Charitable diversions: tax implications and tips for addressing them.

• Author: Walker, Katrina D.

Federal tax laws and state charity laws require charitable organizations to use their assets exclusively for charitable purposes. The misuse of charitable assets has been a long-standing concern, and enforcement in this area has been a challenge for government authorities.

Until recently, diversion issues were uncovered primarily through audits or third-party referrals. This changed following the 2008 redesign of Form 990, Return of Organization Exempt From Income Tax, which requires more transparency by tax-exempt organizations. A key question now included on Form 990 asks, "Did the organization become aware during the year of a significant diversion of the organization's assets?" (Form 990, Part VI, Section A, line 5).

A "diversion" includes any unauthorized conversion or use of the organization's assets, other than for the organization's authorized purposes, including embezzlement and theft, and is considered significant if it, along with all diversions for the tax year, exceeds the lesser of: $250,000; 5% of the organization's gross receipts for the tax year in which the diversion or diversions occurred; or 5% of the organization's total assets. Public disclosures responding to this question have prompted IRS inquiries and media attention.

Effect of Form 990 Reporting

In 2012, the IRS reviewed tax filings and publicly available online information of 285 organizations that reported a significant diversion of assets on their 2009 Forms 990 and considered how governance practices might contribute to these diversions. In the Exempt Organizations FY 2012 Annual Report & FY 2013 Workplan, the IRS noted it intended to conduct examinations and review the governance practices of the organizations both before and after diversion events.

In October 2013, a Washington Post report identified more than 1,000 nonprofit organizations that reported a significant diversion of assets since the 2008 redesign of Form 990 (Stephens and Flaherty, "Inside the Hidden World of Thefts, Scams and Phantom Purchases at the Nation's Nonprofits," The Washington Post (Oct. 26, 2013)). The report revealed that most diversions were attributable to theft or embezzlement and found that despite Form 990 instructions requiring specific details regarding the diversion, many organizations provided few details. In conjunction with its investigation, The Washington Post created an online database listing organizations reporting a diversion and excerpts of the related Form 990...