Not-For-Profit Group Newsletter – Fall 2023
Charles J. Burke, Alison Fetzer

What Not-For-Profits Need to Know About Alternative Investments

Charles J. Burke

With today’s economic uncertainty, businesses, including not-for-profit organizations, are increasingly mulling so-called alternative investments. However, these investments can have unexpected tax implications for not-for-profit organizations. 

The basics

The term “alternative investment” stands in contrast to more traditional investment vehicles for not-for-profit organizations, such as stocks, bonds and mutual funds. Alternative investments generally do not have an easily ascertained fair market value. Examples include hedge funds, private equity, real estate, venture capital and cryptocurrency investments.

Alternative investments are appealing largely because their long-term performance can be greater than those of traditional securities. They may provide investors with access to high-growth companies in cutting-edge industries and often are less vulnerable to financial market swings. However, because alternative investments may be illiquid, investors typically cannot easily cash out or shift their allocations. This can be a substantial risk to a not-for-profit without other sources of available operating capital. The complex nature of such assets also increases risk to the investor, which is why returns may be higher. For instance, cash paid into a venture capital fund could be lost if that new business investment is not successful. 

Form and management

Alternative investment funds generally are formed as partnerships or limited liability companies (LLCs). Both are types of pass-through entities, meaning the income and the tax liability pass through to the investors, who are considered partners or members.

Manager selection is crucial — you want someone with a proven track record and access to the best investments. Not-for-profits organizations must pay attention to management fees. In addition to a base management fee (generally about 1.5% to 2% of the fund’s capital or net asset value), managers generally charge performance-based fees known as carried interest. These fees can reach as high as 20% or more of an alternative investment’s profits.

Tax matters

Although investment income (for example, dividends, gains and interest) typically is excluded from taxable unrelated business income (UBI), investors in partnerships or LLCs are treated as if they’re conducting that entity’s business. As a result, their distributions of income may be treated as taxable UBI.

In addition, UBI includes unrelated debt-financed income from investment property in proportion to the debt acquired to purchase it. The IRS defines debt-financed property as any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness. In other words, if you used financing to invest in a fund — or, if the fund financed the purchase of an income-producing asset — some of the associated income may be taxable.

Pass-through entities report each partner’s or member’s share of income, dividends, losses, deductions and credits on IRS Schedule K-1. Not-for-profit organizations can use the schedule to determine if they have received UBI income that must be reported on their Form 990-T. State taxes may also apply.

UBI could be included on the form in the boxes for ordinary income, net rental real estate income or other income, as well as in the footnotes, but may not appear anywhere on the form or footnotes, especially if the income is derived from debt-financed property.

Related Read: Buyer Beware: UBIT Can Take a Bite Out of Alternative Investments

Tread carefully

Your organization must consider its objectives, short- and long-term needs, and the trade-offs (including loss of your original investment) that the organization is willing to accept before venturing into alternative investments. Your ORBA advisor can help you evaluate whether alternative investments may be right for you.

For more information, contact Charles Burke at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.

How to Find Key Nonfinancial Information on Form 990

Alison Fetzer

For many people, the Form 990 is a long and overwhelming document, but do not let its length keep you from diving in.  It is actually a very useful and an easy-to-read return if you know how to find what you are looking for. 

The federal Form 990 is an annual information return required to be filed with the IRS by most organizations exempt from income tax under section 501(a).  It consists of a 12-part core form and up to 16 supplemental schedules.  While all parts are important, some are more useful to the casual reader than others.  Below is a quick summary of where to find useful nonfinancial information that is included in the parts of the core form and schedules to assist you in your review.

Location of Key Nonfinancial Information in the Form 990 Core Form

  • Part I Summary – Provides a great executive summary of an organization, including the mission statement, number of board members, number of volunteers and key financial data all on one page.
  • Part III Statement of Program Service Accomplishments – Provides details on the organization’s mission and major programs. This is where the organization can describe their programming, including any major changes to programming as compared to the prior year.  It also provides information regarding expenses, amounts paid in grants and program service revenue received by major program.
  • Part VI Governance, Management, and Disclosure – Provides information on board members, family and business relationships of the organization and other key governance information. Additionally, in Section B, the IRS has listed a handful of key policies to which an organization is required to answer yes or no.   For three of the identified polices, the organization is required to describe on Schedule O.    
  • Part VII Compensation of Officers, Directors, Trustees, Key Employees, Highest Compensated Employees, and Independent Contractors – Provides information on the members of governance and certain employees including their names, titles, hours worked per week and compensation.
  • Part XII Financial Statements and Reporting – Provides information regarding whether an organization’s financial statements were compiled, reviewed or audited and if the organization was subject to Federal Uniform Guidance rules.

Location of Key Nonfinancial Information in the Schedules to Form 990

  • Schedule A Public Charity Status and Public Support – This schedule provides the reason for the organization’s public support status in Part I and shows the calculation in either Part II or Part III. Organizations are required to receive at least 33.3% in funding from the general public to maintain their public charity status.
  • Schedule F Statement of Activities Outside the United States – This schedule provides information regarding grants and other assistance made outside of the United States to organizations, entities or individuals. Additionally, organizations are required to detail their activities by region, including number of offices, employees, activities and total expenditures.
  • Schedule I Grants and Other Assistance to Organizations, Governments and Individuals in the United States – Like Schedule F, this schedule provides information regarding grants and other assistance made to organizations, governments and individuals in the United States.
  • Schedule J Compensation Information – This schedule provides detailed compensation information for certain officers, directors, trustees, key employees and highest-compensated employees who at a minimum make in excess of $150,000 in calendar year compensation. This schedule also provides information on perks or nonstandard arrangements for compensation.
  • Schedule L Transactions with Interested Persons – This schedule provides detailed information on various transactions with interested persons including excess benefit transactions, loans to and/or from interested persons, grants or assistance benefiting interested persons and business transactions involving interested persons.
  • Schedule O Supplemental Information to Form 990 or 990-EZ – This schedule provides the space for organizations to answer specific questions asked on the Form 990 as well as to further elaborate on any answer that the organization may wish to include.
  • Schedule R Related Organizations and Unrelated Partnerships – This schedule identifies related organizations and provides details on the transactions between the entities.

Related Read: How to Define Business Transactions with Interested Persons

The above list is not comprehensive but is a good place to start if you are new to reading Form 990s and are unsure how to navigate the nonfinancial data.  Detailed financial data can be found in Part VIII Statement of Revenue, Part IX Statement of Functional Expenses and Part X Balance Sheet. 

Hopefully you now feel more confident on how to review a Form 990.  If you have any questions, please reach out to your ORBA advisor or Ali Fetzer at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.

Forward Thinking