A nonprofit may want to change its year-end for many reasons. Once the decision is made, how does a nonprofit actually change its year-end, and what consequences does that have? There are three potential areas of concern for the change: legal documents, tax implications, and financial statement implications.
Legal document considerations
Legal documents should be the easiest ones to change. Review the organization’s bylaws and other organizing documents to see if there is a reference to a particular year-end. If there is a reference to year-end, work with your lawyer and the board of directors to amend those documents to change the year-end. Also consider, do the terms for members of the board of directors match the fiscal year-end, and does the organization want them to. There is no requirement for the terms to match the year-end, but from a tax reporting standpoint, all board members at any point during the year must be listed on the Form 990, so there could be two years’ worth reported on each 990 if the terms and the year-end are different.
Income tax considerations
The income tax returns have more stringent rules on changing fiscal year-ends. Nonprofits may be able to change their fiscal year-end with a timely filed return. Generally, suppose a nonprofit has not changed its fiscal year-end in the prior 10 years. In that case, it can simply change its fiscal year-end by filing a short-year return timely and indicating a change in the accounting period (simplified procedure). However, farmers’ cooperatives, shipowners’ protection and indemnity associations, political organizations and homeowners’ associations cannot use this simplified procedure to change year-ends. If a nonprofit does not qualify for the simplified procedure, it will have to file Form 1128 to request a ruling from the IRS to allow the change in year-end. This request involves a substantial user fee ($5,000 or more) and should not be entered into lightly.
A nonprofit must do a short-year return to switch the year-end. This means the return will be for less than 12 months. Some of the schedules in the Form 990 may seem odd in the short year. For example, you may report the same board of directors calendar year salaries on the last full year of the old year-end and the short-year return; you can always add an explanatory note to Schedule O to let users understand that this information is duplicated. Similarly, the Schedule A tests will look odd as there will be four full years and one short year of information in the five-year schedule, but this is correct. The Form 990 instructions must still be followed, but Schedule O is a free-form schedule, and you can add any additional descriptions explaining the situations that will be relevant to users of the Form 990.
For a short-year income tax return using the simplified procedure, the return cannot be e-filed, even though there is an e-file requirement. This means an attempt at e-filing will be required, knowing that it will be unsuccessful; the e-file rejection must be documented. Then it must be paper-filed. It is imperative to ensure that it is paper-filed on time with a certified return receipt so that the entity has documentation of timely filing. An IRS notice is likely to generate either from paper filing or from not timely filing (due to the IRS being backlogged). This notice will likely indicate penalties, and they could be a significant amount. It will need to be responded to promptly with information showing that a short-year return was filed timely and could not be e-filed. The penalties should be abated once the IRS notice is responded to and it is proven that the return was in fact timely filed and could not be e-filed. In addition to e-filing rejections for the return, extensions will also likely not e-file properly and will therefore need to be paper-filed; procedures similar to those for the return will need to be done.
Consider other filings that are tax returns (state) or charitable solicitation registrations. Those will likely also need to be done on a short-year basis. Charitable solicitation registrations may also require other attachments, which may be based on different thresholds. For example, the State of Michigan requires audited or reviewed financial statements based on different thresholds. However, in a short year, normally met thresholds may or may not be met, so careful planning is necessary to ensure that the required attachments based on the short year are provided.
Financial statement considerations
Financial statements are the last area to consider. There is not a one-size-fits-all when it comes to financial statements and changing year-ends. Some entities choose to do a long-year (>12 months) and others a short-year. The users of the financial statements will dictate whether a short-year must be done or a long-year can be done. From an audit, review, and compilation standard perspective, your accountant can do either a short-year or a long-year. However, if there is a need for a Single Audit or other annual audit requirements, the users may require a short-year. Also, keep in mind that often financial statements accompany the charitable solicitation registrations, so it is important to determine what will be necessary for the short-year charitable solicitation.
Whether a short-year or a long-year financial statement is chosen, it will generally be noncomparative for that year. It would not be useful to show comparative financial statements for a three-month short-year and a 12-month regular year. Typically, additional administrative costs will result from changing presentation from comparative to single year. In addition, all descriptions of “for the year ended” must be modified to match the correct period. If assurance is provided on the financial statements, typically it is no less work to do a short-year than a regular year.
Also consider what other entities relate to this nonprofit that may want to be on the same year-end as the nonprofit. If there are subsidiaries, generally those subsidiaries would want to be on the same year-end, if possible. If there is a defined benefit pension plan, typically numbers from the year-end of the plan flow into the nonprofit, and therefore a similar year-end may be desired.
There are lots of valid business reasons to change a nonprofit’s year-end. Generally, it is not difficult to do. However, it needs to be planned out ahead of time to ensure that all the requirements are thought through, filings are made, and users of financial statements have clarified expectations.
Contact a member of Yeo & Yeo’s Nonprofit Services Group if you need assistance with changing your nonprofit organization’s year-end.