to answer our second question -- does the filer have sufficient assets in reserve to draw
upon to meet near-term needs if it should encounter a temporary period of declining
revenue145 -- we focus our analysis on the Assets and Liabilities sections of Part IV.
However in answering the second question, if the filer reports either temporarily or
permanently restricted net assets, we also look at the Net Assets section.
138
Lines 45 and 46.
Lines 47, 48, 49, 50, 52, 53, 60, 61 and 62.
140
Lines 50, 51, 63 and 64.
141
Lines 54, 55 and 56.
142
Line 57. Finally, Lines 58 (Other assets) and 65 (Other liabilities) are catchall Lines for other assets and
liabilities that do not appear to fit within any of the categories listed earlier.
143
The financial capacity question.
144
However, in some cases there may be information in the Assets and Liabilities sections of Part IV that
bears on the first question.
145
The adequacy of reserves question.
139
81
Subsection 1– Net Assets and the Financial Capacity Question
This subsection reviews the Net Assets section of Part IV. The Net Assets section is
important for answering both the financial capacity question (does the filer have the
capacity to raise funds to meet its future operating cost?) and the adequacy of reserves
question (how long could the filer continue its operations if it encountered an income
shortfall?). This subsection will focus on the Net Assets section as it bears on the
financial capacity question. At the end of this subsection, we consider several asset lines
that bear on the financial capacity question.
As noted above, Line 18 reports the surplus or deficit for the year, that is, the amount by
which total revenue (Line 12) exceeds or is less than total expenses (Line 17). In terms
of answering the financial capacity question, if the past-is-prologue-to-the-future
assumption is followed and the filer ended the year with a surplus, one may provisionally
assume that in the next period the filer’s income will exceed its expenses, and
consequently, as a financial matter, that the filer will be able to continue its operations in
the next period.146 But, as noted in the Introduction to this section, the filer could have
received contributions during the year that require that the filer’s surplus be examined
quite carefully. Examples of such gifts include gifts to an endowment or gifts with
restrictions that they be used for special programs. Such gifts would be included in
income and reflected in Line 18, but since they may not consist of the kind of income that
can be used to meet the ordinary operating expenses of the filer’s core program,147 it may
be inappropriate to consider them in making assumptions about the filer’s financial
future. The first kind of gift (the endowment gift) would be included in the amount
146
On the other hand if the filer ended the year in a deficit, and the past-is-prologue-to-the-future
assumption is followed, one may conclude that in the next period the filer’s income will be less than its
expenses and that it consequently may, as a financial matter, have difficulty continuing. Of course, there
may be special reasons why the filer ended the year in a deficit which will not apply to the next period.
Furthermore, it hardly follows necessarily or even probably that because a filer ended the year in a deficit
in the year being reported on it will do so again in the next period. In any event when the filer does end the
year in a deficit, the adequacy of reserves question becomes prominent.
In the extremely rare instance of a filer ending the year in balance – income (Line 12) equals expenses
(Line 17) and Line 18 reports 0 -- applying the past-is-prologue-to-the-future assumption, one may
conclude that the filer will generate sufficient income to be able to cover its expenses in the next period.
147
Below we define what we mean by “core program” and how it contrasts with “special program.”
82
reported at Line 69(B) in the Net Assets section as permanently restricted net assets, and
the unexpended portion of the second kind of gift (the gift restricted for a special
program) would be included in the amount reported at Line 68(B) in the Net Assets
section as temporarily restricted net assets.148 Thus, before relying on Line 18 as an
indicator of the filer’s financial future, a careful reader of the Form 990 will look at the
Net Assets section of Part IV of the Form 990 to see whether any temporarily or
permanently restricted net assets are reported. As will be noted below, where a filer
reports either temporarily or permanently restricted net assets, it is best to review the
change in the filer’s unrestricted net assets149 to assess its financial ability to continue its
core program.
Below we set out the Net Assets section of Part IV.
148
Temporarily restricted net assets are assets that have been given with restrictions that they be used in a
later period, or only for a specified purpose or both. A typical example might be a grant from a foundation
with a stipulation that the funds be used over several years (a multi-year grant) to support a particular
program. The grant may be to support a special program or the filer’s core program or both. Any
unexpended funds (unexpended because they are to be spent in future years) on hand at the end of the year
would be included in temporarily restricted net assets reported at Line 68(B).
The Instructions to Form 990 define temporarily restricted net assets as funds upon which donors have
imposed restrictions that “require that funds be used in a later period or after a specified date (time
restrictions), or that resources be used for a specified purposes (purpose restrictions), or both.” FASB (The
Financial Accounting Standards Board) defines temporarily restricted net assets as follows: “The part of net
assets of a not-for-profit organization resulting (a) from contributions and other inflows of assets whose
use by the organization is limited by donor-imposed stipulations that either expire by the passage of time or
can be fulfilled and removed by actions of the organization pursuant to those stipulations, (b) from other
asset enhancements and diminishments subject to the same kinds of stipulations, and (c) from
reclassifications to (or from) other classes of net assets as a consequence of donor-imposed stipulations,
their expiration by the passage of time, or their fulfillment and removal by actions of the organization
pursuant to those stipulations.” Id. At 78.
83
As noted above, there are four categories of net assets: unrestricted net assets,
temporarily restricted net assets, permanently restricted net assets and total net assets.
Part IV of Form 990 lists unrestricted net assets at Line 67, temporarily restricted net
assets at Line 68, permanently restricted net assets at Line 69 and total net assets at Line
73. Column (A) lists net assets on hand at the beginning of the year. For example, Line
67(A) reports unrestricted net assets on hand at the beginning of the year. Column (B)
lists net assets on hand at the end of the year. For example, Line 67(B) reports
unrestricted net assets on hand at the end of the year. Total net assets are also listed on
page 1 of the Form 990 at Line 19 (net assets on hand at the beginning of the year) and
Line 21 (net assets on hand at the end of the year). Note that the change in a filer’s total
net assets (Line 73(B) – Line 73(A)) is identical to the amount reported at Line 18.150
Above, in discussing contributions that may require special care in evaluating the filer’s
surplus or deficit, we identified contributions for special programs as one kind of
contribution that requires this special attention and suggested that the income provided by
such contributions may not be used to meet the filer’s ordinary expenses incurred in its
core program. Thus, we implicitly referred to a distinction mentioned earlier between a
filer’s core program and its special programs. This distinction is important since, as will
be suggested below, we believe that the most significant question the financial capacity
question asks is whether the filer will be able to generate sufficient income to cover its
core program expenses in the future. Because of this distinction’s importance to our
analysis in this subsection, we repeat what has been said earlier. A filer’s core program is
its general mission, that which it was principally set up to accomplish. What is
particularly relevant for our present purposes is that a filer’s core program is supported by
unrestricted revenues or by revenues only restricted as to time.151 Special programs,
while consistent with the filer’s general mission, are not part of its core activities. As we
Line 67(A) – Line 67(B) = the change in a filer’s unrestricted net assets
In the case of a surplus, Line 73(B) will be larger than Line 73(A) and the difference will be the amount
reported as a surplus at Line 18. In the case of a deficit, Line 73(B) will be smaller than Line 73(A) and the
difference will be the amount reported as a deficit at Line 18.
151
For example, a contribution may be made to support the filer’s core program with the limitation that it
be used in equal portions over four years. That portion of the contribution that was not to be used in the
year received would consist of revenues for the filer’s core program but such revenues would be restricted
as to time.
149
150
84
are using the term, a special program is supported by contributions that restrict the use of
their funds to support the particular special program for which the funds were
contributed. In most cases when the funds for a special program run out, the special
program is terminated, but, of course, the filer continues its core program. As just
mentioned, we believe the distinction between a filer’s core program and its special
programs is particularly important since many readers of a filer’s Form 990 will be
primarily interested in the question of whether the filer will be able to continue its core
program. If it is unable to continue a special program, the special program will be shut
down but the core program will continue. If, however, the filer is unable to continue its
core program, this ordinarily means the whole operation will be shut down.
Following from what has just been said, in much of what follows we focus upon a filer’s
core program surplus or deficit. A filer’s core program surplus or deficit is the difference
between its “core program income” and “core program expenses.”152 By “core program
income” we refer to the unrestricted income the filer received during the year.153 By
“core program expenses” we refer to the expenses the filer incurred during the year not
defrayed by restricted income. As will be shown, a filer’s core program surplus or deficit
can be determined by looking at Line 67.154
In cases where a filer reports no temporarily or permanently restricted net assets, no
special complications will be involved. In these circumstances, all the income the filer
received during the year would have been unrestricted income available for the filer’s
core program and all the expenses that the filer incurred during the year would have been
core program expenses. Consequently, the surplus or deficit reported at Line 18 on page
1 of the Form 990 would be a core program surplus or deficit and would be sufficient for
triggering the past-is-prologue-to-the-future assumption for purpose of answering the
Core program income – core program expenses = core program surplus or deficit.
If a filer receives a contribution to support its core program that is to be expended over several years
starting with the year being reported on, the income from the contribution to be used during the year being
reported on is core program income.
154
Line 67(B) (unrestricted net assets at the end of the year) – Line 67(A) (unrestricted net assets at the
beginning of the year) = core program surplus or deficit. As noted above, a filer’s total program surplus or
deficit can be determined by looking at Line 18 and the differences between Lines 73(A) and (B).
152
153
85
financial capacity question as to the filer’s core program.155 But, as suggested, when the
filer reports temporarily or permanently restricted net assets, making assessments solely
on the basis of Line 18 may result in misleading conclusions.
While this last point was made at the start of this subsection, because of its importance,
we now expand upon it. A contribution with a restriction that it be held permanently will
be included in income in the year received and reflected in Line 18. But no amount of
such contribution may be used to support the filer’s core program. Thus, in this instance,
the income reported at Line 12 will not consist entirely of core program income and the
amount reported at Line 18 will not consist entirely of a core program surplus (or
deficit).156 Consequently, it would be inapt to base on Line 18 one’s judgment on the
financial future of the filer’s core program. A similar analysis would apply to a
155
Where no temporarily or permanently restricted net assets are reported and nothing is reported at Line
20, the change in net assets during the year will be reflected not only in Line 18 but also (as just noted) in
the differences between Lines 73(A) and (B) and Lines 67(A) and (B). Thus, in these circumstances Line
73(B) – Line 73(A) = Line 18 and Line 67(B) – Line 67(A) = Line 18.
In every case where nothing is reported at Lines 68 and 69 or where there is no increase in Lines 68 and 69
from the beginning to the end of the year (and nothing is reported at Line 20), the surplus or deficit reported
at Line 18 will be the core program’s surplus or deficit for the year being reported on. There are, however,
circumstances where the amount reported at Line 18 represents a core program surplus, but all the amounts
reported at Lines 12 and 17 do not represent core program income and core program expenses. Consider
the following example. The filer received a contribution during the year which was restricted to be spent on
a special program and was spent during the year on the special program; then some of the Line 12 income
would consist of non-core program income and some of the Line 17 expenses would consist of non-core
program expenses. As these two amounts would be identical and would in effect cancel each other out, the
surplus or deficit reported at Line 18 would consist of a core program surplus or deficit. (“Core program
income” – “core program expenses” = “core program surplus or deficit.”)
There is another circumstance where there is no increase in Lines 68 and 69 from the beginning to the end
of the year and where the amount reported at Line 18 represents a core program surplus but where all the
amounts reported at Lines 12 and 17 do not represent core program income and core program expenses. In
this case the amounts reported at Line 68(A) and 68(B) do not change but in fact during the year an amount
was released from Line 68(A) to support a special program and a contribution was received during the year
in the same amount restricted to be spent on a special program in a future period. In this case some of the
income reported at Line 12 would consist of restricted (non-core program) income which was not spent
during the year and some of the expenses reported at Line 17 would consist of restricted (non-core
program) expenses, but these expenses will have been defrayed by the amounts released from Line 68(A)
(not included in Line 12) so that the surplus or deficit reported at Line 18 will be a core program surplus or
deficit.
156
To make the point, here is a very simple example. The filer received $1,000 of unrestricted income and
a contribution of $500 with a restriction that it be held as an endowment and that only the income it
generates may be used. The filer incurred $900 of core program expenses. Assuming no other relevant
transactions during the year, here is what would be reported on the key lines of the filer’s Form 990: Line
12 - $1,500, Line 17 - $900, Line 18 - $600. However, of the $1,500 reported at Line 12, only $1,000
consists of core program income (and $500 of restricted, non-core program income). Therefore the filer’s
86
contribution with a restriction that it be used only to support a special program.
Furthermore, if amounts reported as temporarily restricted net assets at Line 68(A) were
used during the year to defray expenses of a special program, such amounts would be
included in Line 17 expenses. Thus, in this latter instance, the expenses reported at Line
17 will not consist entirely of core program expenses and the amount reported at Line 18
will not consist entirely of a core program surplus (or deficit).157 Consequently, in either
of these cases it would be inapt to base on Line 18 one’s judgment on the financial future
of the filer’s core program.
Thus, it is critically important that a reader of a Form 990 review the Net Assets section
of Part IV to find out whether any temporarily or permanently restricted net assets are
reported. We estimate that maybe as many as half of all the Forms 990 filed report
temporarily or permanently restricted net assets.
If either temporarily or permanently restricted net assets are reported, while one may not
rely upon the surplus of deficit reported at Line 18 for answering the financial capacity
question, in most cases, by looking at the changes in Line 67 (unrestricted net assets), one
can determine whether the filer ended the year with a core program surplus or deficit, and
this information is sufficient for making judgments about the financial future of the filer’s
core program. If unrestricted net assets increased during the year, this means that the
filer received more core program income than it incurred core program expenses, i.e., that
it ended the year with a core program surplus. In these circumstances applying the pastis-prologue-to-the-future assumption, one may fairly suppose that the filer will generate
sufficient core program income in the next period to cover its anticipated core program
core program surplus in this case would be $100 (core program income of $1,000 less core program
expenses of $900).
157
To make the point, here is another very simple example. The filer received $1,000 of unrestricted
income and incurred $900 of core program expenses. It reported $200 at Line 68(A) and nothing at Line
68(B). The amount reported at Line 68(A) was restricted to be spent on a special program. Assuming no
other relevant transactions during the year, here is what would be reported on the key lines of the filer’s
Form 990: Line 12 - $1,000, Line 17 - $1,100, Line 18 - ($100). However, of the $1,100 of expenses
reported at Line 17, only $900 consists of core program expenses. $200 were released from Line 68(A)
during the year and were used to defray special program expenses. Thus, of the $1,100 of expenses
reported at Line 17, $900 were core program expenses ($1,100 - $200 = $900). Therefore the filer’s core
program surplus in this case would be $100 (core program income of $1,000 less core program expenses of
$900 = core program surplus of $100).
87
expenses. Thus, whatever may be reported at Lines 68 and 69, by looking at Line 67 one
can assess the financial prospects of the filer’s core program.
We will now demonstrate that, whatever may be reported at Line 68, by looking at Line
67 one can assess the financial prospects of the filer’s core program.158 We do this by
offering a simple example. (In Appendix A to this paper, we demonstrate the proposition
by considering a large number of possibilities.)
Suppose the filer ordinarily received $1,000 in core income and ordinarily had $1,000 in
core expenses. Thus, as a usual matter the filer would operate in balance and show 0 at
Line 18 and no increase or decrease in net assets. Let us assume that the filer continued
to receive $1,000 in core income but in addition received a contribution consisting of a
multi-year grant of $1,500, $500 of which was to be spent in the year being reported on
and $500 in each of the two succeeding years.159 Further assume that the filer incurred
$1,400 of expenses. If we assume that the filer’s only assets were cash and that it started
the year with $1,000 in cash and no liabilities and ended the year with no liabilities, the
key lines on its Form 990 would look like this:
From Part I on page 1
Line 12 $2,500
Line 17 $1,400
Line 18 $1,100
Line 19 $1,000
Line 21 $2,100
158
Below we consider Line 69 and make the same point.
As will be seen below, given the facts reported on the filer’s Form 990 (which is all a reader would have
access to), the contribution could have involved endless other possibilities with the result in each case being
that the filer reported $1,000 in temporarily restricted net assets at Line 68(B). For example, the
contribution may have been for $1,000, all of which was to be spent in a future period. In this case in the
year being reported on the filer would have received $1,500 of non-restricted income instead of $1,000 as
we assume above. In setting up the example, we use the possibility of a contribution of $1,500, $500 of
which is to be spent each year starting with the year being reported on, to give the example a realistic
context.
159
88
From Part IV on page 3
Line 45(A) $1,000
Line 45(B) $2,100
Line 59(A) $1,000
Line 59(B) $2,100
Line 66(A)
Line 66(B)
0
0
Line 67(A) $1,000
Line 67(B) $1,100
Line 68(A)
0
Line 68(B) $1,000
Line 69(A)
0
Line 69(B)
Line 73(A) $1,000
0
Line 73(B) $2,100
We begin by noting that the filer received significantly more income than the expenses it
incurred and ended the year with a substantial surplus reported at Line 18.160 If the filer’s
Forms 990 for the two years preceding the year being reported on were available, which
on the assumptions we are making would show income and expenses of $1,000, the
increase in income (of $1,500 or 150%) would be conspicuous. Even without the prior
years’ Forms 990, the difference between income and expenses would be notable and
should suggest that a look be given to the Net Assets section of Part IV. There, by
looking at Line 68, we would find that the filer began the year with no temporarily
restricted net assets and ended the year with $1,000 of temporarily restricted net assets to
be spent in the future. This would tell us that $1,000 of the $2,500 of income received
during the year ended consisted of a contribution at least part of which ($1,000) ended the
year in the category of temporarily restricted net assets. With this information we would
understand that the filer received only $1,500 available for spending during the year
being reported on.
160
The surplus is also reflected at Line 73. Line 73(B) $2,100 – Line 73(A) $1,000 = $1,100.
89
What we cannot tell from the Form 990 is whether the contribution included funds that
were to be spent during the year being reported on as well as funds ($1,000) to be spent
in future years. We also cannot tell whether the contribution was for support of the filer’s
core program or for support of a special program or both.161 Without knowing how much
of the filer’s income and expenses are attributable to its core program, it may seem that
we could not tell what the filer’s core program surplus or deficit was. If we did not know
this, it would be hard to estimate what the future financial prospects of the filer’s core
program were.162 But if we look at Line 67, we see that the filer began the year with
$1,000 of unrestricted net assets (Line 67(A)) and ended the year with $1,100 of
unrestricted net assets (Line 67 (B)) and thus that unrestricted net assets increased by
$100. This means that the filer ended the year with a core program surplus of $100. This
is so even though there are many possibilities regarding the amount reported at Line
68(B) and what the filer’s core program income and expenses might have been.163 Thus,
we may conclude from the amounts reported at Line 67 that the filer ended the year with
a $100 core program surplus.164 Having determined this, we may activate the past-is161
These possibilities may be significant. If, for example, part of the contribution was to be spent in the
year being reported on and was also for a special program, then presumably some part of the filer’s total
expenses for the year being reported on ($1,400 in the above example) consisted of core program expenses
and some part of special program expenses.
162
That is, we could not very well answer the financial capacity question with regard to the filer’s core
program.
163
For example, given the amounts reported on the filer’s Form 990, the contribution which gave rise to an
amount being reported at Line 68(B) might have been for a special program in the amount of $1,500 with
the stipulation that $500 of the contribution was to be spent in the year received and $1,000 to be spent in a
future period. In this case, Line 12 would consist of $1,000 of unrestricted core program income, $500 of
income restricted to be spent during the year being reported on a special program and $1,000 to be spent on
a special program in the future. The $1,400 of Line 17 expenses would consist of $900 of core program
expenses and $500 of special program expenses. In this case, with $1,000 of core program income and
$900 of core program expenses the filer would have a core program surplus of $100. Or the contribution
may have been for the filer’s core program, all of which was to be spent in a future year. In this case, Line
12 would consist of $1,500 of unrestricted core program income and $1,000 to be spent on the core
program in the future and Line 17 of $1,400 of core program expenses with a resulting core program
surplus of $100. In both cases, the $100 core program surplus is reflected in the increase in unrestricted net
assets of $100 indicated at Line 67. As Appendix A at the end of this paper shows, given the amounts
reported on the filer’s Form 990 in the above example, there are nearly an infinite number of other
possibilities of how and when the contribution which gave rise to the amount reported at Line 68(B) may
have been required to be spent, but in each case the amounts reported at Line 67 indicate that the filer
ended the year with a $100 core program surplus.
164
As suggested in the preceding note, it is not, however, possible to tell from the difference between Lines
67(B) and 67(A) how much of the amount reported at Line 12 is core program income and how much is
non-core program income and how much of the amount reported at Line 17 is core program expenses and
how much is non-core program expenses. This may not be too important, however, since whatever the
amounts are in applying the past-is-prologue-to-the-future axiom, it may be assumed that they will be
90
prologue-to-the-future assumption and conclude that the filer as a financial matter is
likely to be able to continue its core program in the next period.
We have pointed out that if amounts are reported at Line 68(B) there is no way of telling
from the Form 990 whether they are restricted in such a way that they may only be spent
on a special program or whether they can be spent on the filer’s core program but at some
time after the expiration of the year being reported on. Thus, when a filer’s unrestricted
net assets reported at Line 67 increase from the beginning to the end of the year and on
the basis of that change it is concluded that financial prospects of the filer’s core program
are positive, if the filer reports amounts at Line 68(B), the financial future of the filer’s
core program may be brighter than the Line 67 change alone suggests since it is possible
that the amounts reported at Line 68(B) may be to support the filer’s core program in the
future.
We turn now to permanently restricted net assets. As explained above, permanently
restricted assets are assets that have been given with restrictions that they be preserved
and not sold.165 One example would be an endowment gift that stipulates that the
principal of the gift is to be permanently held and that only the income generated by the
principal may be currently used. Another example would be a gift of a work of art or real
estate with a restriction that it be held permanently and not sold. We estimate that only
roughly the same in the next period. As the example in the preceding note suggests, it may be that the filer
received $1,000 of unrestricted core program income and incurred $900 of core program expenses or that it
received $1,500 of unrestricted core program income and incurred $1,400 of core program expenses (or any
number of other combinations). In any case, it received $100 more unrestricted core program income than
it incurred in core program expenses and so, under the past-is-prologue-to-the-future assumption, it may be
expected to receive and spend the same amounts in the next year and thus end the next year with a $100
core program surplus.
165
The Instructions define permanently restricted net assets as assets that “are (a) assets, such as land or
works of art, donated with stipulations that they be used for a specified purpose, be preserved, and not be
sold or (b) assets donated with stipulations that they be invested to provide a permanent source of income.”
FASB defines permanently restricted net assets as follows: “The part of net assets of a not-for-profit
organization resulting (a) from contributions and other inflows of assets whose use by the organization is
limited by donor-imposed stipulations that neither expire by the passage of time nor can be fulfilled and
removed by actions of the organization, (b) from other asset enhancements and diminishments subject to
the same kinds of stipulations, and (c) from reclassifications to (or from) other classes of net assets as a
consequence of donor-imposed stipulations.” FASB, Statement of Financial Accounting Standards No.117,
78 (1993).
91
about a quarter of all organizations filing Forms 990 report permanently restricted net
assets.
If nothing is reported at Line 69(A) and an amount is reported at Line 69(B), the amount
reported at Line 69(B) reflects a contribution during the year that was restricted in such a
way that it cannot be used for the filer’s core program or for any other expenses for that
matter. If amounts are reported at Lines 69(A) and (B) and the amount reported at Line
69(B) is larger than the amount reported at Line 69(A), in most cases the excess of the
amount reported at Line 69(B) over the amount reported at Line 69(A) will also reflect a
contribution during the year that was restricted in such a way that it cannot be used for
the filer’s core program or for any other expenses for that matter.166 If Line 69 indicates
166
Here is a simple example, which involves permanently restricted net assets. Suppose the filer
ordinarily received $1,000 in income and ordinarily had $1,000 in expenses. Thus, as a usual matter, the
filer would operate in balance and show 0 at Line 18 and no increase or decrease in net assets. Let us
assume that for the year being examined, the filer continued to receive $1,000 in income but in addition
received a contribution of $500 as a gift establishing a permanent endowment. Let us further assume that
this year the filer incurred $1,050 of expenses. If we assume that the filer’s only assets were cash and that
it started the year with $100 in cash and no liabilities and ended the year with no liabilities, the key Lines
on its Form 990 would look like this:
From Part I on page 1
Line 12 $1,500
Line 17 $1,050
Line 18 $ 450
Line 19 $ 100
Line 21 $ 550
From Part IV on page 3
Line 45(A) $100
Line 59(A) $100
Line 66(A) 0
Line 67(A) $100
Line 68(A) 0
Line 69(A) 0
Line 73(A) $100
Line 45(B) $550
Line 59(B) $550
Line 66(B)
0
Line 67(B) $ 50
Line 68(B)
0
Line 69(B) $500
Line 73(B) $550
Here we see that the filer received significantly more income than the expenses it incurred and ended the
year with a substantial surplus. If the filer’s Forms 990 for the two years preceding the year being reported
on were available, which on the assumptions we are making would show income and expenses of $1,000,
the increase in income (of 50%) would be conspicuous. Even without the prior years’ Forms 990, the
difference between income and expenses would be notable and should suggest that a look be given to the
Net Assets section of Part IV. There, by looking at Line 69, we would find that the filer began the year
with no permanently restricted net assets and ended the year with $500 of permanently restricted net assets.
This would tell us that $500 of the $1,500 of income received during the year constituted permanently
92
that a contribution was made during the year that did not consist of core program income,
although the contribution is included in Line 12 and Line 18, as with temporarily
restricted net assets, by looking at Line 67, the reader of a Form 990 can tell whether the
filer ended the year with a core program surplus or deficit.
In most cases the amounts reported at Line 69(A) and (B) will be the same and Line 69
will have no functional relationship to Line 67 and will not be directly relevant to the
filer’s future capacity.167 If, as is usually the case, part of or all of the amounts reported
at Line 69 consist of investments which are reported at market value and the value of
such investments increases or decreases during the year, the amount of the increase or
decrease will be reflected in Line 67. This raises a special complication which we will
return to below.
In rare cases, if the assets that make up the filer’s permanently restricted net assets consist
in part, for example, of tangible personal property and that property is valued at market
value and has appreciated during the year, or if the property had been damaged during the
year and thereby lost value during the year, the amount reported at Line 69(B) may be
larger or smaller than the amount reported at Line 69(A). In these circumstances, the
appreciation or depreciation will be reported at Line 20 and the amounts reported at Line
67 will not be affected by the change in Line 69.
restricted assets (most likely a gift to an endowment). With this information we would understand that of
$1,500 of income reported at Line 12, $1,000 was core program income and $500 was restricted income.
Because nothing was reported at Line 68, we would also know that all the expenses reported at Line 17
were core program expenses. Thus, with $1,000 of core program income and $1,050 of core program
expenses, the filer ended the year with a core program deficit of $50 in contrast to the $450 surplus
reported at Line 18. This core program deficit is reflected in the decrease of $50 in unrestricted net assets
from $100 (Line 67(A)) to $50 (Line 67(B). Knowing that the filer ended the year with a core program
deficit, we might predict that in the next period the filer would have difficulty generating enough income to
cover its expenses.
167
Of course, in many cases the net assets reported at Line 69(B) may consist of an endowment generating
income each year which income is certainly relevant to the filer’s future financial capacity. However, in
most cases the level of income generated from the endowment will be pretty much the same from year to
year. Thus, for example, if the filer reports a decrease between Line 67(A) and (B) in the year being
reported on, a question may be raised about the filer’s ability to generate sufficient core program income to
cover its core program expenses in the next year despite the fact of an endowment which generates income
each year.
93
In cases where the filer reports both temporarily and permanently restricted net assets, for
reasons explained above, the reader of the filer’s Form 990 can rely on the changes in the
amounts reported at Line 67 for purposes of assessing the filer’s future financial capacity
to support its core program.
This subsection has focused primarily on how the Net Assets section bears upon the
financial capacity question, i.e., whether the filer will generate sufficient support in the
next period to cover its core program expenses. There are in addition several lines in the
Assets section of Part IV that may be important for answering this question. These
include pledges receivable (Line 48) and the investments lines.
We begin with pledges. But before addressing pledges directly, some preliminary
observations are needed. In asking the financial capacity question, we seek to find out
whether the filer will generate sufficient resources in the next period to cover its core
program expenses. We have shown how a good purchase on this question can be gained
by looking at Line 67. We have noted that if Line 67(B) is larger than Line 67(A), the
filer ended the year with a core program surplus, i.e., it generated more core program
income than core program expenses. An aspect of this question is the implicit
assumption that the filer will generate “spendable” resources in the next period at a level
sufficient to cover its core program expenses. For example, if some of the core program
income received in the year being reported on consisted of receivables, the receivables
may not be the kind of assets that may be used to defray core program expenses. 168
While this may be the case with respect to some receivables,169 it is not the case for all
receivables. For example, as will now be shown, it is not the case for accounts receivable.
It might be supposed that if the past-is-prologue-to-the-future and, for example, the filer
reports core program income in the year being reported which consisted half of cash and
half of accounts receivable, that in the next period the filer will also receive core program
income consisting half of cash and half of accounts receivable. If the estimated amount
of core program expenses will be more than the cash it is estimated will be received,
168
169
In this sense they are not spendable.
We will suggest below that it may be the case for some pledges receivable.
94
since accounts receivables are not necessarily a “spendable” asset, it might be thought
that in these circumstances the filer would not be able to cover its core program expenses
even though it ended the year with a core program surplus. This would almost certainly
be a wrong conclusion with respect to accounts receivable. To begin with, if the next
period was the same as the year being reported on, as the past-is-prologue-to-the-future
assumption would suppose, then during that next year as a rough approximation it is
likely that accounts receivable would be paid even as new accounts receivable were
received.170 So in this particular circumstance, if the filer had generated sufficient
resources in the year being reported on to cover core program expenses that year, it
would be fair to assume that it would do so again in the next period. Generally, in normal
circumstances with income being received and expenses being paid, while the level of
receivables and payables, etc., may not be exactly the same from year to year, if the filer
ended the year being reported on with a core program surplus and presumably had
sufficient resources to meet its core program, it may be estimated that the filer will end
the next period with a core program surplus and presumably have sufficient resources to
meet its core program expenses.171
In contrast to this analysis, in subsection 2 we assume circumstances that are not normal,
namely, that the filer will stop receiving income for a period of time. In these
circumstances, as we will see, it does make sense to estimate the amount of outstanding
receivables and payables, etc., that will be satisfied and paid in the next period and in
periods thereafter.
170
Thus, resources to meet expenses would be made available as a result of the accounts receivable being
paid even as new accounts receivable were received which would not be spendable resources. The
assumption made by the past-is prologue-to the-future axiom is that the amount reported at Line 47(B)
would be the same for the year being reported on and the next year. If this is so, either accounts receivable
would be satisfied in the next period in an amount equal to new accounts receivable being received or some
accounts receivable would be paid and new accounts receivable in an equal amount would be received or
no accounts receivable would be satisfied and no new accounts receivable would be received in the next
period. In each case, the amount of the filer’s spendable resources available to defray expenses would not
be affected by accounts receivable and if the filer was in a position to defray its core program expenses in
the year being reported on, following the past-is-prologue-to-the-future assumption, it would be able to do
so in the next period.
171
For example, in the normal course, as new receivables are received, prior year receivables will be paid
and thus provide spendable resources with which to defray expenses, and as prior year payables are paid,
new payables will be incurred which would also in effect provide spendable resources with which to defray
expenses.
95
There is one receivable, however, namely, pledges receivable reported at Line 48, for
which the above analysis of the financial capacity question may in some circumstances
not be appropriate. In some cases it may be supposed that pledges receivable will not be
satisfied for some time. There is no way of telling from the Form 990 when pledges
receivable will be satisfied. It is not unusual for pledges to be made in one year and not
be satisfied until several years later (e.g., even 5 years or 10 years later).172 When,
however, such pledges are made they are included in the filer’s income in the year made
and thus are reflected in its core program surplus (or deficit). If it appears that pledges
are a fairly unusual source of income for the filer or that in the year being reported on an
unusually large amount of pledges were made – which could be suggested if several of
the filer’s past Forms 990 were available – it might reasonably be expected that at least
some of such pledges will not be satisfied in the next period. In any event, if an amount
is included at Line 48(B), it would seem reasonable to suppose that at least some of such
pledges should be regarded as being different from the usual receivables precisely
because they may not be expected to be satisfied in the near future. Thus, in these
circumstances and on this supposition, the filer’s core program surplus would reflect a
source of income that may not be expected to be available as a spendable resource in the
near-term and therefore that it might reasonably be decided that the filer’s core program
surplus ought to be discounted somewhat before the past-is-prologue-to-the-future
assumption is applied.
Such a conclusion would be based on the assumption that the pledges were made for the
filer’s core program. If the filer reported nothing at Lines 68 and 69, this would be the
case. If, however, the filer did report amounts at Lines 69 and/or 69, then it is possible
that the pledges were made for a special program or to be held permanently.173 There is
172
As will be noted below, in cases where a pledge explicitly states that it will be satisfied at specified
times in the future (e.g., a pledge of $25,000 is made with the stipulation that payments on the pledge will
be made at the rate of $5,000 per year for the next five years), the amounts that are stipulated to be satisfied
in periods after the year being reported on would be treated as temporarily restricted assets and would be
included in the amount reported at Line 68(B).
173
If the pledges were made, for example, for a special program, then the filer’s core program surplus (or
deficit) would not be affected by the pledges. Furthermore, as suggested above, if a pledge is made with
the stipulation that it will be paid at specified times in the future, some part or all of the pledge might be
96
no way of telling from the Form 990 what the pledges were made for (or, as mentioned,
when they are due to be satisfied). If pledges were made either for a special program or
to a permanent endowment,174 they would be included on Lines 68 or 69 and, as
suggested earlier, would not affect the filer’s core program surplus or deficit (and thus
that surplus or deficit would be a good index for the future financial performance of the
filer’s core program). We believe however that, when considering pledges, if amounts
are reported at either Line 68 or 69, a conservative approach should be taken which
would assume that pledges were made for the filer’s core program and that some of them
would not be satisfied for some time.175 On this assumption the reader would, in effect,
make a reduction of the filer’s core program surplus (or an increase of the filer’s core
program deficit), in an amount that seems sensible.
We turn now to investments reported at market value. In most cases, only securities
investments at Line 54 will be reported at market value (but they may be reported at book
value). In virtually every case, the appreciation or depreciation of investments reported
at market value will affect the amount of unrestricted net assets reported at the end of the
year.176 In many cases, such increase or decrease may be the result of unrealized gains or
treated as temporarily restricted assets, even if it not restricted as to purpose. That is to say, in the
extremely unusual case where all the amount reported on Line 48(B) included only pledges with restrictions
which would cause them to be included on either Line 68 or 69, or both, Line 67 would not be affected by
the pledges and in these circumstances if Line 67(B) was larger than Line 67(A), the filer would have
ended the year with a core program surplus and it might be expected that it would do so again in the next
period. Of course, as noted, there is no way of telling from the Form 990 what the pledges reported on
Line 48 were received for.
174
If pledges are made for the filer’s core program with the stipulation that they will be paid in future years,
following the analysis given earlier in this subsection, they also would not affect the filer’s core program
surplus or deficit.
175
This approach is conservative in the sense that if the pledges were made, for example, for a special
program or to a permanent endowment fund, as just suggested, no account would need to be taken of them
in evaluating the future prospects for the filer’s core program. If, however, it is assumed that at least some
of the pledges reported at Line 48(B) are for the filer’s core program, then it may be prudent to reduce the
filer’s core program surplus (or increase the filer’s core program deficit) (Line 67(B) – Line 67(A) = core
program surplus/deficit)) to take account of the possibility that some pledges to the filer’s core program
might not be received the next year. As repeatedly noted, there is no way of telling from the Form 990 for
what purposes reported pledges were made and thus, for these purposes, it may not be conservative to
assume they were made for the filer’s core program.
176
If securities make up part of the assets reported as permanently restricted assets (as might be the case
where a gift of securities was made to an endowment with a direction that the securities be kept in the
endowment), as explained below, any gain or loss on such securities will increase of decrease the amounts
reported at Line 67(B). The cases where securities would be part of the assets included as temporarily
restricted assets are so rare as to not merit analysis.
97
losses177 and these gains and losses may not be considered to directly affect the filer’s
ability to continue its operations in the next period.178 Thus, in determining how much
unrestricted net assets increased or decreased during the year being reported on for
purposes of evaluating the filer’s financial prospects for continuing its core program, in
the case of an unrealized market gain on investments, it may be decided to reduce the
amount reported at Line 67(B) by the amount of the gain. Likewise in the case of a
unrealized market loss, it may be decided to increase the amount reported at Line 67(B)
by the amount of the loss. The amount and direction of such market gain or loss can be
found at Line 20, which requires the filer to attach an explanation that will presumably
indicate the nature and amount of such gains and losses. As with pledges, we believe that
this concern should be prominent only when it appears that there has been a large
increase or decrease in the market value of investments. Otherwise, it is appropriate to
make the Line 67 analysis without considering investments.
In some cases investments reported at Line 56179 are reported at market value and thus
the filer may report unrealized gains or losses during the year on such assets.180 As with
securities investments, these gains and losses may not be considered to directly affect the
filer’s ability to continue its operations in the next period, and consequently the analysis
made in the above paragraph with regard to securities investments applies to such gains
or losses. A filer is required to attach a schedule of such assets reported at Line 56 so
that, by analyzing such schedule and the schedule attached to Line 54 and the amounts
reported at Line 20, in many cases it will be possible to determine the amount of such
gain or loss. Thus, in determining how much unrestricted net assets increased or
decreased during the year being reported on for purposes of evaluating the filer’s
financial prospects for continuing its core program, in the case of a market gain on such
177
In this case, such appreciation or depreciation would be reported at Line 20.
As will be discussed below, even in the case of realized gains or losses, those gains or losses may not be
considered, in the case of gains, as resources available for the filer’s core program or, in the case of losses,
as the elimination of resources that might otherwise have been available for the filer’s core program and
thus such gains or losses would not be thought of as directly affecting the filer’s ability to continue its
operations in the next period.
179
Line 56 is titled “Investments – other” and the Instructions prescribe that the filer “[e]nter the amount of
all investment holdings not reported on Line 54 or 55.” Line 54 relates to securities investments and Line
55 to investments in land, buildings and equipment.
180
Below we discuss how such gains of losses might be analyzed if they were realized.
178
98
Line 56 investments, it may be decided to reduce the amount reported at Line 67(B) by
the amount of the gain. Likewise, in the case of a market loss, it may be decided to
increase the amount reported at Line 67(B) by the amount of the loss. As with the above
analysis of pledges and the unrealized gains or losses of Line 54 assets, we believe that
this concern should be prominent only when it appears that there has been a large
increase or decrease in the market value of Line 56 investments. Otherwise, it is
appropriate to make the Line 67 analysis without considering investments.
From time to time assets that are held as investments and are reported on Lines 54-56 on
Part IV are sold and gains or losses are realized. Such gains or losses will be reported as
income (or loss) on Line 8 and included in total revenue on Line 12. In terms of the
analysis developed above, such income would be core program income. Of course in
many cases, the sales of such assets may be fairly unusual events and not be likely to
recur. Thus, as with unrealized gains and losses from securities investments, it may be
decided to eliminate such gains or losses from core program income for purposes of
applying the past-is-prologue-to-the-future axiom. The amount of such realized gains
and losses could be determined from examining the schedules attached to Lines 54-56
and the amounts reported at Line 8. As with the above analysis of pledges and the
unrealized gains and losses on Line 54 and Line 56 assets, we believe that this concern
should be prominent only when it appears that there has been a large amount of gains or
losses on Line 54 - 56 investments. Otherwise, it is appropriate to make the Line 67
analysis without considering investments.
Subsection 2 – The Adequacy of Reserves Question
In this subsection we address the second question: will the filer have sufficient reserves
to continue its operations in the future in the event it meets a temporary lapse181 in its
ability to generate income? As noted, we refer to this second question as the “adequacy
of reserves question.” As suggested in the Introduction to this section, in the
overwhelming majority of cases one would not realistically suppose that in the periods
181
In effect, we ask how long the filer could continue its operations if it stopped receiving income.
99
after the period being reported on the filer would receive no income. Nevertheless, we
believe that making this merely hypothetical worst-case assumption provides a useful
perspective by which to assess a filer’s reserves.
The adequacy of reserves question asks in effect how long the filer will be able to
continue operating its program if it receives no more income and is thus forced to defray
its future operating expenses out of resources it has on hand at the end of the period being
reported on.182 Obviously, all of a filer’s resources (all of its assets) will not be available
for such purposes. In most cases a portion of such resources will be needed to satisfy
pre-existing liabilities, such as the principal on a mortgage that will soon become due.
Furthermore, only resources that can be readily accessed, such as cash, for example,
should be considered as available to meet expenses in the next period. Available
resources for these purposes consist primarily of cash, cash equivalents and, in most
cases, receivables. Consequently, our analysis aims at determining net available assets.
We use the term “Spendable Resources” to designate the net assets that would be readily
available in the next period to meet operating expenses if the filer received no income.
Our analysis is limited to asking how long the filer could continue its core program183 if it
stopped receiving income. We do not inquire into how long the filer might be able to
continue any special program or programs.
For our purposes, the Assets section of Part IV of Form 990 can be thought of as being
made up of five categories of assets: (1) cash and cash equivalents (Lines 45 and 46)184,
(2) receivables (Lines 47-51), (3) inventories (Line 52) and prepaid expenses (Line 53),
(4) investments (Lines 54-56) and (5) land, buildings or equipment used in the conduct of
the filer’s operations (Line 57).185 The Liabilities section of Part IV can be thought of as
182
As will be seen below, the assumption is that the filer will have expenses in the next period equal to the
expenses it incurred in the period being reported on.
183
We defined a filer’s core program in subsection one.
184
Henceforth, we shall lump the amount reported at Line 45 (Cash -- non-interest-bearing) and the
amounts listed at Line 46 (Savings and temporary cash investments) under the single term “cash.”
185
Line 58 of the Assets section is for "Other assets." The filer must attach a schedule describing the
assets.
100
being made up of three categories of liabilities: (1) payables (Lines 60-61), (2) deferred
revenue (Line 62) and (3) loans (Lines 63-64).186
Before starting our analysis, we provide some brief background information on what
assets and liabilities are likely to be found in Part IV and what assets and liabilities are
less likely to be found. The most common assets reported in the Assets section of Part
IV, other than cash, include accounts receivable (Line 47) and prepaid expenses (Line
53). It is not uncommon for securities investments (Line 54) and buildings and land used
in the filer’s operations (Line 57) also to be reported. Less frequently, though hardly
uncommon, pledges receivable (Line 48), grants receivable (Line 49) and inventories
(Line 52) may be reported in the Assets section. Less common are receivables from
officers, directors, trustees and key employees (Line 50), other notes and loans receivable
(Line 51), land, buildings and equipment investments (Line 55) and other investments
(Line 56).187 In cases where the Forms 990 of large nonprofits are being examined, it is
usual to find assets reported on all of the asset lines of the Assets section of Part IV.
We now turn to the Liabilities section of Part IV. The most common liabilities reported
in the Liabilities section of Part IV include accounts payable (Line 60) and deferred
revenue (Line 62). It is less common to find liabilities reported on the other lines in the
Liabilities section.188 In cases where the Forms 990 of large nonprofits are being
examined, it is usual to find liabilities reported on all of the liability lines of the
Liabilities section.
The analysis we are recommending makes a number of simplifying assumptions with
regard to accounts receivable and payable and a few other items. For example, it might
186
Line 65 of the Liabilities section is for "Other liabilities." The filer must attach a schedule describing
the liabilities.
187 Other assets (Line 58) may or may not be commonly reported depending on the nature of the assets.
[See subsection 3 below.]
188
Grants payable (Line 62) may be common for philanthropies but not for non-grant-making nonprofits.
Most nonprofits that file the Form 990 do not report grants payable. (Philanthropies that file Form 990PF
do usually report grants payable.) It is fairly uncommon for loans from officers, directors, trustees and key
employees (Line 63) and tax-exempt bond liabilities, mortgages and other notes payable (Line 64) to be
reported. Other liabilities (Line 65) may or may not be commonly reported depending on the nature of the
liabilities. [See subsection 3 below.]
101
be supposed that not all of the accounts receivable would be received in the next period
and that not all of the accounts payable would be paid in the next period.189 If, for
example, it was known that only half of the amount of accounts receivable reported at
Line 47(B) were going to be received in the next period, then, in determining Spendable
Resources, half of such amount should be subtracted from Line 67(B).190 But there is no
way of knowing whether all the accounts receivable reported at Line 47(B) will be
received in the next period or whether some of that amount will be received in the next
period and some in periods thereafter. So either an arbitrary estimate would need to be
made regarding the amount that would be received in the next period or it might be
assumed that the entire amount will be received in the next period. We believe that it
makes sense to make the latter assumption, i.e., that all the receivables will be received in
the next period. We propose that similar assumptions be made with respect to
inventories, prepaid expenses and accounts payable.191 We believe that in most cases it
will make very little difference in determining the length of time that a filer could
continue without income whether it is assumed that all such assets will be received or
used in the next period and all accounts payable paid in the next period or whether an
arbitrary estimate is made of the amounts that would be received, used and paid in the
next period.192 In sum, we believe that the approach offered here is straightforward and
provides a satisfactory answer to the adequacy of reserves question.
Our approach is to begin with the amount reported at Line 67(B) -- net unrestricted
assets on hand at the end of the year. It is only from this amount that resources may be
found to meet expenses for the filer’s core program in the next period. Obviously, any
189
That is, it might be expected that some of the amount of accounts receivable reported at Line 47(B) will
be received in a period after the next period and that some of the amount of accounts payable reported at
Line 60(B) will be paid in a period after the next period.
190
For example, if Line 47(B) reported $50,000 and it was known that only $25,000 of this amount would
be received in the next period, then only $25,000 of the accounts receivable reported at Line 47(B) would
be available as Spendable Resources in the next period. Consequently $25,000 would have to be subtracted
from Line 67(B) to determine Spendable Resources.
191
As will be explained below, we make no similar simplifying assumption for pledges receivable reported
at Line 48(B) and in some cases for deferred revenue reported at Line 63(B).
192
Below we present two examples to explain our approach. In a note to our analysis of Example 1, we
demonstrate how it makes little difference whether it is assumed that all such accounts receivable and
payable, etc., are received and paid in the next period or whether an arbitrary estimate is made of the
102
amount reported at Line 69(B) as permanently restricted net assets would not be available
for meeting a filer’s core program. It may be that some or all the amount reported at Line
68(B) as net temporarily restricted assets would be available in the next period to meet
core program expenses.193 In many cases, however, the amount reported at Line 68(B)
will be for a special program or for the filer’s core program in a period after the next
period. As there is no way of telling from the Form 990 how or when the amount
reported at Line 68(B) is to be used, prudence recommends that none of that amount be
considered available for spending in the filer’s core program in the next period.194 Thus,
as follows from what has just been said, for present purposes one should not look to Line
73(B), the amount of a filer’s total net assets (which is the same as the amount reported at
Line 21 on Part I On page 1).195 So we start with the amount reported at Line 67(B).
Of course, as suggested, all of the amount reported at Line 67(B) may not be available for
meeting expenses in the next period. For example, it might include a loan due the filer
that is not due to be repaid to the filer for several years. Such an asset is obviously not
the kind of “spendable resource” that might be used for meeting expenses in the
following year. So our approach is to begin by determining which of the assets reported
in Part IV (Lines 45-58) are not likely to be available in the next period as resources
available to meet expenses and then to subtract the sum of such amounts from the amount
reported at Line 67(B). A similar approach is taken as to liabilities. For example, the
filer may report a loan that it is not obligated to repay until after the next period. This
means that the amount of the loan, which, in effect, was subtracted from total assets to
reach net assets, would be available to meet expenses in the next period. Under our
approach, such amount is added to the amount reported on Line 67(B) to determine
amounts that may be received or paid. Below we also discuss the circumstance of a filer who reports what
appears to be an unusual increase in accounts receivable, etc.
193
This would be the case if the amount reported at Line 68(B) represented, for example, a multi-year grant
to support the filer’s core program, some or all of which was to be spent in the next period.
194
For most of the analysis below we assume that the filer reports no temporarily restricted net assets (i.e.,
nothing would be reported at Line 68) and no permanently restricted net assets (i.e., nothing would be
reported at Line 69). If the filer reports no temporarily restricted net assets, it means that the filer would
only be conducting its core program, i.e., it would not be conducting any special programs, and all
expenses would be core program expenses. At the end of this subsection we briefly consider the impact of
temporarily and permanently restricted net assets.
195
This amount will include the amounts reported at Lines 68(B) and 69(B). Of course, if a filer reports
nothing on these two lines, Line 67(B) will be equal to Lines 73(B) and 21.
103
Spendable Resources in the next period. (Note, however, that treating such a loan as a
Spendable Resource must be done with recognition of the need to have assets on hand to
pay off the loan when it is due.)
So our approach is to first consider assets and determine which ones would not be
available to meet expenses in the next period. These are to be subtracted from Line
67(B). Then we consider liabilities and determine which ones will not have to be met in
the next period and so, in effect, will be available for meeting expenses in the next
period. These amounts are added to Line 67(B). The results of these additions and
subtractions produce what we call Spendable Resources.
As noted, we begin with an analysis of which assets (Lines 45-58) should be subtracted
from the amount reported at Line 67(B). Clearly Cash (Line 45) and Savings and
temporary cash investments (Line 46) should not be subtracted. These are the most
obvious components of Spendable Resources.
As explained above, we believe it is best to assume that the entire amount of accounts
receivable reported at Line 47(B) will be received in the next period. Thus, following
this approach, none of the amount reported at Line 47(B) as accounts receivable would be
subtracted from Line 67(B).196 If, however, one has access to three or more of the filer’s
past Forms 990 and it appears that the amount of accounts receivable increased markedly
in the year being reported on as compared to prior years, it may not be prudent to assume
that the entire amount reported at Line 47(B) will be received in the next period. In this
case, some estimate should be made of how much will not be received in the next period
and the amount of such estimate should be subtracted from Line 67(B). Of course, an
unusual increase in accounts receivable may reflect the fact that the filer’s financial
196
We have suggested why, despite the likelihood that some of the amount of accounts receivable reported
at Line 47(B) might not be received in the next period, in most instances we make the simplifying
assumption that the whole amount will be received in the next period.
104
position is weakening197 and this possibility should be weighed in considering the filer’s
future prospects.
Moving down the Assets section of Part IV, we come to Pledges receivable at Line 48.
As suggested above in subsection 1, it is not very likely that the entire amount reported as
pledges at Line 48(B) will be received in the next period. Many pledges are promised to
be satisfied in years after the next period. Thus, some part of the amount reported at Line
48(B), the part that it is estimated will not be received in the next period, should be
subtracted from Line 67(B). The estimate of the amount to be subtracted will necessarily
be wholly arbitrary. There is no way of telling from the Form 990 in what period the
various pledges included at Line 48(B) will be paid. We recommend 50% as a prudent
estimate.
As will be explained below, in our consideration of temporarily restricted assets, no
adjustment is needed to be made on account of Line 49, Grants receivable.
Next are loans due to the filer – Lines 50 and 51. Each of these lines requires that a
schedule be attached which shows, among other things, when the loans will come due.
Thus, if it is found out that the loans will come due in a period after the next period, such
amounts should be subtracted from Line 67(B). If it is shown that some of the loans are
due to be repaid in the next period and some in periods after the next period, only the
amount due to be paid in periods after the next period should be subtracted from Line
67(B).
We recommend that neither the amounts reported as inventories at Line 52198 nor prepaid
expenses at Line 53199 be subtracted from Line 67(B).200
The unusual increase in the amount reported at Line 47(B) may signal, for example, that the filer’s
creditors are experiencing new difficulties in paying their bills and this may be a continuing condition.
198
Inventories, reported at Line 52, are defined in the Instructions as “materials, goods, and supplies
purchased or manufactured by the organization and held for future sale or use.” One example might be
publications that an organization sells or issues to the public. Another example might be supplies. For
example, an organization may purchase $15,000 worth of publications and use only $10,000 worth. The
$10,000 worth of used publications would be reported as an expense at Line 38 of Part II. On the balance
sheet at Part IV, the $5,000 worth of publications not used during the year would be reported at Line 52(B).
197
105
Next we come to investments – Lines 54-56. As a general proposition we recommend as
a first cut that all of the amounts reported at these lines be subtracted from Line 67(B).
Of course, securities investments reported at Line 54(B) might be sold with no great
difficulty and thus converted into spendable resources. In some cases, however, it may
not be prudent, feasible or advantageous to do so. Thus, at this stage of our analysis we
recommend subtracting the entire amount reported at Line 54(B) from Line 67(B). (As
explained below,201 after the first run-though of our analysis, we take into account the
amount reported at Line 54(B).) The amount reported at Line 55(B), investments in land,
building and equipment, may very well not be easily converted to cash. Thus, we
recommend that the amount reported at Line 55(B) be subtracted from Line 67(B). As
the investments reported at Line 56(B) are likely to be unusual investments and not easily
converted to cash, we recommend that the amount reported at Line 56(B) be treated like
the amount reported at Line 55(B) and be subtracted from Line 67(B). If any amount is
reported at Lines 55 or 56, a schedule must be attached explaining the nature of the
investments. If these schedules make clear that some or all of the amounts reported as
investments at these lines might be easily liquidated, then such amounts should not be
subtracted from Line 67(B). It is not likely that the schedules will show this, so that in
most cases it will be best to subtract these amounts from Line 67(B).
Finally, we come to Line 57(B). The amount reported here represents the value of land,
building or equipment used by the filer in carrying out its activities. Since, as suggested
above, in most cases these assets could not be liquidated without critically altering the
filer’s ability to continue its operations, the amount reported here would not be available
Inventories reflect payments made for goods or supplies in a period before those goods or supplies are
used. Generally, for assessing a filer’s financial position, inventories are not too significant. Most groups
do not have inventories and, if they do, they are usually a relatively small item.
199
Prepaid expenses and deferred charges (Line 53) are like inventories. These are amounts paid out in the
year being reported on but not accruable to that year. An example might be a payment for a workshop that
one of the organization’s employees will be attending next year. Like inventories, so far as assessing a
filer’s financial position, prepaid expenses are usually not too significant since they are ordinarily a
relatively small item. Unlike inventories, however, they are a very common balance sheet item.
200
Above, we suggested the reason for assuming that the entire amounts reported at Lines 52 and 53 will be
used in the next period.
201
See Example 2 below.
106
for Spendable Resources in the next period and thus should be subtracted from Line
67(B).
Line 58 (Other assets) usually includes assets that are not current (i.e., assets to be held
for more than 12 months), such as security deposits on leases and art assets.202 In
virtually all cases, they will not be assets that can be used to defray expenses in the next
period (i.e., will not be available for Spendable Resources) and therefore they should be
subtracted from Line 67(B). Line 58 asks the filer to describe the assets reported and the
Instructions advise to attach a schedule if more space is needed (which will usually be the
case). By reviewing the descriptive material, the reader of the Form 990 can confirm that
the assets reported on Line 58 will not be available for Spendable Resources in the next
period.
We come now to liabilities (Lines 60 –65 of Part IV). We recommend that the amount
reported as accounts payable at Line 60 not be added to Line 67(B), that is, we
recommend that it be assumed that the whole amount reported at Line 60(B) will be paid
in the next period.203 If, however, one has access to three of more of the filer’s past
Forms 990 and it appears that the amount of accounts payable increased markedly in the
year being reported on as compared to prior years, it may be prudent to assume that the
entire amount reported at Line 60(B) will not be paid in the next period. In this case,
some estimate should be made of how much will not be paid in the next period, and the
amount of such estimate should be added to Line 67(B). Of course, an unusual increase
in accounts payable may reflect the fact that the filer’s financial position is weakening,204
and this possibility should be weighed in considering the filer’s future prospects.
The treatment we recommend of deferred revenue reported at Line 62 is somewhat
complicated and requires a briefly extended comment. Deferred revenue refers to income
The Instructions ask the filer to “List and show the book value of each category of assets not reportable
on lines 45 through 57.”
203
As suggested above, we make the same simplifying assumption for accounts payable as we do for
accounts receivable, namely, that the whole amount reported at Line 60(B) will be paid in the next period.
202
107
actually received but accruable to a future period. For example, an organization on a
calendar year may receive an annual membership fee in December. Most of that fee will
be accruable (e.g., 11/12ths) to the next year. Since these payments are for expenses that
will be incurred in a future period, they represent a liability at the end of the year being
reported on. It is an amount that the filer is liable to pay in a future period to defray
expenses it has obligated itself to meet. For purpose of the approach we are suggesting
here, the first part of the immediately following analysis of deferred revenue may be
thought to be counterintuitive. To the extent that some portion of the amount reported at
Line 62(B) represents payments for expenses (services) that the filer has undertaken to
deliver in the next period in carrying out its program, then such portion in effect
represents funds available to meet those expenses in the next period. Thus, this portion
of the amount that is reported at Line 62(B) should be added to Line 67(B). However, to
the extent that some portion of the amount reported at Line 62(B) represents payments for
expenses (services) that the filer has undertaken to deliver in periods after the next period
in carrying out its core program, such portion in effect represents funds that are not
available to meet expenses in the next period. Thus, this portion of the amount that is
reported at Line 62(B) should not be added to Line 67(B). An estimate needs to be made
of the part of the amount reported at Line 62(B) that would be spent in the next period
and this amount should be added to Line 62(B).205
Finally, we come to loans that the filer owes to others – Lines 62 and 64. If amounts are
reported at these lines, the filer must attach a schedule explaining their nature. These
schedules will show whether any of these loans are due to be paid in the next period. If
none of the loans is due in the next period, then the amounts reported at these lines
should be added to Line 67(B). If some are due in the following period and some not,
204
An unusual increase in the amount reported at Line 60(B) may signal, for example, that the filer is
having increasing difficulty in paying its bills and that this condition, which is troubling in itself, may
continue.
205
It may be noted that the treatment of deferred revenue recommended here is different from that
recommended for accounts payable (and certain assets items). We suggest this different approach for
deferred revenue because we believe that in most cases it is very likely that some part of the amount
reported at Line 62(B) will be spent in a period after the next period. If, however, the amount reported at
Line 62(B) is small, it may be decided to assume that it will all be spent in the next period and thus the
entire amount reported at Line 62(B) should be added to Line 67(B).
108
then only the amount of the loans not due in the following period should be added to Line
67(B).
Line 65 (Other liabilities) usually includes advances on grants, and security deposits
received from tenants and the like.206 In virtually all cases, these will be amounts that do
not have to be paid in the next period and thus should be added to Line 67(B). Line 65
asks the filer to describe the liabilities reported and the Instructions advise to attach a
schedule if more space is needed (which will usually be the case). By reviewing the
descriptive material, the reader of the Form 990 can confirm that the liabilities reported
on Line 65 will not have to be satisfied in the next period.
Our approach in answering the adequacy of reserves question is to determine how many
months the filer could continue its operations without receiving any income. To do this,
we first estimate how much the filer will expend each month in the next period. We do
this by taking the expenses the filer incurred in the year being examined (which are
reported on Line 17 of page 1 of the Form 990) and dividing this amount by 12. This is,
of course, just an estimate, an estimate based in part on the past-is-prologue-to-the-future
axiom: the filer’s expenses in the year after the year being examined are likely to be close
to those reported at Line 17 for the year being examined. It is also true that it may be the
case that the filer will spend different amounts in different months. But again for
purposes of making rough estimates, which as noted is all anyone can do, we believe that
it is fair to assume monthly expense payments of an equal amount.
To show how our approach works we offer two examples. We begin with a simple
example. Assume that the filer reports total expenses on Line 17 of $912,000 and that
the key lines of its Part IV balance sheet207 report the following year-end amounts of
assets and liabilities.
The Instructions ask the filer to “List and show the amount of each liability not reportable on lines 60
through 65.”
206
109
Example 1
Line 45(B)
$ 300,000
Cash
Line 47(B)
$ 70,000
Accounts Receivable
Line 48(B)
$
0
$
0
Pledges
Line 51(B)
Loans
Line 53(B)
$ 10,000
Prepaid Expenses
Line 54(B)
$
0
$
0
Securities Investments
Line 55(B)
Land Investments
Line 57(B)
$1,000,000
Building
Line 59(B)
$1,380,000
Total Assets
Line 60(B)
$
50,000
Accounts Payable
Line 62(B)
$
0
$
0
Deferred Revenue
Line 63(B)
Loans
Line 66(B)
$
50,000
Total Liabilities
Line 67(B)
$1,330,000
Net Unrestricted Assets
Line 73(B)
$1,330,000
Total Net Assets
207
Obviously, we have left out many of the lines presented in Part IV. We have done this to save space and
to advance clarity and avoid clutter. Some of the lines set out below in Example 1 report $0. They are
included because amounts are reported in such lines in Example 2.
110
We begin our analysis with Line 67(B) – unrestricted net assets.208 It is to this amount,
$1,330,000 in Example 1, that additions and subtractions will be made to determine
Spendable Resources. Next we examine assets and, in accordance with what has been
suggested above, note that only the amount reported at Line 57(B) need be subtracted
from the amount reported at Line 67(B).209 Turning to liabilities, we note, in accordance
with what has been suggested above, that none of the amounts reported as liabilities need
to be added to Line 67(B).210 Thus, the only adjustment that need be made to Line 67(B)
is the subtraction of the amount reported at Line 57(B), and we arrive at a Spendable
Resources amount of $330,000.211
We then take the amount of expenses reported at Line 17, namely $912,000, and divide
this amount by 12. This results in an estimated monthly expenditure of $76,000. Finally,
we divide $76,000 into the amount of Spendable Resources ($330,000) and thus
determine that the filer could continue in the next period for 4.3 months212 without
receiving income.213
208
Note that in this case, since no temporarily or permanently restricted assets are reported, Line 67(B) is
the same as Line 73(B).
209
As suggested above, we assume that the entire amount reported at Line 47(B) will be received in the
next period and all the amount of prepaid expenses reported at Line 53(B) will be used in the next period.
Thus, no adjustments need to be made to Line 67(B) on account of these items.
210
As suggested above, we assume that all of the amount of accounts payable reported at Line 60(B) will
be paid in the next period.
211
$1,330,000 - $1,000,000 = $330,000.
212
$330,000/$76,000 = 4.3 months.
213
As suggested above, it might be supposed that, more realistically, not all of the accounts receivable
would be received in the next period and that not all of the accounts payable would be paid in the next
period. Assume, for example, that it was estimated that only $40,000 of the $70,000 of accounts receivable
reported at Line 47(B) would be received in the next period and that only $25,000 of the $50,000 of
accounts payable reported at Line 60(B) would be paid in the next period. Making the necessary
adjustments for these estimates would result in Spendable Resources of $325,000. ($30,000 less accounts
receivable would be received and $25,000 less accounts payable would be paid than in the original
estimate.) In this case, the filer would be able to continue for 4.2 months without receiving further income.
Or assume that it was estimated that only $20,000 of the accounts receivable reported at Line 47(B) would
be received in the next period and all of the accounts payable reported at Line 60(B) would be paid in the
next period. In this case, Spendable Resources would be $280,000 and with this amount the filer could
continue for 3.6 months without receiving any further income. The point, of course, is that in terms of
making rough estimates, the difference between 4.6, 4.2 and 3.6 months is not great and so it is reasonable
to assume that all accounts receivable will be received and all accounts payable will be paid in the next
period.
111
We next consider a slightly more complicated example. As in the past example, it is
assumed that $912,000 is reported at Line 17.
For Example 2, the key lines of the filer’s
Part IV balance sheet report the following year-end amounts of asset and liabilities.
Example 2
Line 45(B)
$ 300,000
Cash
Line 47(B)
$
70,000
Accounts Receivable
Line 48(B)
$ 300,000
Pledges
Line 51(B)
$
50,000
$
10,000
Loans
Line 53(B)
Prepaid Expenses
Line 54(B)
$ 200,000
Securities Investments
Line 55(B)
$
75,000
Land Investments
Line 57(B)
$1,000,000
Building
Line 59(B)
$2,005,000
Total Assets
Line 60(B)
$
50,000
$
30,000
Accounts Payable
Line 62(B)
Deferred Revenue
Line 63(B)
$100,000
Loans
Line 66(B)
$ 180,000
Total Liabilities
Line 67(B)
$1,825,000
Net Unrestricted Assets
Line 73(B)
$1,200,000
Total Net Assets
112
Again, we begin with Line 67(B) – unrestricted net assets214 and then see how this
amount, here $1,825,000, needs to be adjusted to determine Spendable Resources. We
start with assets. As in Example 1, no adjustment is to be made for accounts receivable.
Next we consider pledges receivable reported at Line 48(B). In line with what we have
suggested above, we believe that it would be prudent to estimate that only $150,000 of
the pledges receivable would be received in the next period. Thus, the remaining
$150,000 of pledges receivable should be subtracted from Line 67(B). Line 51(B)
reports a loan of $50,000. Assume that the attached schedule shows that the loan is not to
be repaid until after the next period. In this case, the whole $50,000 would be subtracted
from Line 67(B).215 As noted above, we suggest that it be assumed that all the prepaid
expenses will be used in the next period and thus no adjustment need be made on account
of prepaid expenses. We come next to $200,000 of securities investments reported at
Line 54(B). As suggested above, as a first cut, we recommend that this amount not be
considered available for Spendable Resources in the next period. Consequently, this
amount would be subtracted from Line 67(B). As suggested above, a similar treatment
would be made to the $75,000 reported as Land investments at Line 55(B) and thus this
amount would also be subtracted from Line 67(B). Finally, as with Example 1, the
amount for “Building” reported at Line 57(B) needs to be subtracted from the amount
reported at Line 67(B). Thus, in sum, as asset adjustments, the following amounts would
be subtracted from Line 67(B): $150,000 (Line 48(B)) + $50,000 (Line 51(B)) +
$200,000 (Line 54(B)) + $75,000 (Line 55(B)) + $1,000,000 (Line 57(B)) for a total of
$1,475,000.
Turning to liabilities, as in Example 1, no adjustment is to be made for accounts payable.
Next, we consider deferred revenue reported at Line 62(B). As noted above, we believe
that the amount of deferred revenue that it is estimated is going to be used in the next
period to meet expenses of that period should be added to Line 67(B). An estimate has to
be made. We believe that it would be prudent to estimate that only $15,000 of the
214
Note that in this case, since no temporarily or permanently restricted assets are reported, Line 67(B) is
the same as Line 73(B).
113
amount reported at Line 62(B) as deferred revenue will be used in the next period. Thus,
as explained above, $15,000 should be added to Line 67(B).216 Line 63(B) reports a loan
owed by the filer of $100,000. Assume that the attached schedule shows that the loan is
not to be repaid until after the next period. In this case the whole $100,000 would be
added to Line 67(B) to reach Spendable Resources.217 Thus, the adjustments that need to
be made to Line 67(B) on account of liabilities are to add $15,000 of deferred revenue
that will be used in the next period and the $100,000 loan that will not be paid in the next
period, for a total of $115,000.
Thus, to determine Spendable Resources, from Line 67(B) we subtract $1,475,000 to
take account of the assets adjustments and add $115,000 to take account of the liability
adjustments. This results in $465,000 for Spendable Resources ($1,825,000 – $1,475,000
+ $115,000 = $465,0000).
Assuming, as in Example 1, a monthly expenditure of $76,000, we would estimate that
the filer could continue for a little over half a year218 without receiving further income.
Now, as a second cut, it might be assumed that the securities investments reported at Line
54(B) are sold to provide spendable resources. This would allow the filer to continue
operations, without receiving further income, for an additional 2.6 months219 beyond the
6.3 months determined in the first cut.
215
Because the loan is not to be repaid until a period after the next period, it does not constitute an asset
that might be available for meeting expenses in the next period and thus it could not be a part of Spendable
Resources.
216
The $15,000 in question, which we have estimated will be spent in the next period, has been part of the
total liabilities subtracted from total assets to reach net assets. As it is estimated that it will be spent in the
next period for regular expenses, it is added to Line 67(B) to determine Spendable Resources (assuming, as
noted above, that it is anticipated that other funds will be available to pay off the loan).
217
The $100,000 in question, which we know will be repaid in a period after the next period, has been part
of the total liabilities subtracted from total assets to reach net assets. As it is estimated that it will not be
repaid in the next period and so will be available for regular expenses, it should be added to Line 67(B) to
determine Spendable Resources.
218
$465,000/$76,000 = 6.1 months.
219
$200,000/$76,000 = 2.6months.
114
So far we have assumed that the filer reports no temporarily or permanently restricted net
assets. Now we consider these possibilities. Spendable Resources is the amount we have
determined would be available to meet the filer’s expenses in the next period if it
received no more income. It reflects subtractions made to Line 67(B) to take account of
assets that would not be readily available in the next period (e.g., loans, investments, etc.)
and additions made to Line 67(B) to take account of liabilities that will not need to be
satisfied in the next period. Line 67, unrestricted net assets, is a subset of total net assets
(Line 73) and so, if a filer reports either temporarily or permanently restricted net assets,
they will have been subtracted from total net assets to reach unrestricted net assets. (The
following formula would be true: Total net assets – [temporarily restricted net assets +
permanently restricted net assets] = unrestricted net assets (i.e., Line73 – [Line68 + Line
69] = Line 67.) The question for present purposes is whether Spendable Resources, as
figured above, has to be adjusted to take account of temporarily or permanently restricted
net assets.
We consider three situations: first, that the filer reports only temporarily restricted net
assets; second, that the filer reports only permanently restricted net assets; and third, that
the filer reports both temporarily and permanently restricted net assets.
We begin with the case of the filer reporting only temporarily restricted net assets. In this
circumstance, in most cases,220 the amount of Spendable Resources as determined above
is what the filer will have available to meet core program expenses in the next period.
Since there is no way of telling from the Form 990 when or for what the funds reported at
Line 68(B) are going to be used, it is prudent to assume that they will be used in the next
period for a special program and thus will not be available for the filer’s core program.221
220
As will be seen below, in cases where the amount of assets that are not readily available to meet core
program expenses in the next period is larger than the amount reported at Line 67(B), then there will be no
funds available to meet the filer’s core program expenses in the next period (i.e., no Spendable Resources).
221
Temporarily restricted net assets consist mostly of multi-year grants (e.g., a grant of $300,000 made in
the year being reported on that is to be spent over a three-year period.) It is not uncommon for the whole
grant not to be paid in the year the grant is made. In such a case, the filer will have a grants receivable
which will be reported at Line 49(B). If the amount reported at Line 49(B) is stipulated to be used after the
period being reported on, then it is part of the amount reported at Line 68(B) and will, in effect, already
have been subtracted in determining the amount reported at Line 67(B) and so no adjustment needs to be
made. If it is for an amount that was to be spent in the period being reported on or before, then it is an asset
115
Consequently, it is assumed that they will be drawn down from assets that would
otherwise be available to meet the filer’s core program expenses in the next period.222
Next we consider the case where the filer reports only permanently restricted net assets at
Line 69(B). This amount by definition will not be spent in the next period. Nevertheless,
the amount of assets that the filer has on hand during the next period cannot fall below
the amount reported at Line 69(B). In most cases, the amount reported at Line 69(B) will
not be assignable to any particular assets (e.g., a building).223 In assessing the impact that
permanently restricted net assets makes on Spendable Resources, we assume that the
permanently restricted assets are made up of the assets that are not readily available to
meet the filer’s expenses in the next period (e.g., loans not due for some time,
investments, buildings. etc.)224
For sake of convenience, we will refer to the total of nonspendable assets as
“Nonspendable Assets.” This term is open to the obvious objection that in many cases
these assets may be thought of as spendable. For example, investments in securities
that can be expected to be received in the next period and thus available to meet core program expenses in
that period and so no adjustment need be made to Line 67(B). Thus, under any circumstance, no
adjustment need be made to Line 67(B) on account of an amount reported at Line 49(B).
222
For example, suppose a filer that reported $500,000 of cash at Line 45(B), $200,000 of investments
securities at Line 54(B) and a building valued at $200,000 at Line 57(B) and no liabilities. Assume the filer
reports only unrestricted net assets. In this circumstance it would report $900,000 unrestricted net assets at
Line 67(B) and $900,000 of total net assets at Line 73(B). In this case, following our approach, the
amounts reported at Lines 54(B) and 57(B), which total $400,000, would be subtracted from the amount
reported at Line 67(B) and the amount left, viz., $500,000, would be available to meet expenses in the next
period, i.e., would constitute Spendable Resources. Now assume the facts are just the same as those just
supposed except that the filer reported $600,000 of unrestricted net assets at Line 67(B) and $300,000 of
temporarily restricted net assets at Line 68(B). In this case Spendable Resources would be determined by
subtracting from Line 67(B) the amount of assets that would not be available in the next period to meet the
filer’s core program expenses. These assets would consist of the $200,000 of investment securities
reported at Line 54(B) and the building valued at $200,000 reported at Line 57(B). Thus, the total of these
assets ($400,000) would be subtracted from the amount reported at Line 67(B) ($600,000) and the
remainder ($200,000) would constitute Spendable Resources.
223
In instances where a permanently restricted asset is traceable to a particular asset (e.g., a building is
given with the stipulation that it be held as a permanent endowment), the asset will be part of assets that are
not readily available to meet the filer’s expenses in the next period, such as a building which has been
given with a stipulation that it be held permanently, and thus the analysis we offer below will not change.
224
This assumption is justifiable since, as mentioned in the text, in most cases permanently restricted net
assets are not traceable to any particular assets. In most cases, permanently restricted assets will be less
than the total of the assets that are not readily available to meet the filer’s expenses in the next period (e.g.,
investments, buildings, etc.) since permanently held assets are usually invested and are rarely held in cash
or cash-equivalents.
116
listed on a public exchange may be readily convertible to cash and thus available for
spending. It might perhaps be more accurate to say that these assets are “not readily
spendable.” In some cases, however, it may be very difficult to convert them into cash
and in other cases it might be inconvenient. There is no perfect term to capture what we
mean, but we believe that “Nonspendable Assets” comes close enough. As another
terminological clarification, we will refer to the adjustments made to Line 67(B) to take
account of such things as the assumption that all the pledges reported on Line 48(B) will
not be received in the next period or that all of the amount reported at Line 63(B) will not
be used in the next period as “Special Adjustments.”
To begin our analysis of the impact of permanently restricted net assets on Spendable
Resources, a comparison is made between the amount reported at Line 69(B) and the
amount of Nonspendable Assets. If Nonspendable Assets exceeds the amount reported at
Line 69(B), then the amount of such excess is to be subtracted from the amount reported
at Line 67(B) and, if no Special Adjustments were made to Line 67(B), the remainder
will be the amount the filer has to spend on its core program in the next period, or
Spendable Resources.225 If Special Adjustments were made to Line 67(B), resulting in
225
Assume facts similar to the above example, that is, that the filer reported $500,000 of cash at Line
45(B), $200,000 of investments securities at Line 54(B) and a building valued at $200,000 at Line 57(B)
and no liabilities. Assume the filer reported $600,000 of unrestricted net asserts at Line 67(B) and
$300,000 of permanently restricted net assets at Line 69(B). In this case, Nonspendable Assets (viz.,
$400,000 made up of $200,000 of investments reported at Line 54(B) and the building worth $200,000
reported at Line 57(B)) exceed the amount reported at Line 69(B) (viz., $300,000). The amount of such
excess, viz., $100,000 ($400,000 - $300,000 = $100,000) is subtracted from the amount reported at Line
67(B), viz., $600,000 and the remainder, viz., $500,000 ($600,000 - $100,000 = $500,000) is the amount
the filer would have in the next period to meet its core program expenses, i.e., Spendable Resources.
Here is how this may be thought about in conceptual terms. Recall that to reach Spendable Resources,
Nonspendable Assets is subtracted from Line 67(B). We assume that the amount reported at Line 69(B) is
part of Nonspendable Assets. In determining the amount reported at Line 67(B), the amount reported at
Line 69(B) has, in effect, already been subtracted. Thus, if the amount reported at Line 69(B) equals or
exceeds Nonspendable Assets, in reaching Spendable Resources, Nonspendable Assets do not have to be
subtracted from Line 67(B). However, if Nonspendable Assets exceed the amount reported at Line 69(B),
the total amount of Nonspendable Assets has not been subtracted from Line 67(B) (a necessary step in
reaching Spendable Resources), but only that amount of Nonspendable Assets which equals the amount
reported at Line 69(B). Thus, the excess has to be subtracted from Line 67(B) as part of the steps needed to
reach Spendable Resources. (In the above examples, Nonspendable Assets equaled $400,000. $300,000
was reported at Line 69(B). In going from total net assets to total unrestricted net assets, $300,000 was
subtracted from total net assets. Since we assume that that $300,000 is part of the Nonspendable Assets
(the amounts reported at Lines 54(B) and 57(B)), this means that $300,000 of Nonspendable Assets has
already been subtracted in reaching Line 67(B). This leaves a final $100,000 to be subtracted from Line
67(B) to reach Spendable Resources (assuming no Special Adjustments have to be made).)
117
what we shall call “Modified Line 67(B),” then the excess should be subtracted from
Modified Line 67(B) and the remainder will be the amount the filer has to spend on its
core program in the next period, or Spendable Resources.226
If Nonspendable Assets is less than the amount reported at Line 69(B), then the amount
reported at Line 67(B), if no Special Adjustments were made to Line 67(B), will be the
amount the filer has to spend on its core program in the next period, or Spendable
Resources. If Special Adjustments were made to Line 67(B), the amount of Modified
Line 67(B) will be the amount the filer has to spend on its core program in the next
period, or Spendable Resources.227
Finally, we come to the case where the filer reports both temporarily restricted and
permanently restricted net assets. In this instance, in virtually every case, the
permanently restricted net assets analysis as just shown above will produce the filer’s
Spendable Resources for the next period and no account need be made of the amount
reported at Line 68(B).228
226
Assume the same facts as in the above example, except that the filer also reports $200,000 of pledges
receivable at Line 48(B) and thus reported $800,000 of unrestricted net assets at Line 67(B) and $300,000
of permanently restricted net assets at Line 69(B). In this case, the analysis would be the same as above
except that Line 67(B) might be modified to reflect an estimate that the whole amount reported at Line
48(B) as pledges would not be received in the next period. Assume it was estimated that only $50,000 of
such an amount would be received. Thus, an adjustment would have to be made to Line 67(B) to reflect
that it is estimated that $150,000 of the amount reported at Line 48(B) would not be received in the next
period, that is, $150,000 should be subtracted from the Line 67(B) amount and this would leave a Modified
Line 67(B) amount of $650,000 ($800,000 - $150,000 = $650,000). As in the above example, the excess
by which Nonspendable Resources exceeds the amount reported at Line 69(B), viz., $100,000, would be
subtracted from Modified Line 67(B) and the remainder, viz., $550,000, would be Spendable Resources.
227
Assume the same facts as in the example immediately above, except that the filer reported $600,000 of
unrestricted net assets at Line 67(B) and $500,000 of permanently restricted net assets at Line 69(B). In
this case, since Nonspendable Assets (viz., $400,000) is less than the amount reported at Line 69(B), the
amount of Modified Line 67(B), viz., $450,000 will be the amount that the filer has to spend on its core
program in the next period or Spendable Resources. (Recall that Line 67(B) was adjusted by subtracting
$150,000 to reflect the estimate that that amount of pledges would not be received in the next period.)
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We take an example very similar to those used above. Suppose that a filer reported $500,000 of cash at
Line 45(B), $200,000 of investments securities at Line 54(B) and a building valued at $200,000 at Line
57(B) and no liabilities. Assume the filer reports $400,000 of unrestricted net assets at Line 67(B),
$200,000 of temporarily restricted net assets at Line 68(B) and $300,000 of permanently restricted net
assets at Line 69(B). In this case, Nonspendable Assets exceed the amount reported at Line 69(B) by
$100,000 and under our approach this excess would then be subtracted from Line 67(B), viz., $400,000, to
produce Spendable Resources of $300,000. Conceptually, the analysis begins as explained above for
permanently restricted net assets. To the extent that the amount reported at Line 69(B) equals or exceeds
Nonspendable Assets, Nonspendable Assets have, in effect, already been subtracted in determining Line
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67(B) and thus do not have to be subtracted again in the process of reaching Spendable Resources. (If
Nonspendable Assets exceed the amount reported at Line 69(B), the excess, as explained above, has to be
subtracted from the amount reported at Line 67(B)). Turning next to the amount reported at Line 68(B),
this amount has also, in effect, been subtracted in determining Line 67(B) and thus no further adjustment
needs to be made on account of that amount.
Now assume the same facts as above, except that the filer reports $500,000 of permanently restricted net
assets at Line 69(B) and $200,000 of unrestricted net assets at Line 67(B). In this case, Nonspendable
Assets are less than the amount reported at Line 69(B) and thus the amount reported at Line 67(B), viz.,
$200,000, can be taken as Spendable Resources or the amount the filer would have in the next period to
continue its core program. (Note that Nonspendable Resources are insufficient to cover the amount reported
at Line 69(B) and thus $100,000 of the cash reported at Line 45(B) would have to be reserved, so-to-speak,
in order for the filer to keep at least $500,000 of assets on hand to meet its obligations towards its
permanently restricted net assets. This would leave $400,000 and from this amount an additional $200,000
would have to be set aside for the filer to meet its obligation for the amount reported at Line 68(B). This
would leave $200,000, the amount reported at Line 67(B).)
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Appendix A
In this Appendix, we show how there are virtually an endless number of possibilities of
how a contribution, at least part of which was included in Line 68(B), might have been
restricted and how, no matter what the possibility, by examining Line 67 one can
ascertain whether the filer ended the year with a core program surplus or deficit and thus
can answer the financial capacity question. We consider the example given in the text in
our discussion of Line 68 in subsection 1 of Part B, Section 4. After we complete the
analysis of this example in the text, we consider a second example where amounts are
reported at both Line 68(A) and (B).
Here is the example we considered in subsection 1 of Part B, Section 4.
Suppose the filer ordinarily received $1,000 in core income and ordinarily had $1,000 in
core expenses. Thus, as a usual matter the filer would operate in balance and show 0 at
Line 18 and no increase or decrease in net assets. Let us assume that, for the year being
examined, the filer continued to receive $1,000 in core income but in addition received a
contribution (the “contribution”) of $1,500, $500 of which was to be spent in the year
being reported on and $500 in each of the two succeeding years.229 Further assume that
the filer incurred $1,400 of expenses. If we assume that the filer’s only assets were cash
and that it started the year with $1,000 in cash and no liabilities and ended the year with
no liabilities, the key Lines on its Form 990 would look like this:
From Part I on page 1
Line 12 $2,500
Line 17 $1,400
Line 18 $1,100
Line 19 $1,000
Line 21 $2,100
As will be seen below, given the facts reported on the filer’s Form 990 (which is all a reader would have
access to), the contribution could have involved endless other possibilities with the result in each case being
that the filer reported $1,000 in temporarily restricted net assets at Line 68(B). For example, the
contribution may have been for $1,000, all of which was to be spent in a future period. In setting up the
example, we use the possibility of a contribution of $1,500, $500 of which is to be spent each year starting
with the year being reported on, to give the example a realistic context.
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From Part IV on page 3
Line 45(A) $1,000
Line 59(A) $1,000
Line 66(A) 0
Line 67(A) $1,000
Line 68(A) 0
Line 69(A) 0
Line 73(A) $1,000
Line 45(B) $2,100
Line 59(B) $2,100
Line 66(B) 0
Line 67(B) $1,100
Line 68(B) $1,000
Line 69(B) 0
Line 73(B) $2,100
In the text, we supposed that, given the amounts reported on the filer’s Form 990, the contribution might
have been for a special program in the amount of $1,500 with the stipulation that $500 of the contribution
was to be spent in the year received and $1,000 to be spent in a future period. In this case, Line 12 would
consist of $1,000 of unrestricted core program income, $500 of income restricted to be spent for a special
program during the year being reported on and $1,000 to be spent on a special program in the future. The
$1,400 of Line 17 expenses would consist of $900 of core program expenses and $500 of special program
expenses. In this case, with $1,000 of core program income and $900 of core program expenses the filer
would have a core program surplus of $100.
We now consider alternatives. On the numbers reported on the Form 990, as one alternative, the
contribution may have been for the filer’s core program, all of which was to be spent in a future year. In
this case, Line 12 would consist of $1,500 of unrestricted, core program income and $1,000 to be spent on
the core program in the future and Line 17 would consist of $1,400 of core program expenses with a
resulting core program surplus of $100. In both cases, the $100 core program surplus is reflected in the
increase in unrestricted assets of $100 indicated at Line 67.
Below we show that there are nearly an infinite number of other possibilities, but in each case the amounts
reported at Line 67 indicate that the filer ended the year with a $100 core program surplus. Thus, having
noted that the filer ended the year with a $100 core program surplus, we may activate the past-is-prologueto-the-future assumption and conclude that the filer as a financial matter is likely to be able to continue its
core program in the next period.
We now consider some other possibilities. As a first possibility, given the amounts reported in the filer’s
Form 990, the contribution might have been for a special program in the amount of $1,200 with $200 to be
spent during the year being reported on and $1,000 to be spent in the future. In this case, the $2,500 of
income reported in Line 12 would be broken down as follows: $1,300 of core program income, $200 of
income to be spent on a special program in the year being reported on and $1,000 of income to be spent in
future years on the special program (which $1,000 ended the year in the temporarily restricted net asset
category (Line 68(B)). Thus, of the $1,500 of income available for spending during the year being reported
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on, $1,300 was for the filer’s core program and $200 for the filer’s special program. Presumably the
amount of the contribution that was used during the year being reported on to support the special program
would have been matched by expenses in an identical amount. Thus, as $200 of the filer’s $1,400 of total
expenses (Line 17) were incurred in connection with the filer’s special program, $1,200 of expenses
($1,400 - $200 = $1,200) were incurred in connection with the filer’s core program. Consequently, the filer
would have operated with a $100 core program surplus ($1,300 core program income - $1,200 core
program expenses = $100 core program surplus). This core program surplus is also reflected in the $100
increase in unrestricted net assets at Line 67.230
Second, given the amounts reported in the filer’s Form 990, there might have been two contributions. One
might have been a $750 grant for a special program with $250 to be spent in the year received and $500 in
future periods. The other might have been a $750 grant for the filer’s core program with $250 to be spent
in the year received and $500 in future periods. In this case, the $2,500 of income reported in Line 12
would be broken down as follows: $1,250 of core program income ($250 from one of the contributions and
$1,000 from other unrestricted sources), $250 of income to be spent on a special program in the year being
reported, $500 of income to be spent in future years on the filer’s core program (which $500 ended the year
in the temporarily restricted net assets at Line 68(B)) and $500 to be spent in future years on the special
program (which $500 ended the year in the temporarily restricted net assets at Line 68(B)). Presumably the
amount of the contribution that was used during the year being reported on to support the special program
would have been matched by expenses in an identical amount. 231 Thus, of the $1,400 of total expenses
(Line 17), $250 was incurred in connection with the filer’s special program and $1,150 ($1,400 - $250 =
$1,150) was incurred in connection with the filer’s core program. Thus, with core program income of
$1,250 and core program expenses of $1,150, the filer ended the year with a core program surplus of $100.
As above, this core program surplus is also reflected in the $100 increase in unrestricted net assets at Line
67. As can be seen, there are endless other possibilities, but in each case a core program surplus of $100
will be reflected in an increase in unrestricted net assets at Line 67.
The above example was based on Line 68(A) reporting 0. We now consider an example
where amounts are reported at both Lines 68(A) and (B) and the amount reported at Line
68(B) is smaller than the amount reported at Line 68(A). In developing this example, we
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Of course, the contribution might have been, as supposed above, for a special program in the amount of
$1,000 with no amount to be spent during the year being reported on and $1,000 to be spent in the future.
Theoretically the contribution might have been for a special program in any number of amounts between
$1,000 and $2,500 with correspondingly varying amounts (equal to the amount of the contribution less
$1,000) to be spent in the year being reported on and $1,000 to be spent in the future. At the extreme for
example, the contribution could have been for a special program in an amount close to $2,500 with close to
$1,500 to be spent during the year being reported on and $1,000 to be spent in the future. In each case a
core program surplus of $100 would be shown by examining Line 67.
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continue with the example supposed above, but this version covers the following year.
Here we assume that the filer received $1,000 in income and incurred $1,400 of expenses
and that $500 of the $1,000 on hand at the beginning of the year as temporarily restricted
net assets (Line 68(A) was released for spending during the year. If we assume that the
filer’s only assets were cash and that it started the year with $2,100 in cash and no
liabilities and ended the year with no liabilities, the key lines on its Form 990 would look
like this:
From Part I on page 1
Line 12 $1,000
Line 17 $1,400
Line 18($ 400)
Line 19 $2,100
Line 21 $1,700
From Part IV on page 3
Line 45(B) $2,100
Line 45(B) $1,700
Line 59(B) $2,100
Line 59(B) $1,700
Line 66(B)
Line 66(B)
0
0
Line 67(B) $1,100
Line 67(B) $1,200
Line 68(B) $1,000
Line 68(B) $ 500
Line 69(B)
Line 69(B)
0
Line 73(B) $2,100
0
Line 73(B) $1,700
Here we would note on the one hand a deficit reported at Line 18 and on the other hand
an increase in unrestricted net assets reported on Line 67. We would also note from Line
68 that temporarily restricted net assets decreased by $500 and this would tell us that at
least $500 of the temporarily restricted net assets on hand at the beginning of the year had
been released. This $500 would not be included in income for the year, but we could
presume that $500 of the expenses reported at Line 17 was charged against it. We would
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Similarly, the amount of the contribution that was used during the year being reported on to support the
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not know whether the $500 of expenses were special program expenses or core program
expenses. If they were special program expenses, of the total expenses of $1,400
reported at Line 17, $900 ($1,400 - $500 = $900) would be core program expenses and
$500 special program expenses (which were defrayed with special program income
included in income in a prior year, viz., the $500 released from Line 68(A)). Thus, with
core program income of $1,000 and core program expenses of $900, the filer would end
the year with a core program surplus of $100. This core program surplus is also reflected
in the $100 increase in unrestricted net assets at Line 67. If the expenses defrayed by the
$500 released from Line 68(A) were for core program expenses, then $500 of the total
expenses of $1,400 reported at Line 17 were defrayed by income not reported on Line 12
(namely, the $500 of income included in income in a prior year, i.e., the $500 released
from Line 68(A)). Thus, the remaining $900 ($1,400 - $500 = $900) of core program
expenses would have been defrayed by the $1,000 of core program income reported at
Line 12. Thus, with core program income of $1,000 and core program expenses of $900,
the filer would end the year with a core program surplus of $100. This core program
surplus is also reflected in the $100 increase in unrestricted net assets at Line 67.
As in the prior example, there are a number of possibilities with regard to the disposition
of the funds included in temporarily restricted net assets on hand at the start of the year
(Line 68(A), all of which would be consistent with the figures reported on the filer’s
Form 990 (as set out above) and all of which would result in a core program surplus of
$100. For example, the filer might have received during the year $750 of unrestricted
income and a contribution for $250 with the restriction that it be spent in a future period
while $750 was released from Line 68(A) to support the filer’s core program. In this
case, of the $1,000 of income reported at Line 12, $750 would be from unrestricted
sources and $250 from a contribution with a restriction that it be spent in a future period.
Of the $1,400 of core program expenses, $750 would be defrayed with income included
in income in a prior year, viz., the $750 released from Line 68(A) and $650 would be
defrayed by the $750 of core program income from unrestricted sources, leaving a core
filer’s core program would have been matched by expenses in an identical amount.
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program surplus of $100. This $100 surplus is reflected in the increase in unrestricted net
assets at Line 67.
Of course, the amounts released from Line 68(A), and whether they were released to
defray core or special program expenses and the amounts of unrestricted and restricted
income received during the year, could vary endlessly with the same result. But in each
case the core program $100 surplus is reflected in the increase in unrestricted net assets at
Line 67. Thus, applying the past-is-prologue-to-the-future assumption, we might fairly
conclude that the filer will generate income in the next period sufficient to cover its
expenses. Since line 18 on page 1 of Form 990 shows a deficit of $400, this is not a
conclusion we would reach if looked only at Line 18 on page 1.
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