Tax-exempt organizations: Form 990, UBIT and compliance

A section 501(c)(3) organization enjoys two tax advantages: it is exempt from federal income tax on income related to its exempt purposes, and donors may deduct contributions to it, subject to limits. In return, it must be organized and operated exclusively for charitable, educational, religious or similar purposes, avoid private inurement and substantial lobbying, never intervene in political campaigns, and file annual information returns. This lesson explains public charity status and the public support test, Form 990, unrelated business income tax (UBIT), substantiation and quid pro quo rules, recent federal law changes affecting charities, and state charitable registration; ACCT-352 covered other aspects of entity taxation.

Exemption and public charity status

An organization obtains recognition of exemption by filing Form 1023 (or the streamlined Form 1023-EZ for small organizations). A 501(c)(3) organization is presumed to be a private foundation unless it qualifies as a public charity under section 509(a): as a church, school or hospital; as a publicly supported organization under section 170(b)(1)(A)(vi) or section 509(a)(2); or as a supporting organization. Private foundations face excise taxes on net investment income, a 5 percent minimum distribution requirement and rules against self-dealing and excess business holdings, so public charity status matters. Riverbend is a public charity that relies on broad public support.

The public support test under section 170(b)(1)(A)(vi) is met if, over a five-year period, public support is at least one-third of total support, or at least 10 percent with facts and circumstances showing the organization is publicly supported. Public support includes gifts from the general public and grants from governments and other public charities; gifts from any one donor count only up to 2 percent of total support for the period. Total support includes gross investment income. New organizations are treated as public charities for their first five years. The test is computed on Schedule A of Form 990, using the cash method.

# Tax-exempt status tests for Riverbend Community Pantry (invented 501(c)(3)),
# five years 2023-2027 (dollars; illustrative).
# 1) Public support test, section 170(b)(1)(A)(vi): one-third of total support.
gifts_by_donor = {"Major donor A": 900_000, "Major donor B": 300_000,
                  "Community foundation (public charity)": 600_000}
small_gifts = 3_200_000            # many donors, each below the 2% cap
government_grants = 1_150_000
investment_income = 210_000
total_support = sum(gifts_by_donor.values()) + small_gifts + government_grants + investment_income
cap = 0.02 * total_support
public = small_gifts + government_grants
for d, g in gifts_by_donor.items():
    counted = g if "public charity" in d else min(g, cap)
    public += counted
    print(f"{d:40} gave {g:>9,}; counted {counted:>9,.0f}")
print(f"Total support {total_support:,}; 2% cap {cap:,.0f}")
print(f"Public support {public:,.0f} = {public / total_support:.1%} (needs 33.3% or the 10% facts and circumstances test)")
# 2) Unrelated business income: advertising in the pantry's monthly newsletter
ad_revenue, direct_costs, specific_deduction = 38_000, 21_500, 1_000
ubti = max(ad_revenue - direct_costs - specific_deduction, 0)
print(f"\nUBTI {ubti:,}; tax at 21% {0.21 * ubti:,.0f} (Form 990-T required: gross income over 1,000)")

Major donor A                            gave   900,000; counted   127,200
Major donor B                            gave   300,000; counted   127,200
Community foundation (public charity)    gave   600,000; counted   600,000
Total support 6,360,000; 2% cap 127,200
Public support 5,204,400 = 81.8% (needs 33.3% or the 10% facts and circumstances test)

UBTI 15,500; tax at 21% 3,255 (Form 990-T required: gross income over 1,000)

The program computes two amounts for Riverbend. Over 2023 to 2027, total support was $6.36 million, so the 2 percent limit is $127,200. Two major donors gave $900,000 and $300,000, but each counts only up to $127,200; the community foundation is a public charity, so its $600,000 counts in full. Public support of $5.2 million is 81.8 percent of total support, far above one-third. The second part computes unrelated business taxable income from newsletter advertising, explained below.

Form 990

Most exempt organizations file Form 990 annually by the 15th day of the fifth month after year-end, with an automatic six-month extension available. Organizations with gross receipts normally of $50,000 or less may file the electronic Form 990-N (e-Postcard); those with gross receipts under $200,000 and total assets under $500,000 may file Form 990-EZ; private foundations file Form 990-PF. Form 990 requires a statement of revenue, a statement of functional expenses with program services, management and general, and fundraising columns similar to ASC 958, a balance sheet, governance questions such as whether the organization has a conflict of interest policy and whether the board reviewed the form, compensation of officers and key employees, and schedules for public support, lobbying, fundraising events and more. Failure to file for three consecutive years automatically revokes exemption.

Form 990 is public: the IRS releases it, and exempt organizations must make their three most recent returns and their exemption application available on request. Donors, journalists and watchdogs use it to compare compensation and spending. Because it presents functional expenses and balance sheet information similar to the audited statements, but on a different basis in places (for example, donated services and investment gains may be reported differently), Schedule D reconciles revenue and expenses per the audited statements with the return.

Unrelated business income and substantiation

UBIT applies to income from a trade or business, regularly carried on, that is not substantially related to the organization's exempt purposes. Exclusions include passive income (dividends, interest, most rents and royalties), activities carried on substantially by volunteers, sales of donated goods, and businesses run for the convenience of members or students. Advertising in a periodical is typically unrelated business. The tax is at corporate rates (21 percent) on unrelated business taxable income after a $1,000 specific deduction; since 2018, losses from one unrelated business cannot offset income from another, and each is computed separately. In the program, Riverbend's newsletter advertising produces $38,000 of revenue and $21,500 of direct costs, so UBTI is $15,500 and the tax $3,255, reported on Form 990-T.

Donors need written acknowledgment from the charity for any single contribution of $250 or more, stating the amount of cash or a description of property, and whether the donor received goods or services in return and, if so, a good faith estimate of their value. For quid pro quo contributions over $75, such as a $250 gala ticket including a $60 dinner, the charity must give a written disclosure that only $190 is deductible. Non-cash gifts above $5,000 generally require a qualified appraisal by the donor. Charities that fail to provide quid pro quo disclosures face penalties of $10 per contribution, up to $5,000 per event.

Recent changes and state oversight

The 2025 federal tax law known as the One Big Beautiful Bill Act changed the rules around charitable giving. From the 2026 tax year, individuals who do not itemize may deduct up to $1,000 ($2,000 for joint filers) of cash gifts to public charities (not donor-advised funds or private foundations); itemizers may deduct charitable contributions only to the extent they exceed 0.5 percent of adjusted gross income; and corporate contributions are deductible only above 1 percent of taxable income. The law also raised the excise tax on the net investment income of large private university endowments to tiered rates of up to 8 percent, and extended the 21 percent excise tax on compensation over $1 million to all covered employees of exempt organizations, from tax years beginning after 2025.

States regulate charities too. About 40 states require charities that solicit their residents to register with the state charity official, usually the attorney general, and file annual reports, often with audited statements above revenue thresholds. Many states, including Nebraska, exempt charities from property tax on property used for exempt purposes, and most exempt certain purchases from sales tax. State attorneys general enforce UPMIFA and can act against misuse of charitable assets.

From the statements to Form 990

Form 990 does not simply copy the financial statements. Part VIII separates contributions, program service revenue, investment income, gains, fundraising event revenue net of direct costs and other revenue, and Part IX presents expenses by natural line and function. Some items are reported differently: donated services and use of facilities recognized under GAAP are excluded from Form 990 revenue and expenses, and unrealized investment gains are reported as other changes in net assets. Schedule D reconciles revenue and expenses per the audited statements with the return. Because the return is public, differences should be explainable, and many organizations prepare the reconciliation as part of the year-end close.

Governance questions on Form 990 also matter. Part VI asks whether the organization has a conflict of interest policy, a whistleblower policy and a document retention policy, whether the board reviewed the return before filing, and how it determines executive compensation. Schedule L reports transactions with interested persons, and section 4958 imposes excise taxes on excess benefit transactions between public charities and disqualified persons, such as board members or key employees, with penalties for organization managers who knowingly approve them. Good accounting records and governance documentation are the best defense in an IRS examination.

Charities must also guard against private benefit and political activity. A 501(c)(3) organization may not allow its net earnings to inure to insiders, may not engage in substantial lobbying (or must stay within the expenditure limits if it elects under section 501(h)), and may never participate in a political campaign for or against a candidate. Violations can lead to excise taxes, loss of exemption or both. Reasonable compensation set by an independent board using comparability data creates a rebuttable presumption that it is not an excess benefit.

Finally, an exempt organization should plan for the long term. Its articles must dedicate its assets to exempt purposes, so on dissolution remaining assets must go to another exempt organization or a government for a public purpose. Boards should understand these rules, and accountants who serve exempt organizations should help them build records and controls that make compliance routine, including tracking unrelated activities, quid pro quo receipts and state registrations.