NONPROFIT NEWSLETTER Spring/Summer 2017

CONTENTS

1| Building a Resilient Organization—A Toolkit for Nonprofit Boards to Manage Transformational Change

4| Public Charities and Private Foundations—What’s the Difference?

6| Accounting and Financial Reporting for Other Postemployment Benefit Plans

8| A Deeper Dive Into ASU Building a Resilient 2016-14 Organization— 10| Supporting Organizations Could Be Putting Their A Toolkit for Nonprofit Charity Designation at Risk Boards to Manage 11| IRS Stresses New Processes at Annual Tax Exempt Transformational Change and Government Entities Meeting By Laurie De Armond, CPA

Many, if not most, nonprofit concrete steps boards and executives can 13| The Importance of Civic organizations will encounter board or take to minimize risk in the event of a Reach leadership turbulence at some point transformational event. 14| IRS Focuses on Employment in their lifecycles. Organizational To illustrate this, let’s examine a few Tax Issues During Tax- transition, the evolution of mission or Exempt Organization Audits executive departures are inevitable. scenarios: There are times when the board must • Mission friction: A large national 15| IRS “Snapshots” Providing make challenging decisions and protect leadership and support organization Technical Guidance the organization from financial and for a variety of local chapters recently organizational risk, as well as potential 17| Best Practices for an began pursuing a strategic partnership reputation damage. Effective Investment with another organization to expand its Committee While the “transformational event” is technical capabilities. Local chapters often unplanned, the consequences find the joint fundraising approach don’t have to derail the organization’s proposed by national leadership programming, future plans or ability to doesn’t support their priorities and successfully carry out its mission. There programming at the ground level. There are a number of different methods and are also concerns in the chapters around tools to address management hiccups increases in executive compensation, and leadership transitions, as well as coupled with decreases in spending

1 on certain service offerings national expertise, can be the best path forward. of experienced professionals, many of leadership believes no longer align with However, expanding the organization’s whom hold positions at the executive the organization’s broader mission. capabilities can come at a high cost in level or on boards, exposes some Some chapter advocates worry this the form of executive compensation nonprofits to added personnel-related tension could escalate if the strategic and a new set of stakeholders to risk. partnership moves forward. consider, which saddles the board with a challenging cost-benefit decision. As a result, conversations around • Succession stress: A longtime CEO at succession planning should shift from a small research organization affiliated On the flip side, organizations reconsider focusing on if a departure will happen, with a regional chain of hospitals has the specifics of their mission or to when. Executive retirement can be just been diagnosed with a severe programming if they’re facing financial planned, or, as we discussed above, it can medical condition requiring him to difficulties or are running a deficit. In happen quite suddenly. Regardless of the accelerate his retirement plans. The cases like this, nonprofits may not have scenario, few things rock the boat like an organization had begun preliminary adjusted spending in certain areas, like executive departure. When considering preparations for its leader’s eventual employee benefits, despite slowing cash your organization’s future growth retirement to plan and protect the flow. The organization may also have and long-term plans, it’s important to organization from risk, but lacks expanded its programming and services proactively factor in succession planning. a thorough succession plan and into areas that no longer make sense Depending on the size and scope of the immediate action steps in the event of a given the marketplace, staffing or the organization, this may include a variety departure as potentially sudden as this needs of the community. of tactics. one. Some organizations encounter tension The succession plan may need to consider • Fragmented leadership: A foundation between founders and the board when a a potential gap between the current CEO associated with a prominent, wealthy reconsideration of mission takes place— and the successor and how workflow philanthropist that has national coined “founder’s syndrome.” Passionate, might need to be managed among operations recently grappled internally dedicated founders can be reticent to other members of the leadership team, with discord around its grantmaking embrace certain changes in favor of the board and staff, as well as other practical practices and priorities. While the way things have always been done. The details around the outgoing CEO’s exit organization has yet to institute introduction of new board members with and onboarding the new CEO. One significant changes, leadership is at a different perspectives can also serve as stumbling block nonprofit organizations crossroads and it’s likely the board will a conduit to bring issues and conflicts are particularly vulnerable to is a gap in need to step in to determine future bubbling up to the surface. relationship or partnership management direction. The CEO is threatening to with key stakeholders and donors. step down, which could likely spur During times of friction around a media interest and generate significant nonprofit’s mission, it’s critical that The best way to mitigate the aftershock negative publicity. the board is educated on the issues at of a sudden departure is to ensure hand, as well as the consequences of there is an up-to-date job description In order to build the right toolkit for each potential outcome and of inaction. for the executive’s position. To develop forging a path through common Leadership also needs to have a dynamic this, the board should consider what transformative events like these, vision of the organization’s future, and skill sets are required for the executive organizations need first to understand be willing to pivot if need be. From there, to be successful in that role. Larger the various reasons the disruption occurs. leadership may need to work with certain organizations might establish a transition individuals at the board level to build team tasked with creating a transition MISSION FRICTION consensus so that a risk mitigation plan, plan, managing priorities, decision- Because many nonprofits operate on as well as a longer-term action plan, can making and communicating across the leaner budgets and resources than be agreed upon and implemented. organization and to stakeholders. for-profit companies, keeping up with a rapidly evolving business landscape and SUCCESSION STRESS Establishing a relationship with a search the rise of technology as both a tool and Succession planning is a moving target firm before the need arises can ensure the a potential threat can be extraordinarily for nonprofits of all sizes and sectors. This organization doesn’t have to vet search taxing. Some organizations are better is due in large part to the approximately firms before beginning the candidate able to navigate this than others. In some 4 million baby boomers reaching search, cutting down on overall hiring cases, like the one mentioned above, a retirement age each year, according to time. Executive hiring can take anywhere joint venture, merger or acquisition with Pew Research Center statistics. While from six months to a year in some cases, an organization that has technology many are staying in the workforce longer so the board will need to develop an infrastructure, or staff with certain than previous generations, the mass exit interim plan in case a successor isn’t

2 immediately found. To bridge the gap Alternatively, membership organizations, • Board-approved succession plan, during this period, the board should particularly in the medical or technology including caveats for various situations also consider whether there are other industries, might prioritize certain that could arise during an executive executives or board members who could credentials that are required among transition. This should include job hold the position or absorb the key duties members, to ensure the leader has descriptions for all leadership positions. of the role until the organization finds the credibility. During the development of this plan, right permanent replacement. the organization should identify and WHAT TOOLS DO BOARDS NEED build a relationship with hiring and FRAGMENTED LEADERSHIP TO MAKE THE BEST DECISIONS? staffing resources, so that they can In the case of discord around financial Above all, culture matters. A board that get familiar with the organization priorities, the organization will need to embraces change as an opportunity and its needs. This ensures they can ultimately choose where to allocate its rather than an obstacle will enjoy be tapped quickly in the event of an resources—a tough decision that will smoother sailing during a rocky unforeseen departure or transition. likely land in the hands of the board. transformation of any kind. Arming The succession plan might also This is especially challenging if board the board to navigate uncertainty and include a list or information on the key members also have competing definitions inevitable change begins here. From relationships or partnerships managed of the organization’s mission and the there, in order to equip the board with by executives. To prevent gaps in purpose and goals of its grantmaking. The the strongest toolkit possible for forging relationship management during an organization will also need to consider ahead through a transformational event, executive transition, organizations can the impact of each possible outcome on organizations should plan ahead by encourage shared ownership and an its reputation. creating and maintaining certain key open flow of information so that key resources: relationships don’t become siloed with There are several proactive steps one individual. nonprofits can take to unify leadership • Board manual that members can around the strategy driven by the board. reference during a transformational • Step-by-step communication road In the example outlined above, the event. This should include standard map for navigating transformation organization’s leadership could submit documents, including the mission, and reputation management, the pros and cons of each strategy to strategic plan, bylaws and other including tools for presenting and the board for consideration. The analysis important literature on the discussing the event with various should include the impact upon the organization’s capabilities and services. internal and external stakeholders and, organization’s finances, the impact upon When faced with difficult decisions, it’s if applicable, the media and public. its mission and potential reputational important that board members have The plan should include a list of key risks. these resources close at hand to help stakeholders who should be kept them align their decision-making with apprised of any leadership issues, as While there are many avenues for the organization’s priorities. well as basic drafted language that can tackling a disruption at the executive be filled in and adapted for use in a level, organizations might consider • Training to engage new and variety of situations. bringing in a “transformational leader.” established board members. This This individual would serve as a resource training should cover key items included While transformational events can to educate key internal stakeholders, in the board manual, and set a tone arise from a wide breadth of causes and manage expectations and institute a plan for the relationship between the board events, they all pose unique challenges of action for navigating and rebuilding and executive leadership. Additionally, to nonprofit organizations and require consensus among leadership and the organizations may consider annual careful consideration of the risks in play board. If an executive departs as a workshops to build board members’ and the right path forward. Boards that result of leadership fragmentation or level of comfort with one another as have developed contingency plans, and evolution of mission and programming, well as their ability to collaborate to are able to focus on efficiently reaching this resource could also support the make decisions and reach consensus. consensus and pivoting when necessary, organization in development of a will be well-prepared to navigate the succession plan or communications plan. • Information on relationships with shifting tides they will inevitably face. key outside consultants and service The right brass-tacks qualifications providers, including staffing firms, Article was originally published in Philanthropy each nonprofit organization will need financial managers and other resources. Journal. in this leader are as wide and varied as This will help ensure that all board This article originally appeared in BDO USA, the sector itself. In some cases, it might members, not just the board chair, are LLP’s “Nonprofit Standard” newsletter (Spring be beneficial for the individual to have equipped to deploy those resources 2017). Copyright © 2017 BDO USA, LLP. All a background in for-profit business. should the need arise. rights reserved. www.bdo.com

3 Public Charities and Private Foundations— What’s the Difference? By Christina K. Patten

When starting a 501(c)(3) organization, publicly supported. of the tests stated above. the IRS will generally classify it one of two ways—either as a public charity or An organization is considered publicly The IRS will automatically presume an a private foundation. supported if: organization to be a private foundation unless it can show that it is a public Public charities are known to perform 1. It normally receives one-third of its charity. After an organization’s initial charitable work, while private support from a governmental unit or five years, its public support test is based foundations are typically grant-making from contributions from the general on a five-year computation period that organizations. The main difference public or at least 10 percent public consists of the current year and the four between public charities and private support, and facts and circumstances years immediately preceding the current foundations is the source of their that show the public nature of the year. financial support. organization; or, PRIVATE FOUNDATIONS PUBLIC CHARITIES 2. It normally receives more than A private foundation is typically Public charities generally have greater one-third of its support from gifts, controlled by members of a family or interaction with the public and grants, contributions or gross receipts by a corporation, and receives much receive the majority of their financial from activities related to its exempt of its support from a few sources and purposes, and not more than one-third support from the general public and/or from investment income. Because they governmental units. Organizations such of its support from gross investment are less open to public scrutiny, private as churches and religious organizations, income. foundations are subject to various operating restrictions and to excise schools, hospitals and medical research An organization can also achieve taxes for failure to comply with those organizations automatically qualify as public charity status if it is a supporting restrictions. public charities while other organizations organization of another charity that must prove to the IRS that they are derives its public charity status under one

4 The IRS recognizes two types of private foundations, regardless of revenue, must a public charity, it must demonstrate foundations: Private non-operating annually file Form 990-PF. Additionally, annually that it meets the public charity foundations and private operating a private foundation must annually tests. Once an organization is classified foundations. The key difference distribute at least 5 percent of the fair as a private foundation, it remains a between the two is how each distributes market value of its net investment assets private foundation. its income: A private non-operating for charitable purposes. The penalty for foundation grants money to other failure to meet the 5 percent required If an organization fails the public support charitable organizations, while a private minimum distribution is 30 percent of test two years in a row, it is at risk of operating foundation distributes funds to the shortfall or the remaining amount reclassification as a private foundation, its own programs that exist for charitable that should have been spent to meet which can have significant implications purposes. the required minimum level. Private for sustainability and mission foundations are also subject to strict self- accomplishment. To regain status BENEFITS OF PUBLIC CHARITIES dealing rules, a 1 percent or 2 percent as a public charity, the organization OVER PRIVATE FOUNDATIONS tax on investment income and certain must notify the IRS in advance that it Classification is important because expenditure responsibilities. intends to make a qualifying 60-month private foundations are subject to strict termination. Only if it meets one of operating rules and regulations that Public charities may engage in limited the public support tests at the end of do not apply to public charities. Some amounts of direct and grassroots a 60-month (five-year) period can the advantages public charities have over lobbying. Private foundations that spend organization again operate as a public private foundations include higher money on lobbying will incur an excise charity. donor tax-deductible giving limits, 50 tax on those expenditures; this tax is percent of adjusted gross income (AGI) so significant that it generally acts as a This article originally appeared in BDO USA, versus a private foundation’s 30 percent lobbying prohibition. LLP’s “Nonprofit Standard” newsletter (Spring of AGI limit, and the ability to attract 2017). Copyright © 2017 BDO USA, LLP. All support from private foundations. Public CONCLUSION rights reserved. www.bdo.com charities also have three possible tax When deciding whether to operate as filing requirements based upon annual a public charity or a private foundation, revenue: Form 990 (> $200,000), Form the decision should depend on the 990-EZ ($50,000 – $200,000), and Form organization’s programs and objectives. 990-N e-postcard (<$50,000). All private Once an organization is classified as

5 Accounting and Financial Reporting for Other Postemployment Benefit Plans By Patricia Duperron, CPA

Beginning with fiscal years ending OPEB standards. There are, however, a GASB 74 applies to defined benefit June 30, 2017, the first of the two few exceptions which will be discussed plans and defined contribution plans Other Postemployment Benefit (OPEB) herein. administered through trusts, as well as standards from the Governmental plans not held in trust. Similar to pension Accounting Standards Board (GASB) OPEB includes postemployment plans, there are three types of defined becomes effective. healthcare benefits such as medical, benefit OPEB plans: dental and vision, whether the benefit GASB Statement No. 74, Financial is provided separately from or through • Single-employer Reporting for Postemployment Benefit a pension plan. However other benefits, Plans Other Than Pension Plans replaces such as death benefits, life insurance, • Cost sharing multiple-employer—in GASB Statements Nos. 43 and 57 for disability and long-term care are which the OPEB obligations to the reporting of OPEB plans and mirrors the considered OPEB, subject to GASB 74 employees of more than one employer requirements of GASB Statement No. only when provided separately from a are pooled and OPEB plan assets 67, Financial Reporting for Pension Plans. pension plan. OPEB does not include can be used to pay the benefits of The good news is that most everything termination benefits or termination the employees of any employer that you learned in implementing the pension payments for sick leave. provides pensions through the plan. standards will apply to implementing the

6 • Agent multiple-employer plans—in actuarial assumptions will also include Deferred inflows and deferred outflows which OPEB assets are pooled for the healthcare cost trend rates. of resources should be fairly rare as GASB investment purposes but separate has not identified any deferrals specific to accounts are maintained for each Required supplementary information OPEB. The draft Implementation Guide individual employer so that each (RSI) for single and cost-sharing identifies a possible deferred outflow or employer’s share of the pooled assets is employers should include 10-year deferred inflow related to derivatives, if legally available to pay the benefits of schedules of: applicable. only its employees. • Changes in the OPEB liability and Implementing GASB 74 for OPEB GASB 74 does not apply to insured plans related key ratios plan financial statements will be very (those financed through an arrangement similar to the implementation of • Actuarially determined contributions whereby premiums are paid to an GASB 67 for pension plans. The GASB and actual contributions insurance company during employees’ intentionally made GASB 74 similar to active service and the insurance company • Annual money-weighted rate of return GASB 67 to minimize implementation unconditionally undertakes an obligation on investments issues for governments. However, in to pay the OPEB of those employees). 2018 governments will be required to • Notes to the required schedules implement GASB statement No.75, GASB 74 requires the same two financial Accounting and Financial Reporting for statements currently required by GASB RSI for agent OPEB plans requires a Postemployment Benefits Other than 43 for plans administered through trust: 10-year schedule of the annual money- Pensions, which will require governments weighted rate of return. The OPEB to record their proportionate share of • Statement of fiduciary net position liability should be determined by an the net OPEB liability in the financial (similar to GASB 67, receivables for actuarial valuation which can be no statements. Previously, governments contributions are only included if due more than 24 months earlier than the only recorded an OPEB obligation pursuant to legal requirements) plan’s most recent year-end, using the if they didn’t fully fund the annual entry age actuarial cost method. The • Statement of changes in fiduciary net required contribution and the net OPEB discount rate should be a single rate position liability was only disclosed in the notes. that reflects the long-term rate of return Implementing GASB 75 will have a • Footnotes specified by paragraph 35 of on investments that will be used to pay significant effect on a government’s net GASB 74 should include: benefits. If there will be insufficient assets position because many OPEB plans are to pay the liability, the index rate for 20- • Basic description of the plan and significantly underfunded or not funded year tax-exempt municipal bonds with an at all. policies average rating of AA/Aa or higher would • Investment information, including the be used. Keep in mind that actuaries will This article originally appeared in BDO USA, annual money weighted rate of return be quite busy as everyone will be required LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All • Information about reserves to get OPEB valuations completed this year, so don’t wait until the last minute. rights reserved. www.bdo.com • Single and cost-sharing plans should also disclose: For assets accumulated to provide › Components of the OPEB liability OPEB but not in a trust, the employer will continue to report the assets in an › Significant assumptions agency fund. For defined contribution › Healthcare cost trend analysis plans there are specific disclosures › Discount rate required. › Long-term expected rate of return GASB has issued an Exposure Draft › Sensitivity analysis of the discount rate Implementation Guide No. 201X-X, and the healthcare cost trend rate Financial Reporting for Postemployment Note that the sensitivity analysis for Benefit Plans other than Pension OPEB includes the healthcare cost trend Plans, which follows the format of rate, which is something that wasn’t the GASB 67 Implementation Guide. required for pension plan financial The Implementation Guide includes statements. The net OPEB liability will illustrations to assist in determining the be shown at the current healthcare cost discount rate, money-weighted rate of trend rate and one percentage point return and sample note disclosures and higher and lower. The discussion of should be finalized in April 2017.

7 A Deeper Dive Into ASU 2016-14 Implementation Issues – Part Two By Tammy Ricciardella, CPA

The Winter Nonprofit Standard classifications are generally shown as: conduct or direct supervision of program Newsletter took a more in-depth look or other supporting activities require at certain changes under Accounting • Program services: Activities that result allocation from management and Standards Update (ASU) 2016-14, in goods and services being distributed general activities. Additionally, certain Not‐for‐Profit Entities (Topic 958): to beneficiaries, customers or members costs benefit more than one function Presentation of Financial Statements that fulfill the purposes or mission for and, therefore, should be allocated. of Not‐for-Profit Entities and the which a nonprofit exists For example, information technology implementation considerations. generally can be identified as benefiting • Supporting services, which often various functions such as management In this issue, we will examine two include: and general (for example, accounting, additional areas of the ASU: Expense • Management and general: Activities financial reporting and human resources), reporting and reclassification upon generally include oversight of the fundraising and programs. Therefore, expiration of donor-imposed restrictions. nonprofit and financial management information technology costs generally • Fundraising: Activities undertaken to would be allocated among functions EXPENSE REPORTING receiving direct benefit. As we noted in the Fall Nonprofit induce potential donors to contribute Standard Newsletter, once ASU 2016-14 to the organization The expense analysis required by ASU is adopted, all nonprofits are required • Membership development: Activities 2016-14 should show the disaggregated to present expenses by nature and undertaken to solicit new members functional expense classifications, such by function, as well as an analysis of and retain existing members as program services and supporting these expenses in one location by both activities by their natural expense nature and function. This analysis can be The ASU has modified the definition of classification, such as salaries, rent, presented on the face of the statement management and general activities. The depreciation, interest, professional fees of activities, as a separate statement (not revised definition is “supporting activities and such. a supplemental schedule) or in the notes that are not directly identifiable with to the financial statements. one or more program, fundraising or If there are expenses that are reported by membership development activities.” a classification other than their natural As a quick refresher, functional expense Thus, activities that represent direct classification, such as when a nonprofit

8 shows costs of goods sold and includes The revised ASU provides specific explicit time restriction for the use of the salaries in this presentation, these examples of direct conduct and asset. However, the depreciation should expenses should still be segregated and supervision as it relates to the be based on the useful economic life of shown in the analysis by their natural determination of certain types of the asset. classification within each function. expenses. These are contained at sections 958-720-55-171 through 958- If the donor does not specify how long However, the external and direct internal 720-55-176 in the ASU. The ASU provides the donated assets or assets constructed investment expenses that are netted examples of allocations of a chief or acquired with cash restricted for the against investment return (as required executive officer, chief financial officer, acquisition or construction must be used, by the ASU) should not be included in human resources department and the then the restrictions on the long-lived this analysis of expenses by nature and grant accounting and reporting function. assets, if any, expire when the assets are function. In these sections it notes that the cost placed in service. of the human resource department is In addition, gains and losses incurred by not generally allocated to any specific The entire amount of the contribution the nonprofit on such items as a loss on program, and that instead all costs would of property, plant or equipment, or cash the sale of equipment or an insurance remain as a component of management shall be reclassified from net assets with loss or gain should not be shown in this and general activities because benefits analysis of expenses. donor restrictions to net assets without administration is a supporting activity of donor restrictions when the asset is It is also important to note that the ASU the entire entity. placed in service if there are no explicit restrictions noted by the donor with does not change any current generally Nonprofits should review the accepted accounting principles (GAAP) clarifications in the ASU with regard to regard to how long the long-lived asset is related to the allocation, reporting and the allocation of expenses and review to be used. disclosures of joint costs. their allocation methodologies to When examining the effect of the ASU determine if there are any changes that The expense analysis presented is on your organization you should look are necessary. Once the organization required to be supplemented with at whether you have any contributions enhanced disclosures about the determines the correct allocation approach, they will need to decide where of long-lived assets that are being allocation methods used to allocate costs reclassified over time without any explicit among the functions. In developing this they want to present this analysis in their financial statements and develop the stipulation of a time period for the use disclosure, a nonprofit should assess of the asset. If these assets have already which activities constitute direct conduct format. Some organizations may also need to evaluate the different programs been placed in service, the amount or direct supervision of a program or of these long-lived assets should be supporting function, and, therefore and supporting activities they have reclassified from net assets with donor require an allocation of costs. An example historically presented to determine if restrictions to net assets without donor of a disclosure regarding the allocation of the presentation is concise. In addition, costs is provided below (this is an excerpt the organization will have to develop the restrictions upon adoption of the ASU. from the ASU at section 958‐720-55-176): wording for its allocation methodology disclosure. In addition, the organization will Note X. Methods Used for Allocation have to modify its policy with regard of Expenses from Management and RECLASSIFICATION UPON to the receipt of contributions for General Activities EXPIRATION OF DONOR- the construction of long-lived assets The financial statements report IMPOSED RESTRICTIONS or donated long-lived assets. Upon certain categories of expenses that are If a nonprofit has received funds adoption of the ASU, an organization will attributable to one or more program or have to recognize revenue without donor supporting functions of the Organization. restricted to the purchase or construction of property, plant or equipment or a restrictions when the donated assets Those expenses include depreciation are placed in service absent any explicit and amortization, the president’s office, donation of such an asset with an explicit communications department and donor-imposed restriction on the length donor stipulations otherwise. In the past, information technology department. of time that the asset must be used, then organizations had an option to either Depreciation is allocated based on net assets with donor restrictions should follow the placed-in-service approach or square footage, the president’s office be reclassified as net assets without to place an implied time restriction on is allocated based on estimates of donor restrictions in the statement the long-lived assets. time and effort, certain costs of the of activities as the restriction expires. communications department are This article originally appeared in BDO USA, allocated based on estimates of time and The amount that is reclassified may or LLP’s “Nonprofit Standard” newsletter (Spring effort, and the information technology may not be the same as the amount of 2017). Copyright © 2017 BDO USA, LLP. All department is allocated based on depreciation recorded on the asset. The rights reserved. www.bdo.com estimates of time and costs of specific amount reclassified each year should technology utilized. be based on the length of time of the

9 Supporting Organizations Could Be Putting Their Charity Designation at Risk By Rebekuh Eley, CPA MST

Supporting organizations have been persons (other than foundation managers organization that is specified within its the subject of scrutiny over the last or organizations described in IRC sections organizing documents. The rules on few years, from the Pension Protection 509(a)(1) or (2)). how to determine what is a “specified Act in 2006, to Treasury Regulations in organization” are very complex and 2012 and 2015, to additional disclosure Additionally, a supporting organization can be found in Treasury Regulation requirements to Form 990 Schedule A must fall into one of three relationship 1.509(a)-4(d). Specified organizations in 2014. categories: operated, supervised, or may be identified by designating an controlled by a supported organization organization by name or by a charitable Supporting organizations, particularly (Type I parent-subsidiary); supervised or class that aligns with the mission of those of grant-making foundations, are controlled in connection with a supported the controlling organization. If the left wondering if their current activities organization (Type II, brother-sister) supporting organization provides will fall within these published rules. or; operated in connection with, one or grants to organizations other than the The consequences for not falling within more publicly supported organizations controlling organization, the organizing these rules includes an organization (Type III). The relationship must ensure documents should designate a supported being treated as a private foundation that the supporting organization is organization by class rather than by instead of a public charity. These responsive to the needs or demands of name. The strict requirements for organizations would be subject to excise the supported organization(s), and the designating a supported organization taxes on investment income and would supporting organization will constitute by class are also found in the Treasury need to abide by stricter operational an integral part of, or maintain a Regulations. This type of designation requirements. significant involvement in, the operations requires additional disclosures on the of the supported organization(s). Control supporting organization’s Form 990 Supporting organizations achieve is determined through the facts around Schedule A, which may be scrutinized by public charity status by passing four the organizing documents, operations, the IRS. tests, including an organizational test, and relationship between the supporting operational test, relationship test and organization and the supported Now is a good time to look at a a control test. For the organizational organization(s). supporting organization’s operations test, an organization must be organized and confirm they are aligned with the and operated exclusively for the benefit Many Type I and II supporting governing documents, and grants made of, to perform the function of, or to organizations do not make grants to properly. If the organizational documents carry out the purposes of one or more the controlling organization, but rather and operations are not aligned, the specified organizations described in IRC make grants to other organizations supporting organization may have to section 509(a)(1) or (2). The organization that address the charitable purpose act intentionally to prevent private must also be operated, supervised, or of the controlling organization. This foundation status. controlled by or in connection with one commonplace industry practice or more organizations described in IRC could risk failure of the operational This article originally appeared in BDO USA, section 509(a)(1) or (2). The control must test. A supporting organization can LLP’s “Nonprofit Standard” newsletter (Spring not be direct or indirect by disqualified only support or grant funds to an 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

10 IRS Stresses New Processes at Annual Tax Exempt and Government Entities Meeting By Laura Kalick, JD, LLM in Taxation

The 2017 Internal Revenue Service budget cuts looming, this challenge Lough noted that, like other government (IRS) Joint TE/GE (Tax Exempt and will likely persist. Lough reported that agencies, the IRS has a hold on Government Entities) Council Meeting the workforce is down by 20 percent, regulations based on President Trump’s was held in Baltimore in February. requiring the division to find new ways to recent “one in, two out” executive order. work efficiently, including more targeted Since there is currently no Assistant These annual meetings were designed examinations, information requests and Secretary for Tax Policy, there is no one to maintain open communication the use of digital communications. to administer which two regulations between practitioners and the IRS TE/ will be eliminated to promulgate a GE Division. Attendees include members Commissioner Lough said the IRS does new one. Despite this hold, the IRS is of the five regional TE/GE Councils. not want to burden organizations that still implementing new procedures for Each regional council is comprised of appear to be tax compliant and is, exempt organizations. two subgroups: Exempt Organizations therefore, making examination decisions (EO) and Employee Plans, and includes based on red flags in an organization’s NEW AUDIT PROCESS FOR representatives from the legal, Form 990. In addition, the IRS may INFORMATION DOCUMENT accounting, consulting and in-house EO even be obtaining data from individuals REQUESTS (IDRS) community. This year, the theme of the associated with organizations to see if The commissioner indicated there meeting, in keeping with the message there are private inurement or private is a new audit process in place for IRS TE/GE Commissioner Sunita B. Lough benefit indicators. To make their process information gathering once an included in the 2017 Tax Exempt Work more efficient, the IRS will combine organization has been identified as Plan, focused on transparency, efficiency the data mining and research staff having a specific audit issue (or issues). and effectiveness. into one compliance-focused unit. Under the new process, the IRS and The commissioner indicated that this the organization will discuss the As we have previously reported, is a dynamic effort, and mentioned issues and the information needed the IRS, and especially the Exempt the agency is constantly tweaking its before the IRS sends the Information Organizations division, is working with processes to gain better results. Document Requests (IDRs) and the IRS fewer resources and, with additional will provide the organizations with a

11 timeline to respond to the requests. issue a notice of deficiency. If the IRS Form 990-EZ has an error rate of 34 Issue identification before the IDRs still does not receive the documents in percent. Under new procedures, if a are sent represents a major procedural time, including extensions, a summons return is not complete, it will be sent breakthrough for both the IRS and will be issued. The goal of this process back to the organization and will not be exempt organizations. In the past, even is to ensure issues are addressed in a considered filed and the organization though both sides knew what issues transparent and timely fashion. will have to refile. The IRS is hoping that were at play, the IRS would bombard the new electronic form will lower the the organization with multiple IDRs DIGITAL COMMUNICATION error rate and encourage organizations (sometimes in the hundreds) that would Commissioner Lough also discussed a to ensure all necessary information is cause an audit to last for extended trial test of digital communications. The included on the form so it is not returned periods of time. Also, many IDRs were IRS will be testing a process for sending by the IRS. duplicative and requested information IDRs through secure messaging, rather that was possibly irrelevant. than through “snail mail,” which could FINAL NOTE also save time. Recent Statistics of Income published for With the new process, it appears that the Tax Year 2012 showed that over 46,000 IRS will be flexible in granting extensions She also indicated that they are testing tax-exempt organizations filed a Form to provide the information, if an electronic return readers that remove 990-T with the IRS that year, and over organization has good cause to request personal information, allowing the half of those organizations did not report one. However, if an extension is granted, information from Forms 990 to be online unrelated business income tax liability the IRS will expect the response to come faster. The Form 1023-EZ information after subtracting deductions from gross by the extended deadline. Additionally, is now available online, so a Freedom unrelated business income. The new the IRS is making a commitment to of Information Act (FOIA) request is no procedures and initiatives that the IRS is respond to information it receives in longer required to obtain the application. implementing should help address this response to an IDR in a reasonable time The IRS will also create a section on the issue, and others. frame. Form 1023-EZ where the organization will input an explanation of the exempt Article reprinted from the BDO Nonprofit Standard In April 2017, the IRS will also implement purpose. blog. a new process for those organizations This article originally appeared in BDO USA, Another advancement is that the Form that do not respond to IDRs on time. LLP’s “Nonprofit Standard” newsletter (Spring If the organization does not respond 990-EZ now has 29 electronic help icons 2017). Copyright © 2017 BDO USA, LLP. All within the given time period, the IRS will that will hopefully reduce the errors on rights reserved. www.bdo.com this return. Currently, the paper-filed

12 The Importance of Civic Reach By Lewis Sharpstone, CPA

Ensuring sustainability is a top reach” refers to an organization’s a host of inspiring and remarkable priority for almost every nonprofit ability to develop, maintain and grow people. While they built well- organization. But one sometimes relationships with individuals who have respected organizations that carry on overlooked piece of the sustainability influence over resources across the wonderful and impactful legacies in the puzzle is managing critical external sectors in which it operates. communities they served, many didn’t relationships and ensuring their devote resources to building ties with the longevity. Most nonprofit executives can attest that wider community and may have been a grant proposal is received differently able to leverage their connections for This is especially important in a climate when you have a relationship with even more meaningful results if they had characterized by pervasive change. As the program officer who receives it. invested in civic reach. we’ve covered in our Nonprofit Standard Similarly, consider how your views about blog posts, executive retirements are a regulatory issue might be taken when To illustrate what civic reach can do for impacting nonprofits of all sizes as you already have a relationship with the an organization, let’s consider a nonprofit leaders age, many of whom have tenured official listening to you. What about how in my area that was facing foreclosure. long careers at their organizations. an influential person might look at an When we were first engaged to work The industry is also seeing an uptick in invitation to join your board when the with them, we were able to stave off merger and acquisition (M&A) activity board is already home to well-connected foreclosure on a temporary basis, buying aimed at consolidating costs, back- and influential members? the organization time. Three years office and administrative functions, and later, though, when the financial issues building efficiencies to expand scope While building civic reach may sound like bubbled up again, they had cultivated a and reach. How new priorities in the mere networking, Vandeventer contends strong civic reach. They engaged local executive branch will impact charitable it’s much more important than that. It’s and even some national politicians, organizations is also a big unknown. essential that every organization have businesspeople and community leaders a sustainability plan. See Laurie De to advocate against foreclosure—and Whether an organization is approaching Armond’s, partner and national co-leader it worked. A favorable long-term loan, succession planning, post-merger of BDO’s Nonprofit & Education practice, a win-win for the organization and the integration or other organizational article on page 1 discussing this topic in bank, was put in place and the nonprofit transition, or simply examining its long- detail. Her advice was that “To prevent is now moving from uncertainty to term sustainability, it’s important to gaps in relationship management during strength. I am convinced that leveraging invest in key relationships. an executive transition, organizations the increased civic reach of this can encourage shared ownership and organization is the only thing that could Paul Vandeventer, CEO of Community an open flow of information so that have achieved this result. Partners, describes this concept key relationships don’t become siloed especially well with what he’s coined with one individual.” Extending an Article reprinted from the BDO Nonprofit Standard “The Civic Power Grid.” He defines organization’s civic reach is an often- blog. an organization’s civic reach as “the forgotten, but essential, element of This article originally appeared in BDO USA, essential third leg of a nonprofit board’s building a sustainable enterprise. LLP’s “Nonprofit Standard” newsletter (Spring sustainability platform,” with fundraising 2017). Copyright © 2017 BDO USA, LLP. All and governance as the first and second Over the course of my career working rights reserved. www.bdo.com legs. As Paul explains, the term “civic with nonprofit organizations, I’ve met

13 IRS Focuses on Employment Tax Issues During Tax-Exempt Organization Audits By Robert Kaelber, J.D.

With tax filing season well underway, • Expense reimbursements and (the “Employment Tax K-Net”) to track organizations of all sizes are beginning accountable plan compliance; and disseminate what is learned during to identify areas of potential audits, and to use it to further train noncompliance and, for nonprofits, • Fringe benefits (e.g., relocation/ employees in this area. It is likely that a common culprit is employment tax moving, automobiles, group term life, with enhanced training, IRS examiners issues. cell phone reimbursement, prizes/ will more readily identify more complex awards, spousal travel and education potential employment tax issues for The IRS has emphasized employment tax benefits); review rather than merely focusing on compliance during its tax-exempt audits the “low hanging fruit.” for many years. The IRS has officially • Independent contractor classification stated that this employment tax focus and income reporting; Based upon the IRS’ continued focus on will continue into 2017. In the IRS’ Tax employment tax issues, it is imperative • Supplemental pay reporting and Exempt and Government Entities FY 2017 that tax exempt entities review their processes, including timing of wage Work Plan, which details its priorities policies and processes and invest in inclusion for various tax and wage and mission for the coming year, the initiatives and resources to ensure types (including retirement pay and IRS disclosed that more than 25 percent compliance. Organizations should also incentives); of closed audits had a “primary issue” document all policies and processes so related to employment tax. At the end of • Form W-9 process, Form 1099 TIN that they may readily demonstrate upon June 2016, 1,323 audits involved primarily matching procedures and backup audit that IRS compliance protocols employment tax issues, out of a total withholding compliance; are followed. Being proactive and 4,984 closed examinations. Further, the completing an internal employment tax IRS continues to include employment tax • Forms W-2c and 941-X processes; process review or even a “mock audit” issues within its list of high-risk areas of may help to identify issues and result in noncompliance. • International cross-border employment the early implementation of corrections tax issues; and before the IRS is involved. Failure to The IRS states in its 2017 Work Plan that, comply with employment tax reporting • General compliance procedures for “Employment Tax includes unreported obligations can result in the imposition employment tax filing obligations. compensation, tips, accountable of significant tax, penalties and interest. plans, worker reclassifications and The IRS appears to be trying to Additional wage inclusion due to noncompliance with FICA, FUTA and streamline its processes for audit employment tax noncompliance could backup withholding requirements.” target identification, focusing on also trigger further questions from the While this definition covers a wide increasing efficiency as it works with IRS pertaining to inurement or private range of areas, our experience with IRS fewer resources. As such, the agency benefits. employment tax audits and associated has implemented a “data-driven case information document requests (IDRs) Article reprinted from the BDO Nonprofit Standard selection process,” and is seeking new indicates that likely issues for review blog. ways to identify data that can indicate may include, but are not limited to, the patterns of noncompliance. Other 2017 This article originally appeared in BDO USA, following: IRS priorities include working to develop LLP’s “Nonprofit Standard” newsletter (Spring 2017). Copyright © 2017 BDO USA, LLP. All an employment tax knowledge database rights reserved. www.bdo.com

14 IRS “Snapshots” Providing Technical Guidance By Joyce Underwood, CPA

The IRS has recently added new For each issue, the guidance provides ••••••• issue-specific guidance regarding lists of relevant law and resources, charities and nonprofits in the form of analysis and background on the issue, If an organization is determined to be “Snapshots.” and tips to help the agent recognize if an Lessening the Burdens of Government organization has an issue in the area. The it can qualify as an Internal Revenue The guidance is a result of internal concise format allows the reader to focus Code (IRC) Section 501(c)(3) charitable collaboration and provides fresh insight on the definitions, law and facts, and organization. The guidance, with the and perspective to agents on compliance hopefully to efficiently and effectively application of facts and circumstances areas to help them effectively and form a conclusion. criteria, helps clarify if the activities efficiently perform their work. These IRS represent a burden of government and if employee job aids are public documents The following is a summary of topics for the organization by its activities lessens and provide insight to nonprofits and charities and nonprofits included in the that burden. other outsiders on how the IRS is thinking Snapshots issued to date: and responding to issues. •••••••

15 Electronic Health Records (EHRs) individuals, corporations, partnerships Direct expenses are those which can be or Regional Health Information and other potential disqualified persons. specifically identified with a particular Organizations (RHIOs) have been activity. Indirect (overhead) expenses formed to facilitate the electronic ••••••• are not specifically identifiable with use and exchange of health-related a particular activity. Neither the information in response to incentives and Taxes on Failure to Distribute Income Internal Revenue Code nor the Treasury appropriations for health information —Carryover: Private foundations with regulations set any limits on the amount technology provided by the American mandatory distribution requirements of administrative expenses that may be Recovery and Reinvestment Act of that carry over excess distributions used as qualifying distributions as long 2009 (ARRA). The IRS’ concern is to from earlier years can correct their as they are reasonable and necessary ensure organizations are organized for distributable amounts and the amounts for the accomplishment of the private an exempt purpose, lessen the burden of qualifying distributions in order to foundation’s exempt purposes. of government, and act in a manner determine the correct excess or deficient consistent with Health and Human distribution carryovers. They are not ••••••• Services (HHS) standards. barred by the statute of limitations on changing the carryover, however, they Private Operating Foundation ••••••• can only correct Section 4942 excise under IRC 4942(j)(3) discusses the tax for years open by the period of advantages to having private operating Taxable unrelated trade or business limitations on assessment. foundation status as opposed to that activity does not include sponsorships, so of a private non-operating foundation, determining if an activity is Advertising ••••••• and reviews the annual tests (Income, or Qualified Sponsorship Payments is Assets, Endowment and Support) for important to many nonprofits. Review Penalty Abatement due to Reasonable qualification based on an organization’s of sponsorship arrangements includes Cause is permitted for private foundation qualifying distributions, income and an assessment of any substantial first-tier taxes under Chapter 42 of assets. An organization that fails to return benefit, payments contingent on the Internal Revenue Code, except for qualify as an operating foundation in attendance, use or acknowledgment penalties assessed for self-dealing. Since a given year may have to distribute of a name or logo, and connections to there is no definition of “reasonable additional amounts to other charities in a qualified convention or trade show or cause,” the determination of whether order to avoid excise taxes on failure to exclusive provider arrangements. Certain a taxpayer’s actions were due to make sufficient qualifying distributions. language is provided which, if used in an reasonable cause under Section 4962 acknowledgment, is an indication of a and in good faith is made on a case-by- ••••••• taxable advertisement. case basis. Examples of court cases and legislative history provide perspective The release of the Snapshots is a ••••••• on how to assess the facts and welcome educational resource. circumstances. Knowing the guidance and resources Definition of a Disqualified Person: recommended by the IRS when The term “disqualified person” is critical ••••••• evaluating a tax position, and the steps to private foundations to analyze they take in their analysis can be helpful whether various Chapter 42 excise taxes For private foundations with distribution in responding to inquiries or avoiding apply, and in determining whether an requirements, Administrative Expenses potential compliance and exemption organization qualifies for public charity Treated as Qualifying Distributions issues. status as a supporting organization or are allowed. Qualifying distributions meets the public support test for IRC This article originally appeared in BDO USA, include that portion of reasonable LLP’s “Nonprofit Standard” newsletter (Spring Section 509(a)(2). It is important to and necessary expenses, direct and 2017). Copyright © 2017 BDO USA, LLP. All identify relationships and transactions indirect, that a foundation incurs rights reserved. www.bdo.com. between the organization and private in implementing exempt purposes.

16 Best Practices for an Effective Investment Committee By Lee Klumpp, CPA CGMA

Most nonprofits rely on an investment 4. Refresh the organizational Investment 9. Have regularly structured investment committee to oversee their investment Policy Statement on a regular basis committee meetings and draft portfolios. This oversight group can to make sure that it continues to minutes from these meetings. have a big impact on real long-term articulate the organization’s long-term wealth preservation and ensuring objectives and unique needs. Above all, these best practices, which resources are available to realize are fundamental regardless of the organizational goals and aspirations. 5. Define a realistic target for investment nature or size of the organization, can success that is consistent with the be boiled down to five C’s: commitment, These best practices are consistent with organization’s resources, and focus on coordination, communication, continuity the fiduciary duties of care, loyalty and the implementation. and completion. obedience, and include: 6. Be strategic in asset and investment While an investment committee can 1. Form a strong investment committee manager selection and perform regular operate successfully with a variety of that embraces the “commit” in evaluations. structures and approaches, these best committee. practices can make any investment 7. Find an appropriate person or committee more efficient and effective. 2. Ensure diversity and experience in organization that can act as the This should lead to improved long- committee composition. organization’s Chief Investment Officer term portfolio operation—ultimately (CIO), to manage its investment benefiting grantees, beneficiaries and 3. Set a strong Investment Governance portfolio, be held accountable to the stakeholders. and Operational Framework that committee and regularly review its establishes an Investment Policy performance. This article originally appeared in BDO USA, Statement— including asset allocation, LLP’s “Nonprofit Standard” newsletter (Spring risk constraints, performance metrics 8. Monitor results and make changes as 2017). Copyright © 2017 BDO USA, LLP. All and pay-out. It should be consistent needed. rights reserved. www.bdo.com with furthering the organization’s objectives and realistic given its resources.

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