Additional disclosures in the annual Form 990 and possible taxable implications — Many associations are investing in alternatives due to the ongoing economic recovery and low rate of returns from traditional investments. Endowment and board designated funds need to achieve investment targets, which can be near impossible to make with the average returns from mutual funds and managed accounts. Alternative investments provide the allure of increased returns, albeit at an increased risk. Many associations have been successful at hitting higher returns through alternative investments. These investments do come with added oversight and considerations for additional disclosures to the government in certain ownership situations or because of certain transactions.
Typical alternative investments are hedge funds, private equity funds, commodities, and private investment funds. When you dig a little deeper into the investment vehicle these alternatives utilize, you find partnerships and Limited Liability Companies (LLC). Most, with the exception of a select few, are not publicly traded on an open market. These investment types require careful analysis to value and record under Generally Accepted Accounting Principles (GAAP), as well as tax review for issues involving special disclosure options. Here are some of the main considerations an association’s financial officer should review annually with regard to alternative investment activity.
If invested in a LLC or partnership, it should be reviewed to understand the origin, whether foreign or domestic. Investment holdings of more than $100,000 in foreign sourced investments require disclosure in Schedule F of the annual Federal Form 990. Additionally, certain activity such as a current investment of $100,000 or more could require additional forms for completion and submission with Form 990. Potential forms can include Form 926 for foreign corporations, and Form 8865 for foreign partnerships. Form 8621 is necessary if the association is a shareholder in a Passive Foreign Investment Company (PFIC) or a qualified electing fund. Identifying these entities and determining the forms to complete may require assistance from an international tax specialist.
Partnerships and LLCs provide K-1s at year-end summarizing the taxable information for the recipient. An association could be subject to unrelated business income from debt-financed property reported on the K-1. Investment managers report details of nonprofit unrelated activity in a special place on a K-1 as footnotes or additional disclosures behind the printed form. This can require the association to file Federal Form 990-T. State taxable income can be disclosed in the K-1 nonprofit section, reporting the states that have nexus by location, requiring one or more state income tax returns in addition to Form 990-T.
The new ASU, 2016-14 Not-for-Profit Entities (Topic 958) Presentation of Financial Statements of Not-for-Profit Entities, will require financials statements of nonprofits to disclose expenses by both functional and natural classifications. In English, this means a Statement or Schedule of Functional Expenses will be required for all, when previously only voluntary health and welfare nonprofits were required to disclose such information. This disclosure will be necessary to report either in the financial statements themselves, or in the notes.
Most assume that this information is readily available to the organization, but when the pedal hits the metal and the report needs to be put together, and further be analyzed by higher ups and board or trustee members, it may not always be the case that it’s the result of merely pushing a button. It could be that easy, though, if your chart of accounts were set up properly to capture information. Not all charts of accounts are set up, or used properly, to do this. The good news is there is time to evaluate your systems and see if they are up to the task. Some small changes may be needed, or an entire overhaul. Now is a good time to find out. Also a tune up of how to use the coding system pairs with a properly functioning system that results in good reporting. So some timely training for the staff that input data, and those who review output, may also be appropriate.
The effective date of the new ASU 2016-14 is for fiscal years beginning after 12/15/2017 (so for calendar year 2018). This is the time to make decisions about changing the underpinning of the accounting system, better known as the chart of accounts.
Effective July 1, 2016, the application fee for filing the Form 1023EZ has been lowered to $275. The old fee was $400. That’s a savings of $125, and is a welcome relief to small nonprofits applying for tax exempt status.
The new streamlined Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, was introduced by the IRS in 2014 to provide relief for small nonprofits applying for tax exempt status from having to complete the full Form 1023, Application for Recognition of Exemption Under Section 501(c)(3). The full form is 26 pages long, and the IRS estimates it requires an average of 15 ½ hours to prepare, with 185 hours of other reading and record keeping; compared to 2 ½ pages and 5 ½ hours to prepare the EZ version, with an additional 12 ½ hours reading and record keeping. So the new 1023-EZ form is a winner when it comes to cutting down on paper work and time invested to comply with IRS requirements.
And customer satisfaction rates are way up for the IRS on the Streamlined EZ form compared to the regular long form.
Not every organization is eligible to complete the streamlined EZ form. Here is a summary of the not-so-short list of twenty-six points your organization needs to pass in order to qualify: