As tax-exempt organizations, many independent schools file Form 990 with the IRS each year. Form 990 is unlike any other type of tax filing: while there is a financial component, a large element of the filing is concerned with the organization’s internal governance policies.
A major element of these internal governance disclosures centers on the independence of the individuals tasked with making decisions on behalf of the organization. In a 501(c)(3) public charity, the majority of these individuals should operate free from conflicts of interest.
It is uncommon for every person in a decision-making capacity in an organization––whether that’s a trustee, director, or executive––to be fully independent. As we’ll explore, various events can cause an individual to lose their independent status. When a nonprofit’s key personnel are not independent, this must be disclosed in Form 990 through what’s known as a related party disclosure.
In this overview, we explore the concept of related party disclosures. We will detail the reporting process, share how schools can understand their reporting requirements, and outline common scenarios that may trigger the need for schools to include related party disclosures on their Form 990 filing.
When a tax-exempt organization prepares to file Form 990 each year, one of the tasks on its pre-filing checklist should be to determine whether it needs to make any related party disclosures. These disclosures acknowledge any transactions between different parties and individuals with decision-making power in the nonprofit organization.
Consider the example of a board member of an independent school who also owns a construction company. The school would like to build a new gymnasium. After considering a range of contractors, the school’s leadership opt to go with a favorable bid from the board member’s construction company.
This would be a related party transaction – exactly the type of activity that must be disclosed on Form 990. When preparing Form 990, the independent school must disclose that this contract was awarded to the board member’s construction company. Additionally, the board member should not vote to approve the decision to hire their company, and the nonprofit must acknowledge that this board member is no longer considered independent.
This is just one example. As we explain below, there are a variety of relationships that can trigger related party disclosures for independent schools.
To identify related parties that should be disclosed, nonprofits should first consider their Trustees, Directors, Officers, and Key Employees. Accountants may refer to this group using the acronym TDOKE.
Each of these individuals is listed on Part VII of Form 990. It’s also necessary to consider the direct relatives of each of these individuals: spouses, sons, daughters, and so on. Other individuals to consider include significant donors to the nonprofit (defined as donors listed on Schedule B), as well as the organization’s founder.
All of the individuals listed above should complete a questionnaire that will clarify whether there were any transactions or other activities that create the need for a related party disclosure to be made. Individuals may self-report, but there should also be internal oversight. When the final Form 990 is presented to the board for review, board members should take care to review the related party disclosures to ensure all information is accurately represented.
Many types of activities and transactions can trigger an independent school to make a related party disclosure. Among the most common of these are:
While it is permissible for key individuals to be non-independent, it’s important to keep this in balance. Many of the independent schools that Smith + Howard support have boards with between 70 – 80% of independent directors.
In reality, determining whether an independent school must disclose related party transactions must be done on a case-by-case basis. At Smith + Howard, our team provides clients with a simple yet comprehensive questionnaire that can be shared with all relevant individuals who have the potential to be involved in related party transactions.
To download this questionnaire, click here.
Understanding your independent school’s related party disclosure requirements is an important element of the Form 990 filing process. The responsibility is on related parties to disclose any activities they believe may qualify, but it’s also best practice to have internal oversight to verify this information. Related party disclosures may remain similar from year to year, but conditions often change, and it’s important organizations proactively revisit this issue each year to ensure ongoing compliance.
At Smith + Howard, we’re proud to advise leading independent schools across the country. Our specialized nonprofit accounting professionals bring a systematic approach to helping independent schools understand their related party disclosure requirements and fulfill all Form 990 reporting obligations.
To learn more about Smith + Howard’s support for nonprofit organizations, contact an advisor today.
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