Nonprofit organizations are required to disclose substantial amounts of information regarding their activities on their annual Form 990. Some of the required information is intuitive; some of it requires understanding certain rules and definitions. Reporting of transactions with interested persons, otherwise known as Schedule L, is one such schedule that requires basic knowledge and understanding of what types of transactions are to be considered and the classes of individuals and entities that are to be included when determining what must be disclosed.
Excess Benefit Transactions
Excess Benefit Transactions is one of the more complex types of transactions to be disclosed on Schedule L. They are reported on Part I of Schedule L and exist where an economic benefit is provided, either directly or indirectly, to or for the use of a disqualified person where the consideration received in return is less than the economic benefit. These transactions are reportable for 501(c)(3), (c)(4), and (c)(29) organizations. All excess benefit transactions, regardless of amount, need to be reported on the annual return to meet 990 reporting requirements.
For purposes of these transactions, a disqualified person is an individual who has substantial influence over the organization’s affairs. This would include an organization’s top-level management,
voting members of the governing board, and anyone who has responsibility for managing the organization’s finances.
When determining whether an excess benefit transaction has occurred, all transactions between the organization and the disqualified person need to be considered as well as the factors that contribute to them being treated as a disqualified person. There are certain indicators to look for when determining whether an individual can be considered a disqualified person:
1. The individual is the organization’s founder or a substantial contributor (donated more than $5,000 in a given year, if that amount also exceeds 2 percent of the total contributions received by the organization in that year).
2. The individual receives compensation that is determined based on the revenues of organizational activities.
3. The individual has the authority to control the organization’s budget, capital expenditures, or employee compensation.
4. The individual owns a controlling interest in a trust, partnership, or corporation that is considered a substantial contributor.
Examples of Excess Benefit Transactions include payment of unreasonable compensation, sale of property to the organization by a disqualified person in excess of fair market value, payment of personal expenses, and embezzlement.
An excise tax is assessed on Excess Benefit Transactions, equal to 25 percent of the excess benefit received. The organization will be given a timeframe within which the transaction is required to be corrected, and the recipient of the excess benefit is liable for the tax. Suppose the organization fails to remedy the excess benefit transaction. In that case, an excise tax equal to 200 percent of the excess benefit may be assessed for the recipient, and the organization could have its tax-exempt status revoked.
Other required disclosures
Loans to or from interested persons should also be disclosed on Schedule L, Part II. These transactions are reportable for all organizations. For purposes of completing this portion of Schedule L, an interested person is defined as any trustee, director, officer, key employee, organization founder, substantial contributor, or family member of any interested person.
Only outstanding loans at the organization’s year-end should be disclosed. Loans can include salary advances, unsecured or secured loans, split-dollar life insurance arrangement payments that are treated as a loan, and any other receivables or advances reported on Form 990, Part X, lines 5, 6, or 22.
Loans to or from the organization to a member of the governing body that are outstanding at year-end will impair those individuals’ independence, even if those loans are made during the ordinary course of business and are done in arms-length transactions. The disclosure of these loans, in conjunction with the other disclosures made throughout the return, allows the users of Form 990 to draw their own conclusions about the organization’s activities and gives a full picture of the organization’s business dealings.
Grants or assistance provided to interested persons are required to be disclosed in Part III of Schedule L. An organization is required to disclose a grant or other assistance provided to an interested person at any time during its tax year, regardless of the amount. Examples include grants, scholarships, and discounted goods or services, including the use of facilities, fellowships, internships, prizes, and awards.
An interested person for this section of Schedule L is deemed to be those considered for Part II loans plus members of the grant selection committee and their families and employees of substantial contributors. However, grants made to a substantial contributor’s employees are not
reportable if the grants were awarded on a nondiscriminatory, predetermined set of criteria reviewed by an independent selection committee.
Grants or assistance to an interested person who is also a member of the charitable class the organization serves in carrying out its exempt purpose are also not required to be reported as long as similar grants or assistance is given to other members of the same charitable class. Part III of Schedule L intends to disclose those grants or assistance given to interested persons and their family members that were made outside of the organization’s exempt purpose and in a biased way.
The last type of transaction reported on Schedule L are business transactions involving interested persons, and these are reported in Part IV. For this section of Schedule L, the definition of an interested person is the same as for Part II.
Business transactions include joint ventures, sales, leases, licenses, insurance, and performance of services. It should be noted that business transactions that benefit the organization should not be reported unless they are between the organization and an interested person.
There are reporting thresholds for these types of transactions, unlike the other types of transactions reported on Schedule L. The minimum thresholds are:
1. The total of all payments made during the year related to one transaction is the greater of $10,000 or 1 percent of the organization’s total revenue for the year.
2. The total payments (regardless of the number of individual transactions) exceed $100,000.
3. Compensation paid to a family member of a current or former trustee, director, officer, or
key employee exceeds $10,000.
4. If entered into a joint venture with an interested person, the organization has invested $10,000 or more, and the combined profits or capital interest of the organization and the interested person in the joint venture exceeds 10 percent.
If a business transaction is required to be disclosed, the transaction should have board approval prior to being entered into.
Importance of identifying disclosures
It is important for an organization to be able to identify the types of transactions required to be disclosed, and it’s also important to know how to mitigate or remedy transactions that may impact the organization negatively. Having members of the board, management, and key employees complete an annual conflict-of-interest statement or questionnaire would assist in identifying potential transactions before they become reportable. Also, having a separate, independent compensation committee would ensure that employees and organization directors are compensated reasonably. An organization’s ability to remain transparent about its transactions with disqualified persons and other interested parties is imperative to remain compliant with the Form
990 reporting.
To satisfy the IRS requirements for identifying and reporting transactions with interested persons, an organization must display reasonable effort in its process. An annual inquiry with suspected interested parties to disclose transactions is a sufficient way for an organization to apply reasonable effort in obtaining information to report on their Form 990. If the organization cannot
obtain satisfactory information from a potentially interested party about a reportable transaction, the organization is not required to provide information about that transaction.
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