The Washington Post has identified over 1,000 nonprofit organizations that have reported a “significant diversion” of nonprofit assets.
The Post concluded that most of the diversions are attributed to theft or embezzlement. The instructions for Part VI, Line 5 of the Form 990 require such diversions to be explained on an attachment; however, the Post’s analysis revealed that many organizations provide little detail regarding the diversions.
“Significant Diversion” Defined. The instructions define a reportable diversion of assets to include “. . . any unauthorized conversion or use of the organization’s assets other than for the organization’s authorized purposes, including but not limited to embezzlement or theft.”
Note only “significant diversions” must be reported. Significant diversions are those that exceed the lesser of:
(i) 5% of the organization’s gross receipts for its tax year;
(ii) 5% of the organization’s total assets as of the end of its tax year; or
These thresholds apply to the initial amount diverted without taking into account any restitution, insurance, or similar recovery.
Reporting Requirements. In addition to disclosing the fact that a significant diversion of assets occurred, the 990 instructions require exempt taxpayers to additional information as follows:
(i) an explanation of the nature of the diversion;
(ii) the amounts or property involved; and
(iii) any corrective action taken to address the matter.
Significant diversions must be reported when they are discovered even if they occurred in a prior tax year. Note that it is not necessary to name the person who diverted the assets on the organization’s Form 990.
Inurement and Excess Benefit Issues. Significant diversions must be reported no matter who they are with whether it be an officer, a director, an employee or an unrelated third party.
If assets are diverted by an individual who stands in the position of a disqualified person to the organization, then it is likely the diversion will also amount to private inurement of the organization’s net earnings which can threaten the non-profit’s tax-exempt status.
In the case of section 501(c)(3) public charity, 501(c)(4), and 501(c)(29) organizations, it also can be an excess benefit transaction taxable under section 4958 and reportable on Schedule L (Form 990 or 990-EZ).
In the case of 501(c)(3) private foundations, a diversion by a disqualified person is likely also a self-dealing transaction subject to penalties and reportable on Form 990-PF.
As part of its analysis, the Post assembled the first public, searchable database of nonprofits that have disclosed diversions. This database can be accessed by the public at wapo.st/ diversions database.
Practical Considerations. Embezzlement and theft raise difficult questions for board members. A sense of sympathy for the perpetrator often leads board members to struggle with whether to report the crime. Board members must remember that their fiduciary duties require them to act in the best interest of the organization. Reporting the crime will generally be required to collect under applicable insurance policies. Accordingly, it is usually the case that the crime must be reported.
Reporting the crime and obtaining a recovery are important corrective steps but we advise our clients to go further. Additional corrective steps may include a thorough review and revision of existing policies and procedures, further segregation of duties, beefed up background checks and anything else that might have prevented the incident from occurring.
Conclusion. Its important to note that there are over 1,616,000 tax-exempt nonprofits in the U.S. today; thus, these filings represent less than 1% of tax-exempt nonprofits. It’s also interesting to note that a quick review of Arizona’s list includes only 21 organizations – most of which reported the diversions in a clear, transparent, and confidence inspiring manner.