FIN 48 will force a closer look at the source of the organization’s funds and the organization’s tax exempt purpose. Analysis in this area is necessary because if the organization strays from its exempt purpose, the income generated could become taxable. FIN 48 implementation requires that the risk of this happening be analyzed and any potential taxes be disclosed. 

This goes along with the second target area, classification of unrelated business income and management’s devotion of time to raising funds unrelated to the exempt purpose. Income unrelated to the exempt purpose of the organization should be taxable and whether or not income is classified as “unrelated” is a tax position. The potential tax liability arising from classifying income as unrelated business income requires a FIN 48 disclosure. 

The last generally applicable target area for exempt organizations is excessive compensation arrangements. If a compensation arrangement is found to be excessive it can result in excise taxes or jeopardize the tax exempt status of the organization. Compensation policies and practices will require analysis and possibly a FIN 48 disclosure of potential tax liability. 

Posted by Jamye Shaffer
RCO – Tax Senior

Ok that is a bunch of tax talk. How can this standard affect tax-exempt organizations? The Financial Accounting Standards Board actually addressed that issue specifically, in a staff position paper issued last year. There are several FIN48 issues that can affect tax exempt agencies, but the most common are (1) performing services that are not consistent with the organization’s tax exempt purpose and (2) unrelated business income.

The first assessment of any tax position is whether or not the position is more likely than not to be upheld during an IRS examination. If the position would be upheld, then it is NOT an uncertain tax position and there is NO liability.  If the position cannot be upheld, then FIN48 requires a liability to be recorded and disclosed. The calculation of the liability is prescribed but allows some judgement. The recorded liability is the difference between the benefit recorded (full amount) and the amount that would be 50% or more likely to be allowed after the examination. The disclosure will identify this as an uncertain tax position, and will raise red flags for an IRS audit. As reported in the Journal of Accountancy, the IRS is currently proposing companies with more than $10 million of assets to disclose uncertain tax positions on their annual returns. 

Need help in determining what is considered an “uncertain tax position”? See our next post.

Information You Will Need to Prepare Schedule D
You will need to gather or prepare the following information:

• Details regarding your donor advised funds, (Part I).
• Details regarding your conservation easements, (Part II).
• Details regarding your collections of art, historical treasures, and similar assets, (Part III).
• Details regarding your trust, escrow, and custodial arrangements, (Part IV).
• Details regarding your endowment funds, (Part V).
• Details regarding your assets, investments, and liabilities, (Part VI, VII, VIII, IX, and X).
• Your audited financial statements, (Part XI, XII, and XIII).
• View the IRS Website for additional instructions for preparation of Schedule D.

How to Prepare Schedule D

Part I, Organizations Maintaining Donor Advised Funds or Other Similar Funds or Accounts

A donor advised funds allow donors to maintain advisory privileges regarding the distribution or investment of their donated funds. Generally a donor advised fund is a fund or account:

1. That is separately identified by reference to contributions of the donor;
2. That is owned and controlled by your organization; and
3. For which the donor or donor advisor has or reasonably expects to have advisory privileges in the distribution or investment of amounts held in the donor advised funds of accounts because of the donor’s status as a donor.

A donor advised fund does not include any fund or accounts:

1. That only makes distributions to a single organization or governmental unit;
2. In which the donor only provides advice regarding the distribution of grants to individuals on an objective basis for travel, study, or other similar purposes as the member of a committee which is not controlled by the donor.

Line 1 – 6: complete the information for your donor advised funds in column (a) and for you funds that are similar to donor advised funds in column (b).

Part II, Conservation Easements
Line 1: Conservation easements restrict the use of or modifications to real property. They must be granted to a qualified organization in perpetuity exclusively for conservation, such as protection of a habitat, preservation of open space, or the preservation of property for educational, historical, or recreational purposes. To qualify as a certified historic structure, the building must be listed in National Register of Historic Places or be certified as being of historic significance to a registered historic district.

Line 2a – 2d: These numbers should be exact, not estimates, using decimals where necessary, such as for acreage.

Line 3: Because conservations easements are supposed to be granted in perpetuity, the IRS wants to know about any changes. An easement is modified if the terms of the easement are modified, such as increasing or decreasing the amount of land included in the easement. An easement is terminated if it is condemned, extinguished by court order, transferred, or rendered void or unenforceable. If the easement was modified, transferred, or terminated during the year, provide an explanation in Part XIV.

Line 5: Briefly summarize in Part XIV any written policies regarding monitoring, inspection, and enforcement. Monitoring occurs when you investigate the condition or use of the restricted property to verify that the owner is adhering to the terms of the easement. Inspection refers to an onsite visit to the property, while enforcement is an action taken by your organization when a violation of the easement stipulations occurs. This may include communicating with the property owner regarding their obligations under the easement, arbitration, or litigation.

Line 8: In order to comply with IRC Sections 170(h)(4)(B)(i) and 170(h)(4)(B)(ii), the easements must meet the following requirements:

1. Restrictions that preserve the entire exterior of a building, (including the space above it) and prohibit any changes to the exterior that are inconsistent with the historical character.
2. Donor and donee agree in writing under penalties of perjury that the donee’s exempt purpose is environmental protection, land conservation, open space preservation, or historic preservation and the donee has the resources and commitment to enforce the restrictions.
3. There is a qualified appraisal, photographs of the entire building exterior, and a description of all development restrictions relating to it, (such as zoning laws, restrictive covenants, etc.)

Part V, Endowment Funds
Section V is a snap shot of the components of your net assets. Quasi-endowments, (board designated) are established by the board to function as endowments. They must retain their purpose and intent as specified by the donor or source of the original funds. Permanent endowments provide a permanent source of income. The principal must be invested and kept intact in perpetuity. The income can be used by your organization. Term endowments provide a source of income for a specific period of time or until a specific event occurs.

Line 1a: Enter the total sum of your quasi, permanent, and term endowments.

Line 1b: Enter the current year contributions to the endowments. Include gifts, grants, and contributions. Also include additional funds established by your board to function like an endowment, but that may be expended at any time at the discretion of the board.

Line 1c: Enter realized and unrealized gains and losses. If earnings are reported net of transaction costs, enter the net on this line. If earnings are reported gross, enter the transaction costs on line 1f.

Line 1e: Enter distributions for facilities and programs, including amounts withdrawn from quasi-endowments. Do not include scholarships on this line. Instead enter them on line 1d.

For more information, view the IRS instructions at http://www.irs.gov/pub/irs-pdf/i990sd.pdf.

Coming Soon
Schedule G coming March, 2010.

To begin the audit, the accountant (or equivalent) will present the auditor with a listing of all accounts and the related balances that are used to compile the financial statements. Basically, the accountant is saying this is what I believe to be the balances of these accounts. Then the auditor goes through various steps, such as confirming information with third parties, reviewing invoices, contracts, receipts, bank statements, and analytical procedures to prove that the balances are not “materially misstated” and that the statements conform to generally accepted accounting principles.

An audit does not look at every transaction that occurred during the year. Normally this would be cost prohibitive. So the auditor will look at various accounts and take a sample of transactions from those accounts. Because we “test” the account balances and not review 100%, our report is not saying that the financial statements are necessarily 100% accurate, but our report tells the users of the financial statements that we believe there is not a material misstatement that would cause you to alter a decision.

For example, your organization may report to us that they have a balance of accounts receivable of $2 million. Through various means of testing this balance, we have reviewed $1.9 million of this balance and believe it to be accurate. But we have not audited the remaining $100,000. We believe that the users of the financial statements would make the same decision if the actual balance were $2 million or $1.9 million. When errors are found during the audit, the auditors will discuss the issues with management and propose adjustments to the financial statements.

Understanding what an audit of financial statements entails helps management, Board of Directors and others to know what they are paying for and that the statements fairly represent the financial status of the organization. If the accountant uses the same generally accepted accounting principles to compile the monthly financial statements, this will help management and the Board of Directors make consistent, well-informed decisions.

Participants will learn:

• The importance of sound budgeting
• The basic principles of budgeting
• How the budget is used as a planning and management tool
• Steps in the budgeting process
• How to develop various types of budgets, including programs and special events

Speaker: Christi Stinson, Executive Director, Funding Information Center
Fee: $20 for FIC members; $40 for nonmembers

Date: Tuesday February 16th, 2010

Time:  9:00 a.m. to 11:00 a.m.

Location: Funding Information Center
329 S. Henderson, Fort Worth, TX 76104
817-334-0228
To register, follow this link.

So what is an audit of financial statements? Usually on a monthly basis, the controller, CFO, or accountant at your organization prepares financial statements, usually consisting of a balance sheet and income statement. These statements are used by staff, management and the Board of Directors to make decisions about the organization. But all of the information is gathered by and reported by people INTERNAL to the organization. A financial statement audit involves someone EXTERNAL to the organization, an independent certified public accountant.

Audits of financial statements are done according to a set of standards that all CPA’s must adhere to, which are referred to as Generally Accepted Auditing Standards (GAAS). These standards have been developed by the American Institute of Certified Public Accountants and are monitored and revised based on financial circumstances, including failures related to fraud.

So how do we perform an audit? See my post, next month.

10. Begin working on your schedules weeks before the audit occurs, you might have questions and your auditor is just a phone call or email away.
9. Keep track of issues you struggled with during the year. It will help the auditor key in on important areas at the beginning of the audit.
8. Get the confirmations back to the auditors quickly! The more time there is to send these out the better chance the auditor receives the accurate information. Not getting them back causes more work for all parties involved.
7. Communicate your schedule to the auditors. This helps the auditor work around your normal responsibilities.
6. Make all your adjustments to your trial balance before you provide it to the auditor.
5. Those schedules we talked about earlier make sure they tie to that final trial balance.
4. Make needed documentation easy to access and provide it to the auditors as soon as possible.
3. Be available! Here’s a tip, set aside time on your calendar devoted to auditor questions and audit prepwork.
2. Implement good segregation of duties among your staff. The more checks & balances you have the less likely you are to have errors or issues.
1. Don’t do anything fraudulent or misleading during the year. (Always a plus). Tell the truth.

The key to success is communication and preparedness. If you apply these steps you should see a reduction in the amount of friction an audit can cause.

Administrators of 403(b) plans do not need to treat annuity contracts and custodial accounts as part of the employer’s plan assets for purposes of ERISA’s annual reporting requirements (further, the employer is not required to count the individual as a participant under the plan for Form 5500 reporting purposes) provided that:

1. The contract/account was issued to a current or former employee before 1/1/09
2. The employer ceased to have any obligation to make contributions and has ceased making contributions to the contract/account before 1/1/09
3. All of the rights and benefits under the contract/account are legally enforceable against the insurer or custodian by the individual owner without any involvement by the employer
4. The individual owner of the contract account is fully vested

The Department will not reject a Form 5500 on the basis of qualified, adverse or disclaimed opinion if the accountant expressly states that the sole reason for such an opinion was because such pre-2009 contracts/accounts were not covered by the audit or included in the plan’s financial statements.

The above information obtained from Field Assistance Bulletin 2009-02.

1. Parent – an organization that controls the filing organization.
2. Subsidiary – an organization controlled by the filing organization.
3. Brother/Sister – an organization controlled by the same person or persons that control the filing organization.
4. Supporting/ Supported – an organization that is (or claims to be) at any time during the organization’s tax year, a supporting or supported organization within the meaning of section 509(a)(3) and 509(f)(3).

According to the IRS – the definition of control is:

1. Power to remove and replace a majority of a nonprofit organization’s directors or trustees,
   or
2. Management or board overlap where a majority of the controlled entity’s directors or trustees are trustees, directors, officers, employees, or agents of the controlling organization.

In the case of stock corporations, and other organizations with owners or persons having beneficial interests, whether such organization is taxable or tax-exempt, any of the following relationships represent control:

1. Ownership of more than 50% of the stock (by voting power or value) of a corporation.
2. Ownership of more than 50% of the profits or capital interest in a partnership.
3. Ownership of more than 50% of the profits or capital in a limited liability company (LLC ) treated as a partnership regardless of the designation under state law of the ownership interests as stock, membership shares or otherwise.
4. Being a managing partner or managing member in a partnership or LLC treated as a partnership which has three or fewer managing partners or managing members (regardless of which partner or member has the most actual control).
5. Being the sole member of a disregarded entity, (an entity wholly owned by the organization that is not a separate entity for Federal tax purposes).
6. Ownership of more than 50% of the beneficial interests in a trust.

What is considered indirect control? If the filing organization controls Entity A, which in turn controls Entity B, the filing organization will be treated as controlling Entity B also.

Sometimes it is difficult to determine “who” owns “what”. If you have questions, call us.

What changed? How is your T-E organization affected?

The final regulations require all 403(b) providers, including churches, to have a plan document in place no later than 12/31/08. Failure to adopt a written plan before 1/1/09 will render all subsequent contributions to the plan to be fully taxable. The plan document must address several issues, including:

• Employee eligibility, Contribution limits, Distributions, Benefits, Salary reductions, Investments, Loans, Hardship withdrawals, Allocation of compliance responsibilities to employers and fund providers (vendors)

The IRS has made available a sample plan document that can be used by tax-exempt organizations: see IRS Publication 2009-3.   If a plan is established directly through a mutual fund or other investment company most of these third-party vendors have created generic plan documents for use by their clients.

The final regulations also require “large” ERISA-covered 401(b) plans (generally plans with 100 or more eligible employees) to file audited financial statements along with their 2009 Form 5500.  Small 401(b) plans (generally fewer than 100 eligible employees) are eligible for a waiver of the audit requirement but are required to file the Short Form 5500 (5500-SF) which includes aggregate financial information related to the Plan.

Additional changes are discussed in detail at http://www.irs.gov/retirement/article/0,,id=172433,00.html

If you need help in understanding these new reporting requirements, please contact me.